Vinod Kothari

1012 Krishna 222 Ashoka Shopping

224 AJC Bose Road Center
Kolkata 700 017 LT Road
Mumbai
www.vinodkothari.com
Email: vinod@vinodkothari.com
 Revises 2006 Guidance Note on Recognition of Revenue by
Real Estate Developers
 Basic principles
◦ Construction contracts
◦ Revenue recognition
 Coverage
◦ All forms of transactions in real estate
 What is real estate?
 Land, buildings and rights in relation thereto
◦ Illustrative list of transactions
 Sale or long term lease of land
 Sale of land with development
 Development and sale of residential/commercial units
 Acquisition, utilisation or transfer of development rights
 Redevelopment of existing buildings
 Joint development agreements
◦ Basic idea of the Guidance Note is to apply the stage of
completion method in real estate transactions
 Should revenue recognition be based on
transfer of legal title, handing of possession
or transfer of risks/rewards
 Since long term sale type leases are included,
and there is an exception in cases where AS
19 applies, hence real estate lease
transactions are excluded
 Real estate acquired as a fixed asset in
business
 Though not specifically excluded, investment
properties should also be excluded by
implication
◦ Since separate AS applicable there
 All projects commenced on or after 1st April
2012
◦ Since the reference is to a project –it obviously
implies construction
◦ Definition of “project” applies
 Or ongoing projects where revenue is being
recognised for the first time on or after 1st
April 2012
 Project
◦ Almost like the definition of an operating unit
 a smallest unit linked with a common set of amenities
 The common amenities are essential to put the property to
intended effective use
◦ Example
 A tower in a complex
 Common amenity is the lift, electricity, water, etc
 Project cost
◦ Cost of land and cost of development rights
 Includes stamp duty, development rights, brokerage, etc
◦ Borrowing costs
 As per AS 16, direct costs or apportioned costs
◦ Construction and development costs
 Direct costs or costs attributable to project
 (a) land conversion costs, betterment charges, municipal
sanction fee and other charges for obtaining building
permissions;
 (b) site labour costs, including site supervision;
 (c) costs of materials used in construction or development of
 property;
 (d) depreciation of plant and equipment used for the project ;
 (e) costs of moving plant, equipment and materials to and from
the project site;
 (f) costs of hiring plant and equipment;
 (g) costs of design and technical assistance that is directly
related to the project;
 (h) estimated costs of rectification and guarantee work, including
expected warranty costs; and
 (i) claims from third parties.
 (a) General administration costs;
 (b) selling costs;
 (c) research and development costs;
 (d) depreciation of idle plant and equipment;
 (e) cost of unconsumed or uninstalled
material delivered at site; and
 (f) payments made to sub-contractors in
advance of work performed.
 (a) insurance;
 (b) costs of design and technical assistance
that is not directly related to a specific
project;
 (c) construction or development overheads;
and
 (d) borrowing costs.
How are these costs allocated: systematic and
rational basis, based on normal level of
project activity
 Revenues from sale of plots, undivided share
in land, sale of finished and semi-finished
structures,
 consideration for construction, consideration
for amenities and interiors,
 consideration for parking spaces and sale of
development rights.
 Measured as consideration received or
receivable
 Significant estimation is required here –
hence, estimates may change over time
 Key to recognition of revenue is Para 11 of AS 9
◦ Recognition of risks and rewards
 What are risks/rewards
◦ The agreement is typically for purchase of a property
◦ Hence, risk is the risk of decrease in the price, reward is reward
for appreciation of the price
◦ Hence, a fixed price contract presumably transfers risks/rewards
to the buyer
 Agreement for sale prima facie transfers risks/rewards
◦ Subject to legal enforceability – every agreement is prima facie
legally enforceable
◦ Satisfaction of conditions signifying transfer of risks/rewards
 Transfer of legal title or handing of possession is not
necessary
 end of revenue
recognition
Commencement
of revenue
recognition

