Guidance Note on Accounting for Real Estate … 11 February 2012, the ICAI finalized the revised GN on Accounting for Real Estate Transactions. This GN supersedes the above existing

Guidance Note on

Accounting for Real

Estate Transactions

Dinesh Jangid

Background and current accounting

practices

Agenda

2

© 2012 KPMG, an Indian Partnership and a member firm of the KPMG network

of independent member firms affiliated with KPMG International Cooperative

(“KPMG International”), a Swiss entity. All rights reserved. 3

Background

Current accounting is mostly driven by the GN of the Institute of Chartered

Accountant of India (ICAI) on ‘Recognition of Revenue by Real Estate Developers’

which was issued in June 2006

On 11 February 2012, the ICAI finalized the revised GN on Accounting for Real

Estate Transactions. This GN supersedes the above existing GN of ICAI

The revised GN seeks to align the current diverse accounting practices by giving

certain bright-lines for determining the eligibility of real estate projects for

revenue recognition

The revised GN should be applied to all projects in real estate which will

commence or on which the revenue is recognised for the first time on or after 1

April 2012. Early application is permitted

4© 2012 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member

firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights

reserved.

Key principles of the existing GN of 2006 (1/2)

© 2012 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member


reserved.

For recognition of revenue in case of real estate sales, it is necessary that ALL the following

conditions, specified in paragraphs 10 and 11 of Accounting Standard (AS) 9, Revenue

Recognition are satisfied:

Ultimate collection is reasonably assured

the property in the goods or all significant risks and rewards of ownership have been transferred to

the buyer

Seller retains no effective control of the goods transferred to a degree usually associated with

ownership

no significant uncertainty exists regarding the amount of the consideration

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.Issue



reserved.

Key principles of the existing GN of 2006 (2/2)



reserved.

As per the existing GN, legally enforceable agreement for sale with the buyer at initial stages of

construction is considered to have the effect of transferring all significant risks and rewards of

ownership to the buyer provided the following conditions have been satisfied:

a) Price risk has been transferred to the buyer

b) The buyer has a legal right to sell or transfer his interest in the property

In case the seller is obliged to perform any substantial acts after the transfer of all significant risks

and rewards of ownership, revenue should be recognised on proportionate basis as the acts are

performed.

The existing GN does not give guidance on the application of the Percentage of

Completion (POC) method but refers to AS 7, Construction Contracts.Issue



reserved.

Current accounting practices – A great diversity in practice



reserved.

Some of the key areas where there is inconsistency in application of the erstwhile GN:

Completed contract vs. POC method

Method for determining the POC – Input vs. output method

Threshold for revenue recognition

Project costs – whether cost of land and development rights are part of the project costs

Borrowing costs – capitalization and the manner of computation

Because of the diversity in practice in the above key areas, it has been

extremely difficult to compare the financial results and true assets of

companies in this sector

Impact



reserved.

Highlights of the revised GN 2012

Agenda

7



reserved.



reserved.

Agreement for sale is considered to have the effect of transferring all significant

risk and rewards of ownership to the buyer provided the agreement is legally

enforceable

Impact

The revised GN 2012 – Percentage of Completion Method

The GN mandates the application of the POC method in respect of transactions in real estate where the

economic substance is similar to construction type contracts

Indicators for determining if the economic substance of the transactions is similar to construction type

contracts :

Period of project is in excess of 12 months

Project features include land development, structural engineering, architectural design, construction

etc.

Individual units are interdependent upon completion of a number of common activities or amenities

Construction or development activities form a significant proportion of the project activity



reserved.



reserved.

Revenue recognition to be deferred until key approvals (environmental and other

clearances, approval of plans & designs, title to land, change in land use) are

obtained

Land and development right costs to be excluded for computation of the 25% cost

threshold (as above)

Impact

The revised GN 2012 – Key principles

There is a rebuttable presumption that the outcome of a real estate project can be estimated reliably

and that revenue should be recognised based on POC method only when all the following events are

completed:

All critical approvals necessary for commencement of the project have been obtained

Expenditure incurred on construction and development is higher than 25 percent of the construction

and development costs

At least 25 percent of the saleable project area is secured by contracts or agreements with buyers; and

At least 10 percent of the total revenue realized from each contracts



reserved.



reserved.

