ANALYSISBEYONDCONSENSUS

THENEWABCOFRESEARCH
RealEstate:Buildingtransparency,brickbybrick

Intheabsenceofmandatedguidelines,Indianrealestatedevelopershave been following different policies for recognition of revenue/expenses, makingcomparisonsamongsectoralplayersdifficult.ICAIrecentlyissued adraftguidancenoteforrecognitionofrevenuebyrealestatedevelopers effectiveFY13.Ifrecommendationsoftheexposuredraftareadoptedin 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
Intheabsenceofspecificguidelinesforrecognitionofrevenues,realestatecompanies follow different methodologies for accounting revenues, varying from determining thresholdlevelsforinitialrevenuerecognitionandinclusionoflandcostforcalculating the stage of completion. This makes the comparison of financials among various real estatedevelopersunwieldy.

Newnormstoclearambiguity,makerevenuerecognitionstringent
Onceaccepted,newnormswillmandaterealestatecompaniestorecognizerevenueas perthepercentageofcompletion method(PoCM).Initial revenuesasper newnorms 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 customerornot.Newnormsprovideformorestringentaccountingnormswhichstate that in case of a default by the customer in making payments as per the contractual agreement,revenueswithrespecttosuchatransactionmustbederecognised.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

AnalysisbeyondConsensus(ABC)isourinitiativetoprovideadifferentiatedperspectivetoourclientson 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,revenuesarerecognisedforpropertiessoldinaccordancewiththeprogressinthe stageofconstruction.Revenuerecognition,however,commencesonlyafterthethreshold stageofconstruction. Thestageofconstructionisdeterminedasapercentageoftotalcostincurredvisvisthe 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 Revenuerecognition Threshold(%) Landcostincluded* GodrejProperties POCM 20 Yes Unitech POCM 20 Yes DLF POCM 30 Yes ParsvnathDevelopers POCM 30 Yes OberoiRealty POCM 20 No Prestige POCM 2030 No Sobhadevelopers 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
ICAIrecentlyissuedanexposuredraftonguidelinesforrecognitionofrevenueamongreal estate companies. Guidelines, once adopted, will lead to standardization of revenue and expenserecognitionbythesectorparticipantsthus,makingthecomparabilityoffinancials muchmoretransparent.Theguidancenoteprovidesforrevenuerecognitiontobeprimarily basedonPoCM,withstageofcompletiontobedeterminedintheproportioninwhichthe 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
Acloserlookattheguidancenoterevealsverystringentnormsfortheinitialrecognitionof revenue as the following conditions need to be complied with before the recognition of revenuefromanyproject: Allcriticalapprovalsnecessaryforcommencementofprojectmustbetaken 25%oftheconstructionanddevelopmentexpendituremusthavebeenincurredthis 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%ofthetotalrevenue,aspertheagreementforsale,mustberealisedandit isreasonabletoexpectthatpartieswillcomplywithpaymenttermsincontracts.

Revenuerecognitionmademore stringentandalignedtoground realities

Consideringthese,webelievethatoverall,thiswilldelaytherevenuerecognitionformost 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 GodrejProperties Unitech DLF* ParsvnathDevelopers OberoiRealty Prestige Sobhadevelopers HDIL

Debtor Debtor>6months Sales FY10 FY11 FY10 FY11 FY10 FY11 1,798 2,899 822 77 2,427 4,515 12,670 21,474 6,089 14,920 30,153 32,921 59,863 93,537 NA NA 74,229 95,606 14,056 13,836 2,563 4,025 9,407 9,029 404 468 39 48 7,899 9,960 3,627 9,347 549 631 10,244 15,431 4,430 4,252 606 804 11,299 14,739 2,030 3,611 202 217 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,onadoptionofnewnorms,allcompanieswithsignificantdebtorsoutstandingwillbe adverselyimpactedasitwillleadtoderecognitionofrevenuesinprojectswhereindebtors 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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