Transcript

Revenue Recognition- Real Estate Companies

CTC

25 NOVEMBER

ZFB & ASSOCIATES, Chartered Accountants

1

Accounting for Real Estate Transactions

• Introduction

• Scope

• Revenue Recognition Criteria

• Project

• Project Cost

• Accounting

• Acquisition of TDRs

• Disclosures

ZFB & ASSOCIATES, Chartered Accountants 2

Introduction

• What is Revenue It is the gross inflow of economic benefitsduring the period arising in the course of the ordinaryactivities of an entity when those inflows result in increasesin equity, other than increases relating to contributions fromequity participants.

• Real Estate Transactions whether covered underconstruction contracts – Ind AS - 11 or sale of goods underInd AS –18 or service revenue under Ind AS –18 ?

• Ind AS - 11 can be applied only if it meets the definition ofconstruction contracts.

• To remove this dichotomy there is a separate Guidance Noteissued for Accounting for Real Estate Transactions

ZFB & ASSOCIATES, Chartered Accountants 3

Introduction

• A construction contract is a contract specifically negotiated for theconstruction of an assets or a combination of assets that are closelyinterrelated or interdependent in terms of their design, technology andfunction or their ultimate purpose or use.

• Many real estate transactions may not satisfy above definition.Consequently, applicability of POCM for revenue recognition is in doubt.

• Ind AS – 18 stresses on transfer of risk and reward and certainty ofrealisation

• However revenue arising from agreements of real estate development arespecifically scoped out from IND AS -18.

• Under the convergence process of IND AS with IFRS, it has been decidedthat for real estate developers IFRIC 15 – Agreement for the Constructionof Real Estate would not be adopted. IND AS -18 accordingly do notinclude IFRIC 15. Instead, it states that for real estate developers, revenueshould be accounted for in accordance with the Guidance Note.

ZFB & ASSOCIATES, Chartered Accountants 4

Scope

• Applies to real estate transactions which covers either land,building or rights in relation thereto.

• It covers transactions in real estate, entered into indifferent forms and covers following :

a) Sale of plots of land with and without development. Italso covers long term sale type leases.

b) Development and sale of residential and commercial unitswith or without an undivided share in land.

c) Acquisition, utilisation and transfer of development rights.d) Redevelopment of existing buildings and structures.e) Joint development agreements for Real Estate.

ZFB & ASSOCIATES, Chartered Accountants 5

Scope

• GN does not cover transactions of the naturecovered by IND AS 16PPE, IND AS 20-Government Grants, IND AS 38 – IntangibleAssets and IND AS 40 – Investment Property.

• GN shall be applied to all projects in realestate by entities to whom Ind AS areapplicable.

ZFB & ASSOCIATES, Chartered Accountants 6

Revenue Recognition Criteria

• Fundamental criteria - revenue should be earnedand realizable

• Recognize revenue only if all criteria met:

a) Evidence that an arrangement exists

b) Products / services are delivered

c) Consideration is fixed or determinable

d) Ultimate collection is reasonably certain

• If any of the above are missing, revenuerecognition must be postponed.

ZFB & ASSOCIATES, Chartered Accountants 7

Project

• Identification of project is important as POCM willbe applied project wise.

• Project is defined as smallest group of units /plots / saleable area which are linked with acommon set of amenities. Unless such amenitiesare available and functional, the said units cannot be put to their intended effective use.

• It is advisable to split / divide larger ventures intosmaller projects so that POCM can be easilyapplied. Generally, larger the unit there will bedifficulty in applying POCM.

ZFB & ASSOCIATES, Chartered Accountants 8

Identification of Project

• Developer Limited has purchased big plot of landmeasuring 200 acres and has a plan to develop 10big tower buildings for commercial and residentialpurposes.

It will have to construct common road for movementof vehicles inside the plot.

As a part of contract it has accepted to providecommon club house facility to each flat owner.

ZFB & ASSOCIATES, Chartered Accountants 9

Identification of Project- Practical Issues

It has also promised to develop sports and swimming facilities tothe members. For this, it has tied up with the third party who willprovide this facility and third party can also allow outsiders to usesuch facilities after collecting charges, subject to condition thatoutside members cannot be more than 500.

Parking areas and energy back-up is common for each set of twotowers. It also provides additional parking space on payment ofRs.5 lacs per parking area.

Jogging track and children park will be common facility for all thetowers for which specific area is earmarked.

