Accounting standards for real estateMOHAN R. LAVI Share · print ·
T+ MOHAN R. LAVI Slush and ill-gotten funds invariably get parked
into real-estate. With limited exceptions, real-estate companies have
not embraced international accounting and governance standards.
Accounting standards encouraged this laxity by prescribing the
percentage-of-completion (POC) method for recognising revenue since
real-estate projects are invariably long-gestation projects and
waiting for the ribbon-cutting ceremony to recognise revenue just did
not seem right. However, the liberty provided by the POC method
encouraged a few to recognise revenue though only a small portion of
the project was visible.
The International Accounting Standard Board (IASB) was seized of the
problem and decided to tackle it from the conceptual stage.
Technically speaking, there were two accounting standards dealing with
revenue recognition for real estate companies- IAS 11 on Construction
Contracts and IAS-18 on Revenue.
Some entities decided to adopt either of these accounting standards on
a convenience basis. The IASB decided to tackle the problem head-on by
getting the Interpretation Committee to issue IFRIC-15- Agreements for
the Construction of Real-Estate. IFRIC sought to end the debate on
which accounting standard would apply.
IAS 11 defines a construction contract to be a contract specifically
negotiated for the construction of an asset or a combination of assets
that are closely interrelated or interdependent in terms of their
design, technology and function or their ultimate purpose or use.
IFRIC-15 clarified that an agreement for the construction of real
estate meets the definition of a construction contract when the buyer
is able to specify the major structural elements of the design of the
real estate before construction begins and/or specify major structural
changes once construction is in progress (whether or not it exercises
that ability).
If the agreement meets the definition of a construction contract,
revenue could be recognised on the basis of the percentage of
completion. If not, IAS-18 on Revenue would operate which would mean
that revenue can be recognised only when the significant risks and
rewards have been transferred and the amount of revenue can be
measured reliably. In real-estate lingo, this event would occur on the
registration of the sale deed.
Guidance Note
The Institute of Chartered Accountants of India (ICAI) has recently
issued a Guidance Note (GN) on Recognition of Revenue by Real-estate
developers. Though the overall direction of the GN is according to
IFRIC-15, it deviates in some aspects.
The GN mandates that the POC method is applied to the accounting of
all real estate transactions/activities where the economic substance
is similar to construction type contracts. Indicators of such
contracts are when the period of such projects is in excess of 12
months, most features of the project are common to construction-type
contracts, 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 and the construction or development
activities form a significant proportion of the project activity.
The GN also specifies that the POC method can be applied only when all
necessary approvals for the commencement of each project have been
obtained, the expenditure on project costs exceeds 25 per cent of the
construction and development costs, atleast 25 per cent of the
estimated project revenues are secured by contracts or agreements with
buyers and at least 10 per cent of the total revenue according to the
agreements of sale or any other legally enforceable documents are
realised at the reporting date in respect of each of the contracts.
When the earnings process of a real-estate project is complete
(typified by transfer of significant risks and rewards, possession has
been handed over, there is no uncertainty on the amount of
consideration and it is not unreasonable to expect ultimate
collection), AS-9 on Revenue Recognition would come into play. The GN
follows IFRS norms in requiring multiple contracts to be unbundled
into their various components.
Agreements
IFRIC-15 rightly attempted to focus on Agreements though critics state
that putting clauses into an agreement is harmless.
The clause on the buyer specifying structural changes is cited as an
example- it can be innocuously put in an agreement triggering the POC
method. Real estate transactions in India involve innovative and
byzantine agreements. The ICAI should ensure that the GN provides
detailed guidance on how to recognise revenue in such cases. The
adoption of the GN and Ind-AS 11 on construction contracts could force
real estate entities to recognise revenue later than at present.
----------------------------------------------------------
The ICAI should ensure that the guidance note specifies in detail on
how to recognise revenue in real estate transactions in India.
