FINANCIAL REPORTING STANDARDS IMPLEMENTATION COMMITTEE FRSIC Consensus 28 Capitalisation of Borrowing Costs in a Township Development Preamble FRSIC Consensus 28 Capitalisation of Borrowing Costs in a Township Development was developed by the Financial Reporting Standards Implementation Committee ( FRSIC ) and issued by the Malaysian Institute of Accountants ( MIA or Institute ) on 26 October 2017. The Consensus contained herein is issued as part of the Institute s initiatives to promote best practices in compliance with the highest standards in financial accounting. Malaysian Institute of Accountants
FRSIC CONSENSUS 28 CAPITALISATION OF BORROWING COSTS IN A TOWNSHIP DEVELOPMENT FRSIC Consensus is guidance issued by MIA and shall be regarded as best practice. It should be read in conjunction with the respective applicable accounting standards. Members of MIA are expected to observe compliance with the consensus issued. In exceptional circumstances where departure is necessary, members shall be prepared to justify the departure. FRSIC Consensus need not be applied to immaterial items. Nothing in the FRSIC Consensus is to be construed as amending or overriding the accounting standards or other statements adopted or issued by the Malaysian Accounting Standards Board ( MASB ) and other relevant laws. Background 1 It is not unusual for a property development entity to acquire large areas of land to develop a township that is financed by borrowings. 2 Typically, a township comprises residential properties, commercial properties and infrastructures that are developed in multiple phases over a period of time. A township is outlined in a Master Layout Plan ( MLP ) that was submitted by a property developer and approved by local authorities. Scope 3 This Consensus applies to borrowing costs incurred on borrowings to acquire a piece of land for a township development. 4 Paragraph 5 of MFRS 123 defines borrowing costs as interest and other costs that an entity incurs in connection with the borrowing of funds. The Issue 5 Paragraph 8 of MFRS 123 requires an entity to capitalise borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset as part of the cost of 2 of 7
the asset. It further requires other borrowing costs to be recognised as an expense in the period they are incurred. 6 Paragraph 5 of MFRS 123 defines a qualifying asset as an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. 7 There are divergent views of what constitutes a qualifying asset in the context of a township development. 8 Some are of the view that the qualifying asset is the township comprising all individual phases. Proponents of this view argue the following: a) The township development should be viewed as a single continuous development as the various phases in a township development are interlinked and dependent on one another. For example, in order to build and sell shop houses, the developer will first need to build and sell residential properties so that the township has sufficient population to attract prospective buyers of shop houses. b) Even though the respective phases are developed and sold separately, the developer is selling the concept of a township (i.e., intended use or sale of the qualifying asset). A buyer looks at the township as a whole (e.g., available facilities in the township such as schools, recreational parks, shop houses, shopping areas) in deciding whether or not to buy the individual unit of the property. In other words, the developer is not selling a unit of house but it is a unit of house in a township. c) It is deliberate for the development of the township to be in phases. Typically, earlier phases of township would involve residential properties in order to create population in the township. When there is sufficient population, the developer will then build shop houses, shopping mall, etc. As such, the success and the ability to sell the future phases is dependent on the success of the earlier launched phases. Accordingly, developing the earlier phases is considered activities necessary to prepare the later phases for its intended use or sale. d) On the basis that activities (c) above are carried out throughout the period of the township development, active development activities are considered to be carried out on the entire township over the entire period of development of the township. e) In addition, costs incurred on construction of roads, sewerage water treatment plants, drainage systems, electrical sub-stations, recreational park, and other common infrastructure are also costs that may be capitalised into current and future phases under the township development as these are common costs that may be allocated to property development activities. 3 of 7
f) Each phase can be developed and sold separately while development activities on the other phases are carried out. This is arguably similar to a business park which is an example of a qualifying asset as illustrated by paragraph 25 of IAS 23. g) Development of the township on a staggered basis is planned intentionally and is for strategic and economic reasons. Developing the earlier phases is considered activities necessary to prepare the later phases for its intended use or sale. Holding back the development of the later phases is a necessary part of the process of getting the later phases ready for its intended use or sale. This is not considered a suspension of active development. 9 Proponents of this view argue that the borrowing costs incurred for the acquisition of land for the entire township should be capitalised over the entire township from the date borrowing costs were incurred to the date of completion of the respective phases. In other words, for a phase of a township development, the proportionate borrowing cost relating to that phase is capitalised from the date when the developer starts the development activities on the township until that phase is ready for its intended use or sale. This is in line with the requirement in paragraph 24 of IAS 23 where it states that when an entity completes the construction of a qualifying asset in parts and each part is capable of being used while construction continues on other parts, the entity shall cease capitalising borrowing costs when it completes substantially all the activities necessary to prepare that part for its intended use or sale. 10 Others are of the view that each individual phase of a township is the qualifying asset. Proponents of this view argue the following: a) The intended use or sale of the development asset is to develop and sell the development by phases. b) Each phase takes a substantial period of time to get it ready for its intended sale. c) Each phase can be developed and sold independently of the other phases because: Each phase has its own Building Plan. Each phase will be issued with its own Certificate of Completion and Compliance ( CCC ) by the submitting architects before it is ready for occupation. The issuance of the CCC is not conditional upon the development of the future phases of the township. Upon the issuance of the CCC, the units within the phase are ready to be occupied by the purchasers regardless of future development on the township. Although the developer is selling the concept of a township, because the properties are launched and sold in phases, buyers of properties in phase 1 for instance, have no contractual rights for legal recourse if the developer does not subsequently develop the remaining township as originally planned under the MLP. 4 of 7