• In the above circumstances, what should be considered as project ?• It may be important to note that identification of unit for the

purpose of project is generally left to the developer, subject tocertain broad parameters. It is not an accounting policy choice

ZFB & ASSOCIATES, Chartered Accountants 10

Identification of Project – Practical Issues

• Construction of 10 petrol pumps at a differentlocations. It may be one contract but assets arenot inter-related and so to be treated as separatecontracts.

• Contract for constructing a Hotel and connectedrestaurants, health club, swimming pool wherelumpsum price is fixed. As the assets areinterrelated and negotiation is combined, it hasto be treated as one single contract.

ZFB & ASSOCIATES, Chartered Accountants 11

Project Costs

Project cost comprises of :• Cost of land and development rights. It also includes

rehabilitation cost, registration charges, stamp duty,brokerage etc.

• Borrowing costs – in accordance with Ind AS 23. It alsomeans that interest cost for the period of abnormalstoppage of work cannot be part of project cost. ForeignExchange difference on loan to the extent considered asinterest under para 6 (e) of Ind AS – 23 will be part of this.

• Construction and Development Cost – includes cost directlyrelated to specific projects and allocated cost which may beattributable to project activity in general.

ZFB & ASSOCIATES, Chartered Accountants 12

Project Costs

Construction and Development cost include:• Land conversation cost• Site labour cost• Cost of material• Depreciation of plant and equipment• Freight cost for transfer of material• Cost of hiring equipment• Cost of design and technical assistance• Expected warranty cost• Any claim from third parties.• Insurance• Normal administrative and general overheads allocated to a project

– should be based on normal level of project activity.

ZFB & ASSOCIATES, Chartered Accountants 13

Project Costs

• In case of slum rehabilitation projects, thecost of rehabilitation will be the cost of landwhich is available to developer for newconstruction.

• Cost of sample model flat, how to be treated ?

• To determine whether it is available for salesubsequently.

ZFB & ASSOCIATES, Chartered Accountants 14

Project Costs

Exclusions:• General administrative cost• Selling cost• Research and development costs• Depreciation of idle plant and equipment• Cost of unconsumed or uninstalled material delivered

at site• Payments made to sub-contractors in advance of work

performed.• Marketing cost though directly relating to a project

can not be considered as part of project cost

ZFB & ASSOCIATES, Chartered Accountants 15

Project Revenue

• Project revenues are measured at fair value ofthe consideration received or receivable.Sometimes it involves estimation which may getrevised periodically.

• For one large contract with multiple elements,one may have to consider allocation of totalconsideration to various elements. Generally, it isdone on the basis of fair value of each element.

• One may have to keep materiality to decidewhether total consideration needs allocation.

ZFB & ASSOCIATES, Chartered Accountants 16

Accounting

• Real estate sales take place in different ways and may be subject to differentterms.

• For recognition of revenue it is important to determine whether significant risksand rewards associated with the ownership is transferred in substance.

• For such determination terms and conditions of the agreement is important.• In case of real estate transactions, the buyer and seller usually enters into

agreement at initial stage of construction.• If agreement for sale is legally enforceable which signifies transferring of

significant risks and rewards, it is considered as satisfying condition of revenuerecognition. It may be possible that legal title is not transferred or the possessionis not handed over.

• It is important to determine economic substance of the transaction considering:a) Agreementb) Understanding between the partiesc) Conduct of the parties• If transaction is in substance a construction contract, POCM shall be applied as per

the provisions in GN.

ZFB & ASSOCIATES, Chartered Accountants 17

Accounting

• Following will be akin to sale of goods and henceit need to be accounted as per the principles ofInd AS 18 at a point of time.

a) Sale of undeveloped landb) Sale of TDRc) Sale of constructed units• Sale of land with significant development or

under construction units will fall under‘Construction contract’ and for recognisingrevenue POCM shall be applied.

ZFB & ASSOCIATES, Chartered Accountants 18

Accounting

• In the above cases, following conditions should be satisfied before revenue is recognised :

Transfer of significant risk and rewards Seller retains no effective control of the real estate to a degree

associated with ownership Seller has effectively handed over possession of real estate unit No significant uncertainty regarding the amount of

consideration Not unreasonable to expect ultimate collection of revenue.

• If transfer of legal title is condition precedent to transfer of significant risk and reward, revenue needs to be recognised only at a point of time of legal title transfer.

