Real Estate Accounting developments

Transcription

1 Workshop on Tax and Accounting Developments in Indian Real Estate Sector Real Estate Accounting developments Neeraj Sharma Partner, Assurance services Walker Chandiok & Co. All rights reserved.

2 Agenda for the session. Applicability and scope What has changed What's new Key highlights Key challenges 2

3 Applicability and Scope: All projects commenced on or after 1 April 2012, and All existing projects, where revenue is being recognized for the first time on or after 1 April Option to apply this new GN from an earlier date provided the new GN is applied to all after the chosen (earlier) date. GN does not apply to transaction covered in scope of AS 10, AS 12, AS 19 and AS 26 3

4 What has changed? Particulars Old GN Revised GN Revenue recognition Revenue should be recognized when: Transfer of risk and rewards of ownership No uncertainty as regards collection of the amount If the economic substance of the transaction is similar to construction contracts, principles of AS-7 should be applied * If real estate transaction is in principle similar to sale of goods and services, principles of AS-9 should be applied Application of Percentage of completion method (PoC) No detailed guidance and reference drawn to AS-7 for POC application Rule based detailed guidance provided 4

5 What has changed? Particulars Old GN Revised GN Key terms defined Real estate- Referred to land as well as building Real estate- Refers to land as well as buildings and rights thereto Revenue thresholds No other definitions provided No guidance provided and reference drawn to AS-7 Definition of various other terms used in the guidance note are provided. [example project, project cost etc] Guidance provided by way of conditions and also the items to be considered for such threshold computations [example, 25% land and development cost] Different models of real estate Not covered Covered Disclosure requirements No disclosure requirements prescribed other than disclosure of accounting policy Additional disclosure requirements have been prescribed 5

6 What's New? Revised GN covers ALL forms of real estate : Sale of land and plots [with or without development] Constructed properties Joint development agreements Barter transaction Acquisition, utilization and transfer of Development rights Multiple element Redevelopment of existing building or structures Elaborate rule based guidelines for revenue recognition. Increased uniformity and comparability of financial statements of various real estate developers 6

7 Application of PoC method Where economic substance similar to construction type contracts, MANDATORY application of PoC method. Indicators are : Period of project> 12 months Project features include land development, structural engineering, architectural design, construction etc. Individual units are interdependent upon completion of a number of common activities or amenities Construction or development activities form a significant proportion of the project activity Questions A company is venturing into a project for construction of a villa wherein the company will sell the land and build a customised villa. Is the aforesaid transaction within the scope of guidance note on accounting for real estate? 7

8 Defining Project 'a smallest group of units/plots/saleable spaces which are linked with a common set of amenities in a manner that unless the common amenities are made available and functional, these units/plots/saleable spaces cannot be put to their intended effective use.' Large developments can be split into smaller projects if the basic conditions are fulfilled Evaluation How will developers identify common set of amenities within a project? Can a further launch of area in an existing project be considered as new project for applicability of revised GN? 8

9 Condition 1 for revenue recognition- Critical approvals All critical approvals necessary for commencement of the project have been obtained Environmental and other clearances; Approvals of plans and design; Title to land or any other rights of developments; Change in land use; etc Questions A company obtained 14 approvals out of 16 required approvals. Will critical approvals required to commence any project would differ based on various factors such as the nature of project, applicable approval authority etc? 9

10 Condition 2 and 3 for revenue recognition- 25% construction/development cost and sale of project area Para 5.3 (b) requires 25% cost of construction and development * to be incurred AND Para 5.3 (c ) requires secured revenue contracts or agreements to be at least 25% of the total project saleable area * Land cost, cost of development rights and Rehabilitation costs in case of redevelopment projects NOT covered per Para 5.3 (b) Question Due to any changes in the estimates subsequently (change in budgets or saleable area etc), can a project be unqualified for revenue recognition and entire revenue and cost to be reversed? 10

11 Condition 4 for revenue recognition- 10% collections Revenue should be recognised for "legally enforceable contracts" only when there are no outstanding defaults of the payment terms in such contracts. Only those contract to be considered where collection is 10% or more at the reporting date. Condition to be looked at Individual contract level Question Whether post balance sheet date defaults or payments are to be considered? 11

12 Legally enforceable contracts (Para 3.3 and 5.3) Agreements to sell is considered to have the effect of transferring all significant risks and rewards of ownership to the buyer provided: agreement is legally enforceable AND subject to satisfaction of the conditions which signify transferring of significant risks and rewards pending transfer of legal title. Example- In some jurisdiction, Memorandum of understanding or booking form has the ability to be enforced by the parties concerned in the court of law. Can we consider it as a eligible contract as per Para 5.3? 12

13 Transferrable development rights (TDR) TDR acquired by way of direct purchase OR on development or construction of built-up area, the cost of acquisition would be the cost or purchase or amount spent on the development or construction of the built-up area respectively When TDR are acquired by way of giving up rights over existing structure or open land, the development right should be accounted at lower of fair market value (FMV) or at net book value of the asset given up FMV may be determined by reference either to the asset or portion thereof given up or to the fair market value of rights acquired whichever is more clearly evident. Examples 1. Developer ABC enters into a collaboration agreement with a land owner to develop a real estate project. Land owner to get certain constructed portion in lieu of the land surrendered to the developer ABC. What is the cost of land for developer ABC? 2. ABC owns a plot of land in Noida and XYZ in Gurgaon. Both enter into an agreement whereby they will exchange properties and XYZ will receive an additional consideration for Rs. 50 lacs. What will be the cost of land in the hands of ABC and XYZ? 13

14 Multiple element contracts Contract consideration should be split into different identifiable components including one for construction and delivery of real estate units. Consideration received or receivable to be split based upon FMV of respective components Example Developer ABC is also providing decorative fittings to its customers? Should the consideration in respect of such fittings be split? Also, the sale consideration of Rs. 25 lacs is assigned to car parkings and club membership fees. Should these be split the Consideration received or receivable to be split and accounted for as a separate element? 14

15 Key challenges: What lies ahead Application forms versus legally enforceable contracts to be carefully reassessed. Tax Issue One of the key consideration of this change should be acceptability of the proposed accounting principles by the income tax authorities as it may result in deferment of revenue and frequent reversal of revenue - consequential MAT impact as computed on book profits. On deferral of revenue, some of the debt covenants may get broken. Time and effective communication with different stakeholders is going to be a key in managing the transition to the new accounting rules For few year, two separate revenue recognition computations to be maintained- projects pre and post implementation of revised GN 15

16 Key challenges: What lies ahead Companies should have a mechanism to track payment defaults around revenue collections Careful evaluation of critical approvals, common set of amenities etc should be done by senior management on a case to case basis To facilitate further uniformity and comparability, significant accounting policies for POCM revenues and costs to be elaborated for key new terms like critical approvals, common set of amenities etc Companies to ensure compliance with the additional disclosure requirements. 16

17 Thank You Neeraj Sharma Partner, Assurance Services Walker, Chandiok & Co M T E Neeraj.sharma@in.gt.com 17