Analysis of Guidance note on Accounting for Real Estate Transactions
The objective of this Guidance Note is to recommend the accounting treatment by enterprises dealing in 'Real Estate’ as sellers or developers. The term ‘real estate’ refers to land as well as buildings and rights in relation thereto. Enterprises who undertake such activity are generally referred to by different terms such as ‘real estate developers’, ‘builders’ or ‘property developers’.
1. Sale of plots of land (including long term sale type leases) without any development.
2. Sale of plots of land (including long term sale type leases) with development.
3. Development and sale of residential and commercial units, row houses, independent houses, with or without an undivided share in land.
4. Acquisition, utilisation and transfer of development rights.(TDR)
5. Redevelopment of existing buildings and structures.
6. Joint development agreements for any of the above activities.
The Guidance Note primarily provides guidance on application of Percentage of Completion Method (PCM) where it is appropriate to apply
In respect of transactions of real estate which are in substance similar to delivery of goods principles enunciated in Accounting Standard (AS) 9, Revenue Recognition, are applied.
Real estate transactions of the nature covered by:
• Accounting Standard (AS) 10, Accounting for Fixed Assets
• Accounting Standard (AS) 12, Accounting for Government Grants
• Accounting Standard (AS) 19, Leases
• Accounting Standard (AS) 26, Intangible Assets
Are outside the scope of this Guidance Note.
This Guidance Note should be applied to all projects in real estate which are commenced on or after April 1, 2012 and also to projects which have already commenced but where revenue is being recognised for the first time on or after April 1, 2012. An enterprise may choose to apply this Guidance Note from an earlier date provided it applies this Guidance Note to all transactions which commenced or were entered into on or after such earlier date. This Guidance Note supersedes the Guidance Note on Recognition of Revenue by Real Estate Developers, issued by the Institute of Chartered Accountants of India in 2006, when this Guidance Note is applied as above.
Real estate activities and transactions take diverse forms
The date when the activity is commenced and the date when the activity is completed usually fall into different accounting periods. It is not unusual for such activities to spread over two or more accounting periods.
For recognition of revenue ALL the conditions specified in paragraphs 10 and 11 of Accounting Standard (AS) 9, Revenue Recognition, are satisfied.
The point of time at which all significant risks and rewards of ownership can be considered as transferred, is required to be determined on the basis of the terms and conditions of the agreement for sale.
This Guidance Note, thus, provides guidance in the application of:
• Principles of AS 9 in respect of sale of goods for recognising revenue, costs and profits from transactions of real estate which are in substance similar to delivery of goods where the revenues, costs and profits are recognised when the revenue recognition process is completed; and
• PCM for recognising revenue, costs and profits from transactions and activities of real estate which have the same economic substance as construction contracts.
Applicationof principles of As 9 in respect of Sale of goods to a real estate project
The completion of the revenue recognition process is usually identified when the following conditions are satisfied:
1. 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;
2. The seller has effectively handed over possession of the real estate unit to the buyer forming part of the transaction;
3. No significant uncertainty exists regarding the amount of consideration that will be derived from the real estate sales; and
4. It is not unreasonable to expect ultimate collection of revenue from buyers.
Where transfer of legal title is a condition precedent to the buyer taking on the significant risks and rewards of ownership and accepting significant completion of the seller’s obligation, revenue should not be recognised till such time legal title is validly transferred to the buyer.
Application -Percentage Completion Method (PCM)
Indicators of real estate transactions/activities
The duration of such projects is beyond 12 months and the project commencement date and project completion date fall into different accounting periods.
Most features of the project are common to construction contracts, viz., land development, structural engineering, architectural design, construction, etc.
While individual units of the project are contracted to be delivered to different buyers these are interdependent upon or interrelated to completion of a number of common activities and/or provision of common amenities.
The construction or development activities form a significant proportion of the project activity.
This method is applied when the outcome of a real estate project can be estimated reliably and when all the following conditions are satisfied:
1. Total project revenues can be estimated reliably;
2. It is probable that the economic benefits associated with the project will flow to the enterprise;
3. The project costs to complete the project and the stage of project completion at the reporting date can be measured reliably; and
4. The project costs attributable to the project can be clearly identified and measured reliably so that actual project costs incurred can be compared with prior estimates.
When the outcome of a project can be estimated reliably, project revenues and project costs associated with the project should be recognised as revenue and expenses respectively applying the PCM
The presumption that the outcome of a real estate project can be estimated reliably and that revenue should be recognised under the percentage completion method only when the events below are completed.
All critical approvals necessary for commencement of the project have been obtained. These include, wherever applicable:
a. Environmental and other clearances.
b. Approval of plans, designs, etc.
c. Title to land or other rights to development/ construction.
d. Change in land use
When the stage of completion of the project reaches a reasonable level of development. A reasonable level of development is not achieved if the expenditure incurred on construction and development costs is less than 25 % of the construction and development costs. At least 25% of the saleable project area is secured by contracts or agreements with buyers. At least 10 % of the total revenue as per the agreements of sale or any other legally enforceable documents are realised at the reporting date in respect of each of the contracts and it is reasonable to expect that the parties to such contracts will comply with the payment terms as defined in the contracts.
