A number of mainland Chinese property firms, including big names such as China Evergrande Group (03333.HK) and Country Garden Holdings (02007.HK) as well as some smaller developers like Guangzhou R&F Properties (02777.HK) and Sino-Ocean Group Holding (03377.HK), saw their share prices shoot up more than 10 percent within three trading sessions last week in Hong Kong.
Implementation of a new accounting rule named HKFRS 15 was said to be the reason triggering investors’ rush into property plays.
In May 2014, the International Accounting Standards Board (IASB) promulgated IFRS 15, a rule that provides guidance on accounting for revenue from contracts with customers to better reflect a company’s financial performance.
Based on that, the Hong Kong Institute of Certified Public Accountants (HKICPA) has unveiled HKFRS 15, which will take effect on January 1 next year.
Listed companies have the option of adopting the new standards in this year’s financial statements.
Simply speaking, HKFRS 15 will allow companies to recognize revenue over a period of time if customers have made full payment, rather than waiting for revenue recognition until the delivery of products.
Most manufacturers have short production cycles, given that customer payment and transfer of products usually occur within the same fiscal year. Therefore, the new rule will have limited impact on them.
But in the case of real-estate firms, there is typically a time gap of 1-2 years between receiving pre-payment from customers and actual delivery of properties.
Property developers typically have to categorize customer pre-payments as liabilities for up to one or two years, and recognize them as revenue until developers complete the construction and complete the transaction.
Therefore, there is usually a significant time lag before the latest sales performances are reflected in financial statements.
The new accounting rule now allows developers to recognize the revenue for full-paid property sales in proportion with the progress of construction over time.
The move may boost the revenue of mainland property firms and help them considerably in securing better valuation and credit ratings.
Property is a capital-intensive industry. Chinese developers need to pay large sums upfront for acquiring land plots, and it takes them at least two to three years to complete the construction. Therefore, they need to borrow heavily during the process.
The new accounting changes could make a relatively large positive impact on their financials.
The rule will, however, not apply to property sales financed by mortgages.
Morgan Stanley estimates that the new accounting rule would boost mainland developers’ revenue by 10 to 15 percent next year.
Among all the players, two kinds of developers are expected to outperform.
First, those who have seen a sales spike but are yet to recognize the revenue. They include Country Garden, Evergrande, Sunac China (01918.HK), China Aoyuan Property (03883.HK) and Times Property (01233.HK).
Second, developers which have high percentage of full-payment customers, such as China Resources Land (01109.HK), Agile Group (03383.HK) and China Overseas Land & Investment (00688.HK), Evergrande and Sunac.
Country Garden has, in fact, taken the initiative of adopting the new rule in its first-half financial statements.
This article appeared in the Hong Kong Economic Journal on Aug 25
Translation by Julie Zhu
[Chinese version 中文版]
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