ANALYSISBEYONDCONSENSUS

THENEWABCOFRESEARCH
RealEstate:Buildingtransparency,brickbybrick

Intheabsenceofmandatedguidelines,Indianrealestatedevelopershave been following different policies for recognition of revenue/expenses, making comparisons among sectoral players difficult.ICAI recently issued adraftguidancenoteforrecognitionofrevenuebyrealestatedevelopers effective FY13. If recommendations of the exposure draft are adopted in the current format, the initial revenue recognition for most real estate companieswillbedelayed.Further,thedraftcontainsstringentnormsfor derecognition of revenues in case payments are not recognised from customers.

Lackofuniformguidelinesmakesfinancialsincomparable
In the absence of specific guidelines for recognition of revenues, real estate companies follow different methodologies for accounting revenues, varying from determining threshold levels for initial revenue recognition and inclusion of land cost for calculating the stage of completion. This makes the comparison of financials among various real estatedevelopersunwieldy.

Newnormstoclearambiguity,makerevenuerecognitionstringent
Onceaccepted,newnormswillmandaterealestatecompaniestorecognizerevenueas per the percentage of completion method (PoCM). Initial revenues as per new norms canberecognisedonlywhenallcriticalapprovalsforprojectsareinplace,aminimum of 25% of the total construction cost has been expensed and 25% of the project has beensold(withatleast10%ofrevenuesaspercontractualagreementrealised).

Revenuederecognitionbecomesstrictascashflowholdskey
In the current scenario, real estate developers continue to recognise revenue from transactions irrespective of whether the actual cash flow is being realised from the customer or not. New norms provide for more stringent accounting norms which state that in case of a default by the customer in making payments as per the contractual agreement, revenues with respect to such a transaction must be derecognised. Hence all companies which today have a significant amount of debtors outstanding as a percentageofrevenuewillbeadverselyimpacted.
ManojBahety,CFA
+912266233362 manoj.bahety@edelcap.com

SandeepGupta
+912240635474 sandeep.gupta@edelcap.com

NitinMangal
+912240635475 nitin.mangal@edelcap.com

AshishGupta
+912266233488 ashishs.gupta@edelcap.com

Analysis beyond Consensus (ABC) is our initiative to provide a differentiated perspective to our clients on various nonroutine and intricate issues. This unit of research works independent of the sector/stock researchteamandviewsexpressedinthisreportmayvarywiththatofrespectivesector/stockanalyst.
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December21,2011 EdelweissSecuritiesLimited

AnalysisBeyondConsensus
Varyingaccountingpracticesmakerevenuerecognitionincomparable
Real estate companies in India generally recognise revenue as per the PoCM. Under the method, revenues are recognised for properties sold in accordance with the progress in the stage of construction. Revenue recognition, however, commences only after the threshold stageofconstruction. The stage of construction is determined as a percentage of total cost incurred visvis the estimated cost of the total project. While determining the total estimated cost, some companiesfollowaggressiveaccountingpoliciesbyincludingthelandvalueintheestimated total cost, while others exclude it. In the absence of a fixed guideline, companies adopt different approaches for determining the stage of construction and the threshold percentage. This makes the reported financials of various companies in the sector incomparable. Table1:Revenuerecognitionpolicy Company Revenue recognition Threshold(%) Landcost included* Godrej Properties POCM 20 Yes Unitech POCM 20 Yes DLF POCM 30 Yes ParsvnathDevelopers POCM 30 Yes Oberoi Realty POCM 20 No Prestige POCM 20 30 No Sobha developers POCM 25 No HDIL Completedcontract 100 NA
Source:EdelweissResearch,Companyannualreport Note:*inestimatedcostfordeterminationofstageofcompletion

Revenuerecognitionpractice variesacrosscompanies Revenuerecognitionisnot dependentonactual billing/collectionfromthe customer Landcostwillnotbeconsidered forthresholdcalculation

Moreover, there is no linkage between actual cash collection from the customer and revenuerecognition.

Proposedguidelinestobridgegapincomparison
ICAI recently issued an exposure draft on guidelines forrecognition of revenue among real estate companies. Guidelines, once adopted, will lead to standardization of revenue and expense recognition by the sector participants thus, making the comparability of financials muchmoretransparent.Theguidancenoteprovidesforrevenuerecognitiontobeprimarily based on PoCM, with stage of completion to be determined in the proportion in which the actual cost incurred on project (including land costs) with regards to the total estimated project cost. Project cost is recognised in the income statement with regards to stage of completionandwouldbematchedwithrevenuesrecognised.

