Question

 

DHA Developer owned 100 hectares of land with a fair value of RM20 million and decides to convert the land to develop a new town in Nilai that comprise a phase residential houses. The company incurred a cost to convert the land into residential land amounted RM5 million. The land is designated for the following purposes:

• Project 1 - 40 hectares to build 200 link houses – selling price RM500,000 per unit
• Project 2 -  50 hectares to build 100 luxury homes – selling price RM1 million per unit
• Common costs - 10 hectares for infrastructure and other common amenities

 

In year x1, the company launched its link house project and sold 120 houses at a selling price of RM500,000 per house. The infrastructure cost is estimated at RM8 million and RM5.6 million was incurred in year x1. At the end of year x1, property development costs incurred was RM9.6 million. Estimated development costs to complete were determined to be RM14.4 million.

 

It is a policy of the company to account for the construction revenue and cost using percentage-of-completion method based on cost-to-cost basis.

 

Required:

 

1. Based on MFRS 15 Revenue from Contracts with Customers, give justification for DHA Developer to use percentage of completion method.
2. Determine the profits to be recognised in the financial year ends 31 December x1. Show your workings.
3. Discuss how should property developers recognise revenue when a contract does not specify the entity’s right to payment over the performance completed to date?

 

Answer 1

(i) Stage of completion

MFRS 15 – recognise revenue when satisfies performance obligation(s) either a point of time or over time. Revenue recognised over time should base on POC Method.

The method recognizes revenues and expenses in proportion to the completeness of the contracted project. It is commonly measured through the cost-to-cost method. PDA normally takes substantial time to complete.

Entity assesses its transfer control over time based on following criteria:

• “The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs.” (Criterion 1)
• “The entity’s performance creates or enhances an asset (for example, work in process) that the customer controls as the asset is created or enhanced.” (Criterion 2)
• “The entity’s performance does not create an asset with an alternative use to the entity, and the entity has an enforceable right to payment for performance completed to date.” (Criterion 3)

 

(ii) Suggested Solution

Summarized information:

Phase	Units of house produced	Type of house	Land area (Hectare)	Sale price (RM)
1	200	Link house	40	500,000
2	100	Luxury homes	50	1,000,000
P		Infrastructure	10
	300		100

 

(a) the common cost

Common cost:		RM’000
Land [(RM20 million + RM5 million) x 1/10]		2,500
Infrastructure and other amenities cost		8,000
Total		10,500

 

Allocation of the common cost of RM10.5 million to the two phases:

	Phase 1 (RM)	Phase 2 (RM)
Relative sales value	200 x RM500,000 = RM100 million	100 x RM1,000,000 = RM100 million
Common costs allocated	RM10.5 million x 100/200 = RM5.25 million	RM10.5 million x 100/200 = RM5.25 million

 

* Total relative sales value = RM100 million + RM100 million

                                           = RM200 million

(b) cost per unit and percentage of completion for year x1

Accumulated property development costs
		RM’000
Land [(RM20 million + RM5 million x 40/100)]		10,000
Common cost [(RM2.5 million + RM5.6 million) x 100/200		4,050
Direct and indirect costs incurred to date		9,600
Total development cost		RM’000
Accumulated property development costs to date		23,650
Further costs to complete		14,400
Common development cost not incurred yet (RM2.4 million x 100/200)		1,200
		39,250
Budgeted cost per unit
		RM
RM39.250 million/200		196,250

 

Percentage of completion       =          Total cost to date less land cost

                                                                     Total estimated cost

                                                =          RM23,650,000 – RM10,000,000* x 100

                                                             RM39,250,000 – RM10,000,000*

                                                 =          46.67%

 

Land cost for the 40 hectares = RM25 million x 40/100

                                                    = RM10 million

 

(c) revenue and expenses for year x1

Revenue and expenses to be recognize for year x1
		RM
Revenue: 120 units x RM500,000 x 46.67%		28,002,000
Expenses: 120 units x RM196,250 x 46.67%		(10,990,785)
Net income		17,011,215

 

(iii) For real estate companies it will be crucial to assess whether the property developer has an enforceable right to payment for performance completed to date or not.

This is not the only criterion to decide, but it is prevailing for real estate.
If the specific contract does not meet this criterion (and also the other two), then the revenue is recognized at the point of time; that is, when an asset is delivered to customer.

1. MFRS 15 – recognise revenue when satisfies performance obligation(s) either a point of time or over time. Revenue recognised over time should base on POC Method.
2. Profits to be recognised in the financial year ends 31 December x1 is RM17,011,215.
3. The revenue is recognized at the point of time; that is, when an asset is delivered to customer.