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A brief on calculation of revenue in case of real estate developers

CA Pawan Kumar , Last updated: 17 June 2013  
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Background

The term 'real estate' refers to land as well as building. This Guidance Note issued by the ICAI has recommended principles for recognition of revenue arising from real estate sales by the enterprises engaged in such activities (commonly referred to as 'real estate developers', 'builders' or 'property developers'). Currently there is no separate Accounting Standard in India for recognition of revenue for real estate transactions, but recording of such transaction are based on principles stipulated in AS 9 (Revenue Recognition) and AS7 (Construction Contract) which is further supplemented by Guidance Note issued by ICAI in June 2006 as revised in February 2012.

Summary

As per the revised Guidance Note issued by the ICAI in Feb' 2012, a revenue shall be recognise if all the condition specified in paragraphs 10 and 11of Accounting Standard (AS) 9, Revenue Recognition are satisfied which is primarily talks about following situations:

(a) The seller has transferred to the buyer all significant risks and rewards of ownership and the seller retains no effective control of the real estate to a degree usually associated with ownership;

(b) The seller has effectively handed over possession of the real estate unit to the buyer forming part of the transaction;

(c) No significant uncertainty exists regarding the amount of consideration that will be derived from the real estate sales; and

(d) It is not unreasonable to expect ultimate collection of revenue from buyer

Mandatory application of the Percentage of Completion Method (POC, as per AS 7):

Once the above mentioned criteria fulfilled revenue shall be recognised by using POC method. The revised GN stipulates certain general conditions to be satisfied for application of POC method, such as:

1. Total project revenue can be estimated reliably;

2. Project cost should be identifiable and measurable clearly;

3. The duration of project is beyond 12 months and the project commencement date and project completion date should fall in different accounting periods;

4. At least 25% of saleable project area is secured by contracts or agreements with buyers;

5. At least 10% of the total revenue as per agreements of sale or any legally enforceable documents are realised at reporting date in respect of each of the contracts;

6. When the stage of completion of the project reaches 25% or more (where construction of development cost is incurred 25% or more of the total cost apart from cost of land)

Illustration on application of percentage completion method:

Total saleable Area 10,000 Sq. ft.

Estimated Project Costs

(This comprises land cost of Rs. 300 Lakhs and construction costs of Rs. 300 lakhs)

Rs. 600 lakhs

Cost incurred till end of reporting period

(This includes land cost of Rs 300 Lakhs and construction cost of Rs 60 Lakhs)

Rs. 360  lakhs

Total Cost incurred Percentage Including the cost of Land 60%
Construction Cost Incurred Percentage 20%
Total Area Sold till the date of reporting period 3,000 Sq. ft.
Total Sale Consideration as per Agreements of Sale executed Rs. 200 Lakhs
Amount realised till the end of the reporting period Rs.50 Lakhs
Percentage Realisation of the total agreement value 25%

Revenue could not be recognised at the end of the reporting period since 25% of construction cost, has not been achieved, though 10% of the agreement amount has been realised.

Continuing with the above illustration:

If the work completed till end of reporting period is

(This includes land cost of Rs 300 Lakhs and construction cost of Rs 90 Lakhs)

Rs. 390 lakhs
Total Cost incurred Percentage Including the cost of Land 65%
Construction Cost Incurred Percentage 30%

The enterprise would be able to recognise revenues at the end of the accounting period.

Revenue recognised at the end of the period

(65 % of Rs 200 Lakhs as per Agreement of Sale)

Rs. 130 lakhs
Proportionate cost (3000/10000*390) Rs. 117 lakhs
Income Rs. 13 lakhs
Work in Progress Rs.  273 lakhs

Name: CA Pawan Kumar (CA, B. Com hons)

Email Id: pawan6may@gmail.com

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