Accounting for Real Estate Transactions- GN (Rev 2012)

Dhruv SETH, LucknowB. Com, FCA, DISA (ICA)

ds@sethspro.com

Types of Accounting Issues

Revenue Recognition Timing Extent of measurement Re-measurement

Profit Recognition Unbundling revenues and profits Accounting of Finance Cost Continuing Involvement

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AS-7 CONSTRUCTION CONTRACTS

Originally issued in 1983 as “Accounting for Construction Contracts”

AS-7 was revised in 2002 which was applicable for accounting period commencing on or after 1.4.2003

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AS-7 OLD NEW Both percentage of completion method and

the completed contract method allowed Applies to Contractors & Developer\Builders

Only percentage of completion method allowed

Applies to Contractors only

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Guidance Note

Guidance Note GN(A) 23 on recognition of revenue by Real Estate Developers issued in 2006 by the ICAI.

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Guidance Note 2006 - Cont.

Recommended recognition of Real Estate Revenue when ALL of the following conditions are satisfied When All significant risk and rewards of

ownership have been transferred and the seller retains no effective control of real estate to a degree usually associated with ownership

Certainty of Consideration exists Certainty of collection

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Guidance Note (Revised 2012) by ICAI

Revised Guidance Note on Accounting for Real Estate Transactions in Feb 2012. (GN 2006 was “Recognition of Revenue”)

“to recommend the accounting treatment by enterprises dealing in 'Real Estate’ as sellers or developers”

‘real estate’ refers to land as well as buildings and rights in relation thereto.

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Scope of Revised GN 2012

Covers ALL forms of transactions in Real Estate. Illustrative List: - Sale of Plots of Land with OR without

Development Development and sale of Residential and

commercial units with or without undivided share in land.

Acquisition, Utilisation and Transfer of Development Rights.

Redevelopment of existing Building Joint Development Agreements

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Scope- Exception

Transactions which are in substance similar to delivery of goods – Principal of Revenue Recognition in AS9 to apply.

Transactions in Real Estate covered by AS 10 (Fixed Assets), AS 12 (Government Grants), AS 19 (Leases) and AS 26 (Intangible Assets)

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Applicability From

All Projects which are commenced on or after 1st April 2012. AND also

Which were commenced before 1st April 2012 but the revenue is being recognised for the first time on or after 1st April 2012

Can be applied from earlier date- IF applied on all transactions

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Definition- “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, these units /plots / saleable spaces cannot be put to their intended effective use.

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Project Costs- Comprises

Cost of Land+ development rights (including rehabilitation cost etc.)

Borrowing Cost in terms of AS 16 Construction & Development Cost

(Includes- Direct Costs and That may be attributable in general and can be allocated to the project and also estimated cost of rectification, guarantee and expected warranty cost)

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Cost NOT part of Construction Cost- If material

General administration costs; selling 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 performed13

Project Revenue- Includes

Sale of plots, undivided share in land, sale of finished and semi-finished

structures, consideration for construction, for amenities and interiors, for parking spaces and sale of

development rights.

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Application of % Completion Method (PCM)

Where economic substance is similar to construction contracts

Indicators- Multiple Accounting periods involved Features common to construction

contracts Individual units to be delivered to different

buyers these are interdependent upon or interrelated to completion of a number of common activities

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PCM applied when

When outcome can be estimated reliably AND when ALL of the following conditions are satisfied total project revenues can be

estimated reliably; probable that economic benefits

will flow to the enterprise;Contd.

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Contd.

the project costs to complete the project and the stage of project completion at the reporting date can be measured reliably; and

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

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Rebuttable presumption

That outcome of a project can be estimated reliably and revenue should be recognised under PCM only when the following (a) to (d) are completed

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(a)

All critical approval necessary for commencement obtained. These include1.Environmental clearances2.Plan approvals3.Title of land and other rights of development

4.Change in Land Use19

(b) Completion reaches a reasonable level- is

achieved if expenditure incurred on construction & development cost is more than 25% of construction and development cost in terms of Para 2.2(c) read with 2.3 to 2.5

i.e. Project Cost LESS: Cost of Land & cost of development

rights etc. Borrowing Cost

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(c)

At least 25% of the Saleable project area is secured by contracts or agreements with buyers

Which are legally enforceable

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(d)

Min 10 % of the total revenue as per the agreements of sale are realised in respect of each contract and it is reasonable to expect that parties will comply with payment terms.