----------------------------------------------------------
(This article was published in the Business Line print edition dated
December 26, 2011)
T+ MOHAN R. LAVI Slush and ill-gotten funds invariably get parked
into real-estate. With limited exceptions, real-estate companies have
not embraced international accounting and governance standards.
Accounting standards encouraged this laxity by prescribing the
percentage-of-completion (POC) method for recognising revenue since
real-estate projects are invariably long-gestation projects and
waiting for the ribbon-cutting ceremony to recognise revenue just did
not seem right. However, the liberty provided by the POC method
encouraged a few to recognise revenue though only a small portion of
the project was visible.
The International Accounting Standard Board (IASB) was seized of the
problem and decided to tackle it from the conceptual stage.
Technically speaking, there were two accounting standards dealing with
revenue recognition for real estate companies- IAS 11 on Construction
Contracts and IAS-18 on Revenue.
Some entities decided to adopt either of these accounting standards on
a convenience basis. The IASB decided to tackle the problem head-on by
getting the Interpretation Committee to issue IFRIC-15- Agreements for
the Construction of Real-Estate. IFRIC sought to end the debate on
which accounting standard would apply.
IAS 11 defines a construction contract to be a contract specifically
negotiated for the construction of an asset or a combination of assets
that are closely interrelated or interdependent in terms of their
design, technology and function or their ultimate purpose or use.
IFRIC-15 clarified that an agreement for the construction of real
estate meets the definition of a construction contract when the buyer
is able to specify the major structural elements of the design of the
real estate before construction begins and/or specify major structural
changes once construction is in progress (whether or not it exercises
that ability).
If the agreement meets the definition of a construction contract,
revenue could be recognised on the basis of the percentage of
completion. If not, IAS-18 on Revenue would operate which would mean
that revenue can be recognised only when the significant risks and
rewards have been transferred and the amount of revenue can be
measured reliably. In real-estate lingo, this event would occur on the
registration of the sale deed.
Guidance Note
The Institute of Chartered Accountants of India (ICAI) has recently
issued a Guidance Note (GN) on Recognition of Revenue by Real-estate
developers. Though the overall direction of the GN is according to
IFRIC-15, it deviates in some aspects.
The GN mandates that the POC method is applied to the accounting of
all real estate transactions/activities where the economic substance
is similar to construction type contracts. Indicators of such
contracts are when the period of such projects is in excess of 12
months, most features of the project are common to construction-type
contracts, 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 and the construction or development
activities form a significant proportion of the project activity.
The GN also specifies that the POC method can be applied only when all
necessary approvals for the commencement of each project have been
obtained, the expenditure on project costs exceeds 25 per cent of the
construction and development costs, atleast 25 per cent of the
estimated project revenues are secured by contracts or agreements with
buyers and at least 10 per cent of the total revenue according to the
agreements of sale or any other legally enforceable documents are
realised at the reporting date in respect of each of the contracts.
When the earnings process of a real-estate project is complete
(typified by transfer of significant risks and rewards, possession has
been handed over, there is no uncertainty on the amount of
consideration and it is not unreasonable to expect ultimate
collection), AS-9 on Revenue Recognition would come into play. The GN
follows IFRS norms in requiring multiple contracts to be unbundled
into their various components.
Agreements
IFRIC-15 rightly attempted to focus on Agreements though critics state
that putting clauses into an agreement is harmless.
The clause on the buyer specifying structural changes is cited as an
example- it can be innocuously put in an agreement triggering the POC
method. Real estate transactions in India involve innovative and
byzantine agreements. The ICAI should ensure that the GN provides
detailed guidance on how to recognise revenue in such cases. The
adoption of the GN and Ind-AS 11 on construction contracts could force
real estate entities to recognise revenue later than at present.
----------------------------------------------------------
The ICAI should ensure that the guidance note specifies in detail on
how to recognise revenue in real estate transactions in India.
----------------------------------------------------------
(This article was published in the Business Line print edition dated
December 26, 2011)
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