Meet an old friend in a local train or on an air-conditioned bus in Mumbai and it won’t be too long before the conversation works its way around to affordability of houses and continually increasing living costs. Everyone has a story of the exorbitant rent, the sky-high asking price for a mere 1-BHK in faraway suburbs and finally about a friend who had to move away because the bills were just too high.

Since the real-estate sector, which constitutes about 11 per cent of our GDP, is one of the many sectors of the economy which is particularly vulnerable to black money, such situations are bound to rise if strong reform measures are not implemented.

Big reforms are yet to creep in this sector, such as repealing the Urban Land Ceiling Regulation Act, getting our records digitalised, reforming the Rent Control Act, introduction of the property title certification system and rationalisation of property tax designs. But what is most important is the need to integrate the local government bodies in a nationwide digital database.

ACCOUNTING REFORMS

Let’s now focus on some burning regulatory issues requiring immediate attention.

A Guidance Note on Accounting for real estate transactions was issued by the Institute of Chartered Accountants of India in February 2012, but its scope was limited, as it primarily provided guidance on application of percentage of completion method for recognition of revenue. In these times, when investment in property is widely perceived as a common means of parking unaccounted money, Accounting Standards 7 (AS 7) on “Construction Contracts” needs to be revised and made applicable to real estate developers. Further, AS-7 and AS-9 (Revenue Recognition) should be notified under the Income Tax Act, 1961. Similar views were expressed in “White paper on black money” issued by the Ministry of Finance in May 2012 and in a committee headed by the Central Board of Direct Taxes Chairman, in its report, “Measures to Tackle Black Money in India and Abroad.”

The revised schedule VI requires companies to disclose the rates of borrowings for loans taken. Many companies, including some of the largest listed companies have been blatantly ignoring this fact, and have been showing an average rate of borrowing rather than specific rates. Such malpractices need be checked.

Companies should be asked to disclose a sensitivity analysis showing how an increase/decrease in the rate of loan affects the profitability of the company.

For example, a company using high discount rate for valuation, over and above industry norms, will have the least impact on sensitivity analysis. The change in interest rates used should be based on the largest annual change in preceding three or six months Mibor/Libor or variable lending rate over a duration of two to five years. British companies, for this matter, take the largest variation in three months Libor over the last ten years.

The calculations for testing of impairment of assets should be made mandatory as companies take either an unreasonably high/low discount rate for calculation of net realisable value from an asset and hence an impairment loss is almost never reflected in the financial statements. And since AS 28 (Impairment of an Asset), requires disclosure only when impairment loss is there, the anomaly is cleanly kept off the books.

Owing to the volatility in the economic scenarios, similar to investment property valuations, there are serious uncertainties about the possible range of outcomes of impairment tests. Currently more than 90 per cent of the companies place only a note about impairment in the ‘Significant Accounting Policies’.

CURBING SPECULATION

Section 54, 54EA and 54F of the Income-Tax Act should be amended to provide for availing the benefit of non-taxability on reinvesting only twice or thrice by a taxpayer in his lifetime. Capping these limits will help in curbing speculation and flipping transactions, as housing finance companies and the property buyers are provided fiscal incentives do the same. It should be made mandatory for companies to have their properties and capital works in progress valued externally, at least once a year by external certified valuers, rather than the current practice adopted by many companies of valuing it internally by company engineers. Further, companies should be encouraged to provide details of projects under construction and a schedule showing a movement in loans/funds appropriated towards such schemes.

AS 2, “Inventory valuation” read with AS 7, should be revised for making it mandatory to give details of inventory (such as quantitative details required by the earlier Companies Act). This should be given in a clear note along with the movement and reconciliation of units of flats, row houses, plots sold or lying unsold with the company. Companies should be asked to disclose information about the methods, inputs, and assumptions used to determine the transaction price for units of flats or plots.

Companies with joint ventures should be asked to apply equity method of accounting as suggested by IFRS 11 (Joint Arrangements), instead of the widely used proportionate consolidation method.

SUSTAINABILITY

Addressing going concern issues should be made mandatory as in the UK. Companies should be asked to report sustainability performance by means of key performance indicators. The United Nations Environment Programme (UNEP) ‘Sustainable Buildings and Climate Initiative’ reports that buildings represent 40 per cent of global energy use and one third of global greenhouse gas emissions.

Further, FIEC (The European Construction Industry Federation) has put sustainable construction very high on its agenda.

Almost none of our companies in real estate report sustainability performance. The European Public Real Estate Association (EPRA) has initiated a similar process and over two thirds of companies in the EPRA region now disclose sustainability performance.

As of January 2013, the Global Reporting Initiative (GRI) has announced a new research project to publish, by May this year a list of internationally recognised reference material beginning with five sectors, i.e. airport operators, construction and real estate, oil and gas, media, and event organisers.

A little down the road our companies are expected to face significant issues with the adoption of IFRS 10, IFRS 11, IFRS 12 and IFRS 13, also compliance with any Government specific practice guides like the EPRA’s or the guidelines of the GRI, so it’s better our companies shape up accordingly.

(The author is Assistant Manager with Deloitte, with a focus on real estate.)

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