Companies that are currently following output method, may either switch to the

input method or maintain a parallel input method based computations

Companies to keep track of defaulting customers to determine the overall cap of

revenue recognition

Impact

The revised GN 2012 – Key principles

Revenue from sale of undeveloped plots of land (including long term sale type leases) not to be recognized

before possession is effectively handed over to the buyer and other conditions have been satisfied

For POC, input method is preferred but other methods are also allowed. Revenue per the other method shall

not exceed the revenue per the input method

Overall restriction on recognition of revenue when there are outstanding defaults in payment by customers

TDRs acquired by giving up of rights over existing structures or open land to be valued at lower of the fair

market value and net book value of the portion given up

For contracts with multiple deliverables, the total sales consideration to be split based on fair market value of

each component



reserved.



reserved.

The revised GN 2012 – Project costs

Project cost includes

Cost of land and cost of development rights

Borrowing costs and

Construction and development costs.

Cost of land and cost of development rights may include cost of land itself or development rights and other

related costs such as stamp duty, registration, brokerage and other incidental expenses. It also includes

rehabilitation costs.

Borrowing costs are capitalized in accordance with AS-16, Borrowing Costs which are incurred directly in

relation to a project



reserved.



reserved.


3) Construction and development costs include:

• Costs that relate directly to a specific project including:

• land conversion costs, betterment charges, municipal sanction fee and other charges for obtaining building

permissions;

• site labour costs, including site supervision;

• costs of materials used in construction or development of property;

• depreciation of plant and equipment used for the project;

• costs of moving plant, equipment and materials to and from the project site;

• costs of hiring plant and equipment;

• costs of design and technical assistance that is directly related to the project;

• claims from third parties

• estimated costs of rectification and guarantee work, including expected warranty costs



reserved.



reserved.


Costs that may be attributable to protect activity in general and allocated to specific projects includes:

• insurance;

• costs of design and technical assistance that is not directly related to a specific project;

• construction and development overheads (includes preparation and processing of construction personnel

payroll cost)

• borrowing costs

NOTE: These allocation is to be based on the normal level of project activity.

Exclusion from project cost, if they are material:

• general administration costs;

• research and development costs;

• depreciation of idle plant and equipment;

• cost of unconsumed or uninstalled material delivered at site; and

• payments made to sub-contractors in advance of work performed.

• selling costs (like brokerage charges);



reserved.



reserved.

The revised GN 2012 – Cost of TDR

*Fair market value may be determined by reference either to the asset or portion thereof given up or to

the fair market value of rights acquired whichever is more clearly evident.

Purchase/ Acquisition: When TDRs are utilized in a real estate project by an entity, the cost of

acquisition should be added to the projects costs.

Sale/ Transfer: When TDRs are sold or transferred, revenue should be recognized when:

• title to the development rights is transferred to the buyer

• it is not unreasonable to expect ultimate realization of revenue.

Mode of acquisition Cost of acquisition

Direct purchase Cost of purchases

Development and construction

of built-up area

Amount spent on development or construction of built-up area

Exchange of rights over

existing structures or open

land

Lower of

* Fair market value or

Net book value

Transferable development rights (TDRs)



reserved.

The revised GN 2012 – Sale of plot of land



reserved.



reserved.

Transition – Long term projects where even a small revenue is recognised before 1 April 2012,

will be accounted for based on the existing GNIssues

The revised GN 2012 – Implementation challenges

The Guidance Note should be applied to all projects in real estate:

which are commenced on or after April 1, 2012; and

to projects which have already commenced but where revenue is being recognized for the first time on or

after April 1, 2012.

An enterprise may choose to apply the Guidance Note from an earlier date provided it applies it to all

transactions which commenced or were entered into on or after such earlier date.

