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

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:

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:

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

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

Email Id: pawan6may@gmail.com