On February 11, 2012, the Institute of Chartered Accountant of India (ICAI) issued a Guidance Note (GN) on Accounting for Real Estate Transactions. This GN supersedes the existing one on this topic and is to be applied from April 1, 2012.

Presently, the revenue recognition practices followed by real-estate companies are diverse. Some companies follow percentage completion method (POC) and some completed contract method.

Further, the percentages of threshold used by companies for revenue recognition differ considerably and generally, range from 20-35 per cent. Some companies consider land and development right costs in the threshold to start recognising revenue as per POC, while the others consider only construction costs

The new Guidance Note seeks to achieve a degree of consistency in the aforesaid practices by providing specific criteria

As per the revised Guidance Note, four important prerequisites for recognition of revenue are:

all critical project approvals, including environmental clearances, plans and designs, title of land and other rights to develop and changes in land use have been obtained;

twenty five per cent of the actual construction costs (that is, only construction costs excluding cost of land and development rights and borrowing costs) have been incurred;

at least 25 per cent of the saleable project area is secured by contracts; and

at least 10 per cent of the revenue is collected on individual contracts. The revised Guidance Note also puts an additional overall restriction on recognition of revenue when there are outstanding defaults in payment by customers.

The Guidance Note is likely to have a significant impact on the reported revenues and profits of companies in the real estate sector. In some cases, this may require complete change in the revenue recognition computations, while in others it may require a deferral of revenue recognition until all the aforesaid thresholds are achieved.

Key governance issue

Ever since the Corporate Affairs Minister, Mr Veerappa Moily, made public his intention to put in place a national corporate governance policy, there has been some buzz around the probables who are in the fray for heading a committee on this matter.

Will it be a well known CEO from a large industrial house or a CFO of a leading company? Or will the minister play safe and settle for a committee headed by a senior bureaucrat? Only time will tell.

Mr Moily has already indicated that his other pet issue of National Competition Policy will most likely be framed by end-March.

Making business more transparent

The Companies Bill 2011 proposes to introduce multiple new requirements aimed at increasing transparency in business, including mandating a whistleblower mechanism for listed companies, introducing the option of class action suits and categorising insider trading by senior management as a criminal offence.

Investor protection has been given utmost importance with powers to the court to reopen cases and redefine the role of the serious fraud investigation office (SFIO) in investigating companies.

The Bill also makes a much needed move to protect investors by recognising fraud as an issue that needs to be dealt with through official legal channels and penalising those involved in fraudulent/unlawful activities.

The Bill also seeks to identify “key managerial personnel” on the boards of corporate entities who would be pinned with responsibility for acts of corporate malfeasance and negligence, thereby augmenting the urge to develop a strong risk management framework in the organisation.

In summary, the Bill is a strong step forward for India in an effort towards bringing in more transparency in financial disclosures and, more importantly, in safeguarding investor wealth.

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