Completion
of revenue
Application of recognition –
completion of when
contracts effective
method possession is
Agreement for handed over,
sale no effective
control with
seller
 To be applied where
◦ Economic substance similar to construction contracts
◦ Construction contract defined as “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.”
 Differences between contracts of sale vs construction contracts
 In a contract of sale, the seller sells a ready-built asset; in a construction
contract, the asset is built based on order
 Indicators:
◦ 12 months or longer duration so that project commencement date and project
completion date fall into different accounting periods.
◦ project includes land development, structural engineering, architectural design,
construction, etc.
◦ 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.
◦ The construction or development activities form a significant proportion of the
project activity.
 When the outcome of the project can be
measured reliably AND all the following
 total project revenues can be estimated reliably;
 it is probable that the economic benefits
associated with the project will flow to the
enterprise;
 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.
 All necessary approvals for commencement of
project obtained, including:
 Environmental clearances
 Plan and design approvals
 Title of land and other development right / construction
 Change of land use
 Stage of completion reaches a reasonable level
◦ Construction and development costs must have reached
25%
 At least 25% of sellable area must have been
secured by contracts or agreements with buyers
 At least 10% of the total revenue with respect to
each agreement has been received
 Various options for stage of completion
 Preferred method
◦ Project cost incurred
 Including land cost, borrowing cost, development and construction costs
 Other methods
◦ Survey of work done, technical estimation, etc
 These methods are not ruled out. However, revenue computed
should not exceed revenue as per project cost incurred method
 The project revenue as per % completion method should not
exceed estimated total revenue from “eligible contracts”
◦ That is, contracts where at least 10% of revenues have been realised, and
there are no defaults in payments
 Estimated loss on completion should be booked outright
 Percentage completion method is applied on cumulative basis :
◦ If estimates change over time, it is change of estimate, effect of which is
applied prospectively
◦ Change of estimate includes cancellation of contracts, or earmarking
property for self use
 Revenue from sale of plot/land may be
booked when risk/rewards transferred
◦ That is, transfer of legal title, conveyance or
possession are not pre-requisite
 In case agreement for sale of developed land,
percentage completion method to be applied
 Cost of acquiring TDRs should be added to
the cost of construction
 In case of transfer fo TDRs, revenue should
be booked
◦ When title is transferred
◦ It is not unreasonable to expect realisation
 If there is a contract for supply of goods or
services in addition to construction contract
◦ Those parts will be segregated
◦ Composite consideration shall be segregated in
proportion to fair market value
 Revenue related disclosures:
◦ the amount of project revenue recognised as revenue in the
reporting period;
◦ 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.
 An enterprise should also disclose each of the following
for projects in progress at the end of the reporting period:
 (a) the aggregate amount of costs incurred and profits
recognised (less recognised losses) to date;
 (b) the amount of advances received;
 (c) the amount of work in progress and the value of
inventories; and
 (d) Excess of revenue recognised over actual bills raised
(unbilled revenue).
 Accounting
 Taxation
◦ MAT
◦ Regular income tax
 IAS 11 Construction contracts
 Snapshot
◦ Key objective:
 Construction contracts normally span more than one accounting
period – hence, the costs/revenues are scattered; the standard
provides for allocation of revenue/costs to the period
 Scope exception

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 Construction contract
◦ Contract for construction of
 an asset
 or group of assets that are interdependent or interrelated
 A contract for a group of assets should be treated as separate if separate bids
have been submitted, the contract may be accepted/rejected for any one or
more assets, and costs/revenues of each may be found separately
 If these conditions are not satisfied, the group contract should be taken as
single contract
◦ Contract for rendering services relating to contracts such as
project managers, architects, are also regarded as construction
contracts
◦ Destruction/restoration contracts also included
 Cost plus contract: reimbursement for all allowable costs +
margin
 Fixed price contract: fixed contract price or fixed price per
unit of output

