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Revenue Recognition- Real Estate Companies
ZFB & ASSOCIATES, Chartered Accountants
Accounting for Real Estate Transactions
Revenue Recognition Criteria
Acquisition of TDRs
ZFB & ASSOCIATES, Chartered Accountants 2
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
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
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
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
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 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.
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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
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.
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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
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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
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
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) Sal