Initialrevenuerecognitiontogetdelayed
A closer look at the guidance note reveals very stringent norms for the initial recognition of revenue as the following conditions need to be complied with before the recognition of revenuefromanyproject: Allcriticalapprovalsnecessaryforcommencementofprojectmustbetaken 25% of the construction and development expenditure must have been incurred this means that the initial revenue recognition from projects may be delayed for companieslike Godrej Properties, Unitech, DLF, Parsvnath Developers and Oberoi Realty.
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RealEstate
Atleast 25% of the estimated project revenues must be secured by contracts or agreements with buyers; if not, this will lead to a delay in revenue recognition for all real estate companies as they, as per the current revenue recognition practice, start doingsofollowingtheexecutionofthefirstagreementwiththebuyer. Atleast10%of thetotalrevenue,aspertheagreementforsale,mustberealisedandit isreasonabletoexpectthatpartieswillcomplywithpaymenttermsincontracts.

Revenuerecognitionmademore stringentandalignedtoground realities

Considering these, we believe that overall, this will delay the revenue recognition for most ofthesectorparticipants,leadingtoasignificantdentonreportedprofitsandrevenues.

Revenuerecognitionprocessofrealestatecompanies Current

Proposedasperguidancenote
Has the property / appartment been sold
Yes No

Has the property / apartment been sold Yes Has the threshold percentage of completion of project achieved Yes Revenue and cost recognised wrt appartment/ property sold basis POCM

No

No

Revenue and cost recognition deferred

Are project's critical approvals in place

Yes

No

Has company incurred 25% of the contruction and development expenditure on the project

No

Yes

Has the company sold at least 25% of the project (secured by contract/agreements)
Yes

No

Revenue and cost recognition deferred

Has the company realized 10% of total revenue as per the agreement

No

Yes

No defaults in payments made by the purchaser

Yes

No

Revenue and cost recognised wrt appartment/ property sold basis POCM

Source:Edelweissresearch

EdelweissSecuritiesLimited

AnalysisBeyondConsensus
Revenuerecognitionalignedto actualcashcollection

Revenuestobederecognizedonpaymentdefault
Theguidancenotefurtherprovidesforderecognitionofprojectrevenue/costforcontracts wherethepurchaserhasdefaultedinmakingthepaymentasperthetermsofthecontract.

Table2:SnapshotofDebtors/sales

(INRmn)
Debtors>6 monthsas%of sales FY10 FY11 33.9 1.7 20.2 45.3 NA NA 27.2 44.6 0.5 0.5 5.4 4.1 5.4 5.5 1.3 1.2

Company Godrej Properties Unitech DLF* ParsvnathDevelopers Oberoi Realty Prestige Sobha developers HDIL

Debtor Debtor >6 months FY10 FY11 FY10 FY11 1,798 2,899 822 77 12,670 21,474 6,089 14,920 59,863 93,537 NA NA 14,056 13,836 2,563 4,025 404 468 39 48 3,627 9,347 549 631 4,430 4,252 606 804 2,030 3,611 202 217

Sales FY10 FY11 2,427 4,515 30,153 32,921 74,229 95,606 9,407 9,029 7,899 9,960 10,244 15,431 11,299 14,739 15,021 18,500

Debtorsas%of sales FY10 FY11 74.1 64.2 42.0 65.2 80.6 97.8 149.4 153.2 5.1 4.7 35.4 60.6 39.2 28.8 13.5 19.5

Source:EdelweissResearch,Companyannualreport Note:NANotavailable*Unbilledrevenueincludedindebtors

Newnormswillrequireareversal ofrevenuesinrespecttooverdue debtors,impactingprofitability andleverageratios. Futurerevenuesfromsuch projectswillbepostponedtillthe timeofactualcollection

Thus, on adoption of new norms, all companies with significant debtors outstanding will be adversely impacted as it will lead to derecognition of revenues in projects wherein debtors areoverdue.

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RealEstate
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VikasKhemani NischalMaheshwari HeadInstitutionalEquities CoHeadInstitutionalEquities&HeadResearch Recentresearch Date 24Nov11 22Nov11 18Nov11 17Nov11 17Nov11 02Nov11 18Oct11 13Oct11 12Oct11 28Sep11 22Sep11 19Sep11 19Sep11 15Sep11 06Sep11 Title vikas.khemani@edelcap.com nischal.maheshwari@edelcap.com +912222864206 +912266233411

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