The developer may and is allowed to change the MLP (the revised MLP would require the necessary approval) throughout the development of the township for economic and other reasons. Any changes to the MLP will neither affect the owners' right to the completed or ongoing phases nor the developer's obligations in relation to the completed or ongoing phases. The fact that the MLP can be changed subsequent to the originally approved MLP, suggests that the township is merely a concept, each individual phase is capable of being constructed and sold independently of the other phases. The time taken to complete a phase is considered as normal operating cycle of the developer. d) The developer develops and sells the properties by phases on a staggered basis primarily due to strategic, economic and other reasons only. There is nothing preventing the developer from commencing development of all the phases within the entire township simultaneously. e) Activities that are necessary to prepare each phase for its intended use or sale comprise activities that are necessary to ensure that the CCC is obtained in respect of each phase. These include: Physical construction of the phase. Construction or development activities undertaken in a particular phase (other than preparing the MLP) are only necessary to prepare that particular phase for its intended use or sale. Construction or development activities undertaken in the first phase, for example, are not necessary to prepare the last phase for its intended use or sale. Regardless of the activities undertaken in the first phase, there is nothing to prevent the developer from developing the last phase (or any other phases) prior to developing the first phase, although it may sometimes not be the most cost efficient. Technical and administrative works associated with obtaining permits (MLP, Building Plan, etc.) prior to the commencement of the physical construction on the phase. f) The following activities are not considered as activities necessary to prepare a phase for its intended sale: Mere researching and exploring what type of property to be constructed on the land throughout the period of the township development (more akin to the research phase) is not considered as development activities. Holding the land on those phases where no active development activities that change the asset's condition is taking place are not considered as development activities. This is specifically excluded in paragraph 19 of MFRS 123. An increase in the value of land held for future phases ( undeveloped phase ) due to development activities undertaken in the earlier phase is not considered as development activities. It is merely a consequence arising from development activities. There is no change to the condition of the land held for future phases. 5 of 7
Land in the undeveloped phases that will benefit from development activities taking place in earlier phases is not considered as development activities, even though all phases are included in the same MLP. It is merely a consequence of activities happening in earlier phases. There is no change to the condition of the land held for future phases. g) Each phase is considered as a cash generating unit because each phase is capable of generating cash flows by itself independent of the other phases. h) Each phase is considered as a unit of account for accounting purposes. 11 Proponents of this view argue that borrowing costs should only be capitalised when the entity undertakes activities that are necessary to prepare each phase for its intended use or sale. 12 At the moment, there is limited guidance in MFRS on what constitutes a qualifying asset. Consensus and Basis of Consensus 13 Paragraph 17 of MFRS 123 states that an entity shall begin capitalising borrowing costs as part of the cost of a qualifying asset on the commencement date. The commencement date for capitalisation is the date when the entity first meets all of the following conditions: a) it incurs expenditures for the asset; b) it incurs borrowing costs; and c) it undertakes activities that are necessary to prepare the asset for its intended use or sale. 14 FRSIC observed that, typically, an entity undertakes the following activities in preparing a township: a) preparing and obtaining approval of the MLP for the township; b) physical construction of common infrastructures required by the township such as main access road and water tower tank; and c) physical construction of the individual phases of the township. These activities may benefit the township and/or each individual phase of the township. 15 FRSIC is of the view that, during the period the entity undertakes activities that benefit the entire township, the borrowing costs incurred on the acquisition of the land should be capitalised to the entire township. Otherwise, the borrowing costs should be capitalised to the individual phase(s) during the period the entity undertakes activities that benefit the individual phase(s). 16 Paragraph 22 of MFRS 123 states that an entity shall cease capitalising borrowing costs when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete. 6 of 7
17 Accordingly, FRSIC is of the view that when the activities that benefit the township or the individual phase(s) are substantially completed, an entity should cease capitalising borrowing costs to the entire township or the individual phase(s). Issuance date of this Consensus 18 This Consensus is issued on 26 October 2017. Effective date of this Consensus 19 This Consensus is effective for the period beginning on or after 1 January 2018. References MFRS 123 Borrowing Costs 7 of 7