JUNE 2014 Q3 (A) MINCO CO

Reference is in the above title to this thread. The question was like this:

“Minco is a major property developer which buys land for the construction of housing. One aspect of its business is to provide low-cost homes through the establishment of a separate entity, known as a housing association. Minco purchases land and transfers ownership to the housing association before construction starts. Minco sells
rights to occupy the housing units to members of the public but the housing association is the legal owner of the building. The housing association enters into loan agreements with the bank to cover the costs of building the homes. However, Minco negotiates and acts as guarantor for the loan, and bears the risk of increases in the loan’s
interest rate above a specified rate. Currently, the housing rights are normally all sold out on the completion of a project. Minco enters into discussions with a housing contractor regarding the construction of the housing units but the agreement is between the housing association and the contractor. Minco is responsible for any construction costs in excess of the amount stated in the contract and is responsible for paying the maintenance costs for any units not sold. Minco sets up the board of the housing association, which comprises one person representing Minco
and two independent board members. Minco recognises income for the entire project when the land is transferred to the housing association. The income recognised is the difference between the total sales price for the finished housing units and the total estimated costs for construction of the units. Minco argues that the transfer of land represents a sale of goods which fulfils the revenue recognition criteria in IAS 18 Revenue. (7 marks)”

The examiner’s answer to this (ACCA website answer) was:

“Minco needs to consider whether its revenue recognition policy is in compliance with IAS 18 Revenue. The criteria for revenue
recognition required by paragraph 14 of IAS 18 do not appear to be met, and no revenue should be accounted for as of the date of the transfer of land to the housing association. Revenue arising from the sale of goods should be recognised when all of the following criteria have been satisfied (IAS 18.14):
(a) the seller has transferred to the buyer the significant risks and rewards of ownership;
(b) the seller retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;
(c) the amount of revenue can be measured reliably;
(d) it is probable that the economic benefits associated with the transaction will flow to the seller; and
(e) the costs incurred or to be incurred in respect of the transaction can be measured reliably.

It is important to consider whether the risks for the project have been transferred to the association and whether Minco has control over the project during the construction period. Even if the risk associated with the land is different to the risk associated with the project directly. Minco should assess the risks for the entire project since it is exposed to material risks during the construction period. Minco provides a guarantee as regards the maintenance costs, is liable for certain increases in the interest rate over expectations, and is responsible for financing variations in the procurement and construction contract
which the contractor would not cover. Further, Minco guarantees the payment for the housing association’s debt on the building loan. Minco is exposed to risk as if it had built the housing units itself because it gives guarantees in respect of the construction process.
Minco also determines the membership of the board of the housing association and thus there is a question mark over whether the board is independent from Minco. Minco guarantees that the housing association would not be liable if budgeted construction costs are exceeded, so the entity is exposed to financial risk in the construction process.
Minco has retained the significant risks and had effective control of the land it had sold and also the entire construction process. Consequently, the revenue recognition criteria in paragraph 14 of IAS 18 are not met on the transfer of the land and Minco should account for the whole project as if it had built the housing units itself. Accordingly, revenue should be recognised when the housing units are finished and delivered to the buyer of the rights in accordance with IAS 18 which appears to be
when the project is completed.

I don’t understand the scenario at all, could you explain to me what’s happening in the scenario? I thought this is a question on IFRS 10, as a separate entity, the housing association has been set up and Minco controls this entity because of the condition in IFRS 10 “that if you can re-elect, appoint or dismiss members of the key management personnel then you have power”

And why does the answer not differentiate risk of the project with risk relating to the land? Aren’t the two different things? I mean taking land, in it’s isolation, the sale is perfectly acceptable. All the risk relating to the land have been transferred and the revenue should be recognized.

And why does the examiner comment that we need to account for this as if Minco was building the houses itself?

Thanks.