(e.g. - If there are 10 Agreements of sale and 10 % of gross amount is realised in case of 8 agreements, revenue can be recognised with respect to these 8 agreements.)
- When the outcome of a real estate project can be estimated reliably and the conditions stipulated in Applicability are satisfied, project revenue and project costs associated with the real estate project should be recognised as revenue and expenses by reference to the stage of completion of the project activity at the reporting date. For computation of revenue the stage of completion is arrived at with reference to the entire project costs incurred including land costs, borrowing costs and construction and development costs.
- Whilst the method of determination of stage of completion with reference to project costs incurred is the preferred method, this Guidance Note does not prohibit other methods of determination of stage of completion, e.g., surveys of work done, technical estimation, etc. However, computation of revenue with reference to other methods of determination of stage of completion should not, in any case, exceed the revenue computed with reference to the 'project costs incurred' method.
- The project costs which are recognised in the statement of profit and loss by reference to the stage of completion of the project activity are matched with the revenues recognised resulting in the reporting of revenue, expenses and profit which can be attributed to the proportion of work completed. Costs incurred that relate to future activity on the project and payments made to sub-contractors in advance of work performed under the sub-contract are excluded and matched with revenues when the activity or work is performed. This method provides useful information to the extent of contract activity and performance during a period.
- The recognition of project revenue by reference to the stage of completion of the project activity should not at any point exceed the estimated total revenues from 'eligible contracts’/other legally enforceable agreements for sale. 'Eligible contracts’ means contracts/agreements where at least 10% of the contracted amounts have been realised and there are no outstanding defaults of the payment terms in such contracts.
- When it is probable that total project costs will exceed total eligible project revenues, the expected loss should be recognised as an expense immediately. The amount of such a loss is determined irrespective of:
(a) Commencement of project work; or
(b) The stage of completion of project activity.
- The percentage of completion method is applied on a cumulative basis in each reporting period to the current estimates of project revenues and project costs. Therefore, the effect of a change in the estimate of project costs, or the effect of a change in the estimate of the outcome of a project, is accounted for as a change in accounting estimate. The changed estimates are used in determination of the amount of revenue and expenses recognised in the statement of profit and loss in the period in which the change is made and in subsequent periods.
- The changes to estimates referred above also include changes arising out of cancellation of contracts and cases where the property or part thereof is subsequently earmarked for own use or for rental purposes. In such cases any revenues attributable to such contracts previously recognised should be reversed and the costs in relation thereto shall be carried forward and accounted in accordance with AS 10, Accounting for Fixed Assets.
Accounting for Sale of Land or Plots
- Sale of land or Plots
- Sale of Plots of land without any development
- Sale of developed plots
- Revenue should be recognised as per AS 9
- PCM should be used to account for such sales.
ACCOUNTING FOR Transferable Development Rights
- Transferable Development Rights (TDRs) are generally acquired in different ways as mentioned hereunder:
a. Direct purchase.
b. Development and construction of built-up area.
c. Giving up of rights over existing structures or open land.
- When development rights are acquired by way of direct purchase or on development or construction of built-up area, cost of acquisition would be the cost of purchases or amount spent on development or construction of built- up area, respectively. Where development rights are acquired by way of giving up of rights over existing structures or open land, the development rights should be recorded either at fair market value or at the net book value of the portion of the asset given up whichever is less. For this purpose, fair market value may be determined by reference either to the asset or portion thereof given up or to the fair market value of the rights acquired whichever is more clearly evident.
- When development rights are utilised in a real estate project by an enterprise, the cost of acquisition should be added to the project costs.
- When development rights are sold or transferred, revenue should be recognised when both the following conditions are fulfilled:
a. Title to the development rights is transferred to the buyer; and
b. It is not unreasonable to expect ultimate realisation of revenue.
An enterprise should disclose:
(a) The amount of project revenue recognised as revenue in the reporting period;
(b) The methods used to determine the project revenue recognised in the reporting period; and
(c) The method used to determine the stage of completion of the project.
An enterprise should also disclose each of the following for projects in progress at the end of the reporting period:
(a) The aggregate amount of costs incurred and profits recognised (less recognised losses) to date;
(b) The amount of advances received;
(c) The amount of work in progress and the value of inventories; and
(d) Excess of revenue recognised over actual bills raised (unbilled revenue).
Illustration onapplication of percentage completion method (Rs. In Lakhs)
Total saleable Area : 10,000 Sq. ft.
Estimated Project Costs Rs. 600
(This comprises land cost of Rs. 300 Lakhs and construction costs of Rs. 300 lakhs)
Cost incurred till end of reporting period Rs. 360
(This includes land cost of Rs 300 Lakhs and construction cost of Rs 60 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
Amount realised till the end of the reporting period Rs. 50
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 Rs. 390
(This includes land cost of Rs 300 Lakhs and construction cost of Rs 90 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 as follows-
Revenue recognised at the end of the period Rs. 130
(65 % of Rs 200 Lakhs as per Agreement of Sale)
Proportionate cost (3000/10000*390) Rs. 117
Income Rs. 13
Work in Progress (Total Cost - Proportionate Cost) Rs. 273
By: CA VIKAS RAI