ZFB & ASSOCIATES, Chartered Accountants 19

Accounting

• POCM shall be applied in case of following indicators :a) Duration of project is more than 12 months Most features are

common to construction contractsb) Individual units are interdependent upon or interrelated to

completion of common amenities.c) Construction / development activities form a significant

proportion of the project activity.• Following conditions have to be collectively satisfied before POCM

can be applied :a) Reliable estimation of total project revenuesb) It is probable that the economic benefits will flow to the

enterprisec) The reliable measurement of future project cost for completion

and stage of project completion.

ZFB & ASSOCIATES, Chartered Accountants 20

Accounting

Before any revenue is recognised following events should have happened :• Critical approvals should have been received such as environment clearance,

approval of plans and design, title to land or rights to development, change in useof land etc. – Implications under RERA need to be considered

• Project should have reached reasonable level of development i.e. 25% ofconstruction and development cost, other than land cost and borrowing costshould have been incurred.

• At least 25% of the saleable project area should have been secured by contractswith buyers.

• At least 10% of the contract consideration as per the legally enforceabledocument should have been realised and it is reasonable to expect that thebalance amount will be recovered as per the payment terms in the contract.

• For this purpose, each contract shall be considered separately and it should not beapplied on overall basis.

• It must be noted that as per Ind AS 11, in early stage of development, revenueand cost will match in P&L while as per GN no revenue can be booked and costwill be carried forward to the next period.

ZFB & ASSOCIATES, Chartered Accountants 21

Accounting

• Revenue and Cost of project has to be recognised as per‘Percentage of Completion Method’.

• Under this method, the revenue and costs are recognised withreference to the stage of completion of the project activity at thereporting date.

• For computation of revenue and stage of completion, the entireproject cost including land cost and borrowing cost should beconsidered. One may apply other method such as technicalestimation, survey of work to determine stage of completion.

• However, revenue recognition should not exceed the revenuecomputed as per the ‘project cost incurred’ method. It means thatrevenue recognition under another method can be lower butcannot exceed revenue as per project cost incurred method.

ZFB & ASSOCIATES, Chartered Accountants 22

Accounting

• Under this method, profit is recognised to the extent of work performed,subject to commencement criteria and profit and loss gives indication ofwork performed during the period.

• Expected loss on the project should be recognised as an expense on eachBalance Sheet date, irrespective of stage of completion.

• Revenue recognised should not exceed the estimated total revenue fromeligible contracts / other legally enforceable agreements.

• For this purpose eligible contracts mean contracts where at least 10% ofthe contracted amounts have been realised and there are no outstandingdefaults of the payment terms for such contracts.

• It means that in case of default in payment, whole of that contract cannot be considered for revenue recognition. It also means that revenueearlier booked for such contracts will have to be reversed. ICAI mayhave to clarify this issue, as it is too harsh provision to reverse revenueearlier booked, specially to the extent money is realised against thecontracts.

ZFB & ASSOCIATES, Chartered Accountants 23

Accounting

• POCM is applied on a cumulative basis for each reporting period on the basis of current estimate of project revenues and project costs. Any change in the estimate is accounted in the period of change.

• The change in estimate also include changes on account of cancellation of contracts or part of the area subsequently earmarked for own use. In such case revenue previously recognised should be reversed and cost incurred will be considered for capitalisation of fixed assets.

ZFB & ASSOCIATES, Chartered Accountants 24

Acquisition of TDRs

• When TDRs are acquired by the builder /developer and utilised in the real estate project,the cost of acquisition will be part of the projectcost.

• When TDRs are acquired by way of agreeing toconstruct built-up area, cost of acquisition shallbe amounts spent on construction of built-uparea.

• Where TDRs are acquired by way of giving up ofrights over existing structure, it should berecorded as per Ind AS 38 at fair market value.

ZFB & ASSOCIATES, Chartered Accountants 25

Disclosures

• The amount of project revenue recognised as revenue in the reporting period

• The methods used to determine the project revenue recognised in the reporting period

• The method used to determine the stage of completion of the project.

• For projects in progress at the end of the reporting period: • The aggregate amount of costs incurred and profits recognised (less

recognised losses) to date• The amount of advances received • The amount of work in progress and the value of inventories • Excess of revenue recognised over actual bills raised (unbilled

revenue).

ZFB & ASSOCIATES, Chartered Accountants 26

Questions????

ZFB & ASSOCIATES, Chartered Accountants 27


Top Related