Levelling the grounds for revenue recognition

Factors such as a fast-growing urban middle-class, rise in organised retail, growth of the IT sector, and easy availability of finance for buying houses have led to tremendous growth and corporatisation of the real estate sector.

This sector has also emerged as one of the best investment opportunities for Indian and foreign investors. The significant amount of foreign direct investment over the last five years in real estate is testimony to this. The growth opportunities and the increased participation by various stakeholders have given rise to the need for a standard and consistent accounting and financial reporting practices for real estate transactions.

Overview

Recognising the real estate sector’s role in fuelling the growth of the economy, and the need for guidance on accounting, especially for sales, the Institute of Chartered Accountants of India had issued a guidance note — ‘Recognition of Revenue by Real Estate Developers’ — in 2006.

Though the sector has grown in volume and complexity, revenue recognition practices are not consistent across the industry. The CA institute realised the need to revise the accounting guidance in order to harmonise the diverse accounting practices into a single uniform practice — particularly in the application of the ‘percentage of completion method’ for recognising revenue. Accordingly, it issued the Revised Guidance Note in February 2012. The accompanying table compares the old and revised notes to highlight the changes introduced.

The revised guidance applies to all real estate projects that commenced on or after April 1, 2012, as also projects that have already commenced but where revenue is being recognised for the first time on or after April 1, 2012. Further conditions for revenue recognition under the percentage completion method include:

Receipt of all critical approvals for commencement of the project;

Incurrence of minimum 25 per cent of the budgeted cost;

Securing at least 25 per cent of the project saleable area through agreement to sale;

Realisation of 10 per cent of the total revenue according to agreement to sale.

It also elaborates on accounting for Transferable Development Rights (TDRs), which are generally acquired in various ways such as direct purchase; development and construction of built-up area; and ceding rights over existing structures or open land. Additionally, it prescribes various disclosures needed in the financial statements.

The revised guidance is expected to streamline the accounting and reporting requirements for real estate developers and standardise accounting and financial reporting, besides facilitating competitive analysis between the different players in the industry.

Nilesh Lahoti is Senior Manager and Ajay Agrawal is Manager, Deloitte Haskins & Sells