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Possible impact on Revenue Recognition in Realty Sector-A view

Adopting, practicing and applying uniformity of the principles of revenue recognition to an industry on overall basis without much room for assumptions and willful adjustments is expected to bring more clarity and transparency in financial statements being published under IFRS regime. International Financial Reporting Standards (IFRS) being implemented in phased manners from 1st April, 2011 is expected to end an era of multiple interpretations of various transactions while being accounted for by different companies in the same industry. Such practices lead to distortion of comparability, relevance and reliability while presenting financial statements for global use.

Presently there is no consistency in principle with regard to recognition of revenue among the industry. Since Indian generally accepted accounting principles (GAAP) does not provide specific structure to differentiate between various activities being carried by companies involved in Reality sector thus revenue is being recognized by the companies on assumptions based on the best possible understanding of nature of transactions while disclosing the same in the accounting policies. Such practices being presently followed in no way mean that there are wrong or erroneous revenues being recognized by these companies but certainly there is a room to adjust revenues of different periods favorably. In the case of real estate companies income from sale of residential units is recognized as revenue in proportion to the construction cost much before the transfer of title and rights of ownership or even before the start of construction. An effort was made to overcome such shortcomings and guidance note on recognition of revenue by real estate developers was issued by the Institute of Chartered Accountants of India but the final impact and adoption of these guidelines by the industry is not known.

Under International Financial Reporting Standards (IFRS) to be applicable from 1st April, 2010 it is expected that there will be much clarity as to recognition of revenue by real estate industry. Every contract or transaction will have to be evaluated and categorized under three broad categories i.e. a service contract, construction contract and or sale contract. After identifying the nature of transaction the relevant standards i.e. IAS18 or IAS11 will be applied and revenue recognized accordingly.  Generally all such contracts where materials are being supplied by the buyers and have control over the design and specifications of the property under construction will qualify as service contract. In case significant risks and rewards of ownership have been transferred and seller losses continuing managerial involvement to a degree usually associated with ownership, the flow of revenue to the seller is reliably measurable and certain, and the cost incurred or to be incurred are identifiable fall under the category of sale contracts. Finally construction contracts are contracts specifically negotiated for the construction of an asset or group of assets closely interrelated or interdependent with respect to design, technology, function or use.

 International Financial Reporting Standards (IFRS) being implemented in phased manner from 1st. April, 2011 in India will definitely have a reasonable impact on the financials of realty sector. Since the first step towards convergence will be to reinstate financial statements on 1st. April, 2011 to comply with the standards under IFRS, it is expected to make enormous changes in the financial statements. Reclassification of assets may have sizeable impact on fixed assets and assets held for investment. Similarly, liabilities with respected to revenues already recognized may have to be reinstated. Certain agreements may have inbuilt clauses necessitating the sale of land and the construction activities to be recorded separately. There are instances where reality sector agencies develop and build real estate on the land being provide by landowners in exchange of certain defined portion of constructed space. Under IFRS all such barter transactions need to be accounted for at fair value.  In short the convergence exercise to reinstate opening financial statement will need in-depth knowledge, time and availability of relevant records to produce a reliable, relevant and realistic financial statement complying with International Financial Reporting Standards.

DILIP K RAINA –Chartered Accountant

B.Com; FCA (ICAI); PGDFM; PGDCA; DBM; Cert. IFRS (ICAEW); Microsoft Certified IT Professional: Application for Microsoft   Dynamics NAV.

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Dilip K Raina
Category Accounts   Report

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