Knowledge sharing session Guidance note on accounting for Real Estate Transactions (Revised 2012)

Neeraj Sharma Client Service Director March 19, 2012

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Agenda

• Why this change? • Overview • Key changes• Impact Analysis of Key changes• Challenges and Way forward

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Why this change….?

• Sector has been on the move for last 5-6 years

• Varied practices being followed by companies

• Earlier GN was not very comprehensive

• Lot of subjectivity in certain areas

• Revised GN attempts to remove ambiguity/ subjectivity

• Brings uniformity in accounting practices

• Will ensure comparability of financial statements

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Overview

Applicability –This GN supersedes the aforementioned existing GN

Effective date - 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.

• Scope:• Comprehensive and considers various dynamics of the sector

• Sale of land/ plots with or without any development• Acquisition, utilisation and transfer of development rights• Joint development arrangements• Transaction involving exchange of assets

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Key Changessome key definitions

Project 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, the units cannot be put their intended effective use.

Project costs • Project costs in relation to a project ordinarily comprise:

• Cost of land and development rights • Borrowings cost • Construction and development costs

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Key Changes (contd.)Application of Percentage Completion Method (POCM)

Indicators where economic substance is similar to construction contracts are:

• duration of the project is beyond 12 months

• project features like land development, structural engineering, architectural design, construction, etc.

• individual units of the project are contracted to be delivered to different buyers are interdependent upon or interrelated to completion of a number of common activities and/or amenities

• construction or development activities form a significant proportion of the project activity

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Key Changes (contd.)Commencement of revenue recognition

Conditions Deferral of revenue

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

Defer revenue recognition till key approvals (environmental and other clearances, approval of plans & designs, title to land, change in land use) are obtained. These now need to defined more precisely by all real estate players.

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

Land, development right costs and rehabilitation costs to be EXCLUDED for computation and assessment of the 25% cost threshold.

At least 25 percent of the saleable project area is secured by eligible contracts or agreements

Revenue recognition for the whole of the project is to be deferred till legally enforceable documents for sale (ATS) of 25% of the saleable project area have been executed

At least 10 percent of the total amount collectible in respect of an agreement to sell (ATS) has been so collected at REPORTING DATE

Revenue for each such ATS executed where (in case amount collected for a particular ATS is less than 10%, revenue for each such ATS is deferred and recognised once this criteria is met). Also cheque bounce cases to be carefully looked at for such purposes

There is a rebuttable presumption that the outcome of a real estate project can be estimated reliably AND revenue should be deferred till all the following conditions are satisfied

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Key Changes (contd.)miscellaneous changes

• The recognition of project revenue by reference to the stage of completion of the project activity should not at any point exceed the total estimated revenues from the "legally enforceable contracts"

• Revenue should be recognised for "legally enforceable contracts" only when there are no outstanding defaults of the payment terms in such contracts

• Following Cost should not be considered part of construction and development cost:• General administration costs• Selling costs (This will include brokerage related costs)• Research & development cost• Depreciation of idle Plant & Machinery

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Key Changes (contd.)disclosures

Disclosure requirements - Additional disclosures:• amount of project revenue recognised in the reporting period,• methods used to determine the project revenue recognised in the reporting period,

and• method used to determine the stage of completion of the project. With respect of projects in progress, the required disclosures are:• aggregate amount of costs incurred and profits recognised (less recognised losses)

to date,• amount of advances received,• amount of work in progress and the value of inventories, and• excess of revenue recognised over actual bills raised (unbilled revenue)

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Key Changes (contd.)transferable development rights (TDR)

TDR may be acquired in either of the way –

• Directly purchased• Cost incurred to acquire the TDR

• Development and construction of built-up area• amount spent on development or construction of built-up area

• Giving up of rights over existing structures or open land.• fair market value or at the net book value of the portion of the asset given up,

whichever is less

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Impact Analysis of Key changes

Defines a project as 'a smallest group of units/plots/saleable spaces which are linked with a common set of amenities in 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.

• Identification of common set of amenities within a project would be key for evaluating the project definition.

• Resultantly any reassessment of project definitions may lead to significant changes in the PoCM calculations.

Defining Project

Evaluation

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Impact Analysis of Key changes

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

Critical approvals required to commence any project would differbased on various factors such as the nature of project, applicable approval authority etc.

Critical Approvals

Evaluation

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Impact Analysis of Key changes

Payment threshold

Only those contract to be considered where collection is10% or more at the reporting date.

Evaluation

What if 10% collection is not made till the end of reporting period but received before accounts are signed off?

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Impact Analysis of Key changes

Revenue should be recognised for "legally enforceable contracts" only when there are no outstanding defaults of the payment terms in such contracts

• A complete track of the defaults made by the customers need to be maintained on real time basis

• Revenues recongised may result in subsequent reversal adjustments as a result of delayed cash inflows

Default in payment of dues

Evaluation

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Impact Analysis of Key changes

Such costs will not form part of the project costs.

This will reduce the cost incurred % and bring an immediate

charge to profit and loss statement.

Administration and marketing costs

Evaluation

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Impact Analysis of Key changes

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

If early application is adopted then impact of the revised percentage of completion would be taken in to Opening Reserve or in the current P&L a/c?

Retrospective applicability of Revised GN

Evaluation

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Challenges and Way forward

• The revised GN will impact revenue recognition – consequential MAT impact as computed on book profits

• For a few years, the real estate companies may have to keep two separate revenue recognition computations – for projects pre and post the implementation of the revised GN

• General administration, selling and research and development costs- whether requires immediate write off of already accumulated components held as inventory upon transition

• Incidental payments including external development charges (EDC) and internal development charges (IDC) - whether to be included as a part of land or development cost

• 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

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Challenges and Way forward

• Transition – Long term projects where even a small portion of revenue has been recognised before 1 April 2012, will be continue to be accounted for on the basis of the existing GN

• 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

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Questions

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Thank you

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