Project is the smallest group of units/plots/saleable spaces which are linked with a common set of

amenities in such a manner that unless the common amenities are made available and functional, these

units /plots / saleable spaces cannot be put to their intended effective use.



reserved.



reserved.

A project is defined as a smallest group of units / plots / saleable spaces which are

linked with a common set of amenities…

For a few years, the real estate companies may have to keep two separate revenue

recognition computations – for projects pre and post the implement of the revised GN

Issues

The revised GN 2012 – Implementation challenges

Impact on revenue recognition if there are restriction of transfer during construction period

Transition – Long term projects where even a small revenue is recognised before 1 April 2012, will be

accounted for based on the existing GN

Payment defaults – It is not clear if post balance sheet date defaults or payments to be considered.

Accounting for costs in case if the revenue is restricted to non-defaulting contracts

Communication with stake holders – On deferral of revenue, some of the debt covenants may get broken.

Time and effective communication with different stakeholders is going to be a key in managing the

transition



reserved.

Example

Agenda

18



reserved.

Examples

Illustration: Relevant details of the project are* :

Total saleable area 20,000 square feet

Land cost INR 30 million

Estimated construction cost INR 30 million

Estimated project costs INR 60 million

Work completed till the reporting date :


Construction cost INR 6 million

Total area sold till reporting date 5,000 square feet

Total sale consideration as per agreements of sale executed INR 20 million

Amount realized till the end of reporting period** INR 5 million

*It is assumed that all critical approvals for commencement have been received

**It is assumed that there are no defaults from customers

Construction type contract (No revenue recognition)– Example (1/2)



reserved.

Examples

Solution:

Level of development 20% (percentage of total construction cost incurred of total estimated

construction cost)

Stage of development 60% (percentage of total project cost incurred of total estimated project cost)

Project area sold 25%

Agreement amount realized 25%

As at the end of the reporting period the entity will not be able to recognize any revenue as reasonable level of development, which is

25% of the total construction cost, has not been achieved.

Construction type contract (No revenue recognition)– Example (2/2)



reserved.

Examples

Illustration: Relevant details of the project are* :

Total saleable area 20,000 square feet


Estimated construction cost INR 30 million

Estimated project costs INR 60 million

Work completed till the reporting date :


Construction cost INR 9 million

Total area sold till reporting date 5,000 square feet

Total sale consideration as per agreements of sale executed INR 20 million

Amount realized till the end of reporting period** INR 5 million

*It is assumed that all critical approvals for commencement have been received

**It is assumed that there are no defaults from customers

Construction type contract (Revenue recognized) – Example (1/2)



reserved.

Examples

Solution:

Level of development 30% (percentage of total construction cost incurred of total estimated

construction cost)

Stage of development 65% (percentage of total project cost incurred of total estimated project

cost)

Project area sold 25%

Agreement amount realized 25%

As all the criteria for revenue recognition are being met, revenue can be recognized using the POCM. However, revenue should

not exceed estimated total revenue from legally binding contracts.

The revenue recognition and profits are:

Revenue recognized INR 13 million

(65% of INR 20 million as per agreement of sale)

Proportionate cost of revenue INR 9.75 million

(39 million X 5,000 sq ft/ 20,000 sq ft)

Income from project INR 3.25 million

Work in progress to be carried forward INR 29.25 million

(INR 39 million – INR 9.75 million)

Construction type contract (Revenue recognized)– Example (2/2)

23

&

Questions

Answers

© 2012 KPMG, an Indian Partnership and a member firm of the KPMG network

of independent member firms affiliated with KPMG International Cooperative

(“KPMG International”), a Swiss entity. All rights reserved.

Thank You

© 2012 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a

Swiss entity. All rights reserved.

The KPMG name, logo and "cutting through complexity" are registered trademarks or trademarks of KPMG International Cooperative ("KPMG International").

Dinesh Jangid

Associate Director

Accounting Advisory Services

KPMG in India

Phone: +91 (22) 30901953

Email: [email protected]

Documents

Guidance Note on Accounting for Real Estate … 11 February 2012, the ICAI finalized the revised GN on Accounting for Real Estate Transactions. This GN supersedes the above existing