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If outcome can be estimated reliably

Revenue & project costs of the project should be recognised as revenue and expenses by reference to the stage of completion of the project activity at the reporting date.

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Computation of Revenue

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 as defined in paragraph 2.2.

Contd. 24

Computation of Revenue- Stage of Computation

Preferred method- is with reference to project costs

Does not prohibit other methods, e.g., surveys of work done, technical estimation, etc.

However, revenue with reference to other methods of determination of stage of completion should not, exceed the revenue computed with reference to the 'project costs incurred‘ method.

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The Recognition of Revenue Not to exceed

At any point the estimated total revenues from 'eligible contracts’ / other legally enforceable

'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.

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If Probable Cost > Eligible Revenue

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.

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PCM applied on

Cumulative basis in each reporting period Change in estimate is accounted for as

change in accounting estimates. include changes arising out of

cancellation of contracts. Where subsequently earmarked for own

use or for rental purposes. Revenue recognised to be reversed & cost to be accounted for as per AS 10

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Sale of Plots

Without Developments To be recognised when conditions of Para

4.2 met

Sale of Developed Plots Where the development activity is

significant the percentage completion method is used to account for such sales.

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Transactions with Multiple Elements Development + e.g. property management

services, sale of decorative fittings (excluding fittings which are an integral part of the unit), rental in lieu of unoccupied premises, etc.].

The consideration should be split into separately identifiable components

The consideration for the contract should be allocated to each component on the basis of the fair market value of each component

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Disclosure

The amount of project revenue recognised

The methods used to determine the project revenue recognised in the reporting period; and

The method used to determine the stage of completion of the project.

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Disclose also- for projects in progress

the aggregate amount of costs incurred and profits recognised (less recognised losses) to date;

the amount of advances received; the 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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Sample Note in Notes to Accounts

Revenue from Projects is recognized on the “Percentage of Completion Method’ of accounting. Revenue is recognized, in relation to the sold areas only, on the basis of percentage of actual cost incurred thereon including land as against the total estimated cost of the project under execution subject to such actual costs being 25% or more of the total estimated cost. The estimates of saleable area and costs are revised periodically by the management. The effect of such changes to estimates is recognized in the period such changes are determined.

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Accounting System “For that purpose it was the duty of the

Income-tax Officer to find out that profit the business has made according to the true accountancy practices “

P.M. Mohd 73 ITR 735 (SC) & 98 ITR 167 Challapalli (SC)

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Virtual Soft Systems Ltd 18 Taxman 119 (Del)Accounting for lease rentals was based on the Guidance Note “Accounting for Leases” issued by the ICAI, the AO was not entitled to disregard the same. The Guidance Note reflects the best practices adopted by accountants the world over and the fact that it was not mandatory is irrelevant.The change by the assessee in the policy of accounting for leases had the imprimatur of the ICAI and so the AO was not entitled to disregard the books of accounts or the method of accounting for leases;Followed Woodward Governor India P Ltd. 294 ITR 451 (Delhi) and Dai Lchi karkaria Ltd 156 CTR 172 (SC)

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TAS and Change in Policy

TAS- The method of valuation of inventory shall not be changed without a reasonable cause

Snow-white food products 141 ITR 847- can be changed if intended to be followed regularly in future

CIT v Mopeds India 173 ITR 347- can be changed for bonafide purposes

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TAS & Anticipated Losses

TAS- Future & anticipated losses shall not be allowed unless actually incurred

Shiv Shanti Punavasan Prakalp 135 ITD 51 (Mum)- Entire anticipated losses can not be allowed. Only proportionate to work completed can be allowed.

Allowed in CIT v Triveni Engg 196 Taxman 94 and Jacobs Engg 14 Taxmann.com 186 (Mum)

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Grey Areas

New Complex structuring of Transactions combined with financing

No clarification where developers takes land and gives the owner constructed space in the project.

Volatility in earnings. Rule based regarding threshold of

applicability of 25%- can be abused

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Have a good day

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