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 Contract revenues
◦ Initial contracted revenue
◦ Variations, to the extent they are probable, and can reliably be measured
 E.g., impact of escalation clauses
 Impact of penalties
 Incentive payments – if the contract has reached a stage where incentive payment looks
highly probable, and may be reliably measured
 Contract costs
◦ Direct costs
 Site labor, materials, depreciation of plant used for the contract, cost of hiring plant,
design and technical assistance, warranty costs, rectification costs, claims of third
parties
◦ Costs attributable to the contract activity and can be allocated to the contract
 Insurance, design or technical assistance not directly on the specific contract,
construction overheads
 These can be systematically allocated based on normal level of construction activity
◦ Costs that are specifically chargeable to the customer as per contract
◦ Following costs are NOT included
 General admin costs for which reimbursement is not allowed in contract
 Selling costs
 R & D costs for which reimbursement is not specified in contract
 Depreciation of idle plant, not used for the contract

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 When the outcome of the contract may be measured reliably
◦ Expected loss on the contract should be booked immediately
◦ Revenues/costs should be split based on stage of completion
 When is the outcome reliably measurable
◦ In fixed price contracts: all the following
 The contract revenue can be measured reliably
 Economic benefits from the contract (that is, consideration) will flow to the entity
 Costs to complete the contract and the stage of completion can be measured
reliaby
 Actual contract costs can be compared with estimated costs
◦ cost plus contracts, all the following
 Economic benefits from the contract (that is, consideration) will flow to the entity
 Contract costs that are reimbursable may reliably be measured
 If the outcome of the contract is not reliably measurable
◦ Revenues should be recognised only to the extent of the costs
◦ Expected loss should be expensed straightaway
 When the uncertainties that prevented the contract from being
recognised on the percentage completion method cease to exist, the
contract should be accounted using percentage completion method

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 Depending on the contract, the stage of
completion may be found based
◦ Percentage of construction cost incurred
◦ Survey
◦ Physical completion

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 As per AS 16 (4) (e), to the extent foreign
currency differences are treated as
adjustment of borrowing cost, they are a part
of borrowing cost
◦ Borrowing cost attributable to acquisition,
construction or production of a qualifying asset to
be capitalised
 ASI 10 clarifies that to the extent the foreign
currency borrowing cost is cheaper than
domestic currency, the loss on exchange
rates is adjustment to borrowing cost

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 Foreign operations are
◦ Integral
◦ Non-integral
 Integral operations are like an extension of the
enterprise – it simply acts as a postman
◦ Its activities are so organised that they have an immediate
effect on the cashflows of the reporting enterprise
◦ Integral enterprises typically do not hold cash or assets
 Non integral operations are those that have their
own individual assets/liabilities
◦ Hence, there is no direct effect on change in the value of
the assets/liabilities of non-integral operation on the
reporting enterprise

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 The activities of the foreign operation are carried out with a
significant degree of autonomy
 transactions with the reporting enterprise are not a high
proportion of the foreign operation’s activities;
 the activities of the foreign operation are financed
autonomously
 Operating exps and other components of the foreign
operation’s products or services are primarily paid or settled
in the local currency rather than in the reporting currency;
 the foreign operation’s sales are mainly in currencies other
than the reporting currency;
 cash flows of the reporting enterprise are insulated from the
day-to-day activities of the foreign operation
 sales prices for the foreign operation’s products are not
primarily responsive on a short-term basis to changes in
exchange rates but are determined more by local competition
or local government regulation
 there is an active local sales market for the foreign
operation’s products,

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 Assets and liabilities at closing rates
 Incomes and exps at the rates (or average
rates) prevailing at the timing of such
incomes/exps
 All resulting foreign exchange differences
should be accumulated in a foreign currency
translation reserve, until disposal of foreign
operations
 Incorporation of a foreign operation into
domestic operation follows consolidation
principles

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