CA Pawan Kumar

Background

The term ‘real estate’ refers to land as well as building. This Guidance Note issued by the ICAI has recommended principles for recognition of revenue arising from real estate sales by the enterprises engaged in such activities (commonly referred to as ‘real estate developers’, ‘builders’ or ‘property developers’). Currently there is no separate Accounting Standard in India for recognition of revenue for real estate transactions, but recording of such transaction are based on principles stipulated in AS 9 ( Revenue Recognition) and AS7 ( Construction Contract) which is further supplemented by Guidance Note issued by ICAI in June 2006 as revised in February 2012.

Summary

As per the revised Guidance Note on Accounting for Real Estate Transactions issued by the  ICAI in Feb’ 2012, a revenue shall be recognise if all the condition specified in paragraphs 10 and 11 of Accounting Standard (AS) 9, Revenue Recognition are satisfied which is primarily talks about following  situations:

(a)    The seller has transferred to the buyer all significant risks and rewards of ownership and the seller retains no effective control of the real estate to a degree usually associated with ownership;

(b)   The seller has effectively handed over possession of the real estate unit to the buyer forming part of the transaction;

(c)    No significant uncertainty exists regarding the amount of consideration that will be derived from the real  estate sales; and

(d)   It is not unreasonable to expect ultimate collection of revenue from buyer

Mandatory application of the Percentage of Completion Method (POC, as per AS 7):

Once the above mentioned criteria fulfilled revenue shall be recognised by using POC method. The revised GN stipulates certain general conditions to be satisfied for application of POC method, such as:

  1. Total project revenue can be estimated reliably;
  2. Project cost should be identifiable and measurable clearly;
  3. The duration of project is beyond 12 months and the project commencement date and project completion date should fall in different accounting periods;
  4. At least 25% of saleable project area is secured by contracts or agreements with buyers;
  5. At least 10% of the total revenue as per agreements of sale or any legally enforceable documents are realised at reporting date  in respect of each of the contracts;
  6. When the stage of completion of the project reaches 25% or more ( where construction of development cost is incurred 25% or more of the total  cost apart from cost of land)

Illustration on application of percentage completion method

Total saleable Area 10,000 Sq. ft.
Estimated Project Costs

(This comprises land cost of Rs. 300 Lakhs and construction costs of Rs. 300 lakhs)

Rs. 600 lakhs
Cost incurred till end of reporting period

(This includes land cost of Rs 300 Lakhs and construction cost of Rs 60 Lakhs)

Rs. 360  lakhs

 

Total Cost incurred Percentage Including the cost of Land 60%
Construction Cost Incurred Percentage 20%
Total Area Sold till the date of reporting period 3,000 Sq. ft.
Total Sale Consideration as per Agreements of Sale executed Rs. 200 Lakhs
Amount realised till the end of the reporting period Rs.50 Lakhs
Percentage Realisation of the total agreement value 25%

Revenue could not be recognised at the end of the reporting period since 25% of construction cost, has not been achieved, though 10% of the agreement amount has been realised.

Continuing with the above illustration:

If the work completed till end of reporting period is

(This includes land cost of Rs 300 Lakhs and construction cost of Rs 90 Lakhs)

Rs. 390 lakhs
Total Cost incurred Percentage Including the cost of Land 65%
Construction Cost Incurred Percentage 30%

The enterprise would be able to recognise revenues at the end of the accounting period. The revenue recognition and profits would be as under:

Revenue recognised at the end of the period

(65 % of Rs 200 Lakhs as per Agreement of Sale)

Rs. 130 lakhs
Proportionate cost (3000/10000*390) Rs. 117 lakhs
Income Rs. 13 lakhs
Work in Progress Rs.  273 lakhs

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Name :   Pawan Kumar ( CA, B. Com hons)

Email Id  : pawan6may@gmail.com

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7 responses to “Brief on Calculation of revenue in case of real estate developers”

  1. Harshit Goyal says:

    Sir,
    I have a doubt about inclusion of value of land in total cost incurred till date of reporting.
    My question is whether we should include the whole value of the land or only the part of total amount that we have paid till the reporting date.
    Example:-
    date of reporting= 31.03.2012
    Total cost of land=50,00,000/-
    Amount paid till = 5,00,000/-
    31.03.2012
    so what value we should include whether 5,00,000/- or 50,00,000/- for calculating %age of completion.

  2. harshit goyal says:

    Sir,
    I have a doubt about inclusion of value of land in total cost incurred till date of reporting.
    My question is whether we should include the whole value of the land or only the part of total amount that we have paid till the reporting date.
    Example:-
    date of reporting= 31.03.2012
    Total cost of land=50,00,000/-
    Amount paid till = 5,00,000/-
    31.03.2012
    so what value we should include whether 5,00,000/- or 50,00,000/- for calculating %age of completion.

  3. Meet says:

    Sir how you calculate WIP

  4. Pooja says:

    Sir what about the balancer rdvenue which is not recognized in the books,what jv has to be passed??

  5. Rakesh Kumar Gupta says:

    Dear Sir,

    If we analyse AS 9, revenue shall be recognised only when the possession is handed over to the customer. But is advance is collected from customers on various stages of completion than whether there is any need to raise invoice/bill and whether there is any need to follow POC method.

  6. Mukesh says:

    Dear Sir,
    Is this applicable to real estate developer??
    Few CAs says yes, it is but some has other opinion.
    The physical possession and ownership of unit is handed over to buyer after completion of project, As such it should not apply on real estate developers.

    In case, it is applicable and the project is for 3-4 years, for example let us continue with same illustration and assume that there was 60 crore increase in cost of construction in next year and 2000 sq ft more are was sold, the revenue wll be recongnized on incremental basis, ie for 5000 sq ft and 450 cost of construction minus revenue recognised till last previous year.

    In case a builder has got approved 10 towers,but is at present constructing only 2 towers, in such case, we would consider 25% of sale for two tower only or for entire project.

    Regards,
    Mukesh
    – See more at: https://taxguru.in/finance/calculation-revenue-case-real-estate-developers.html#comment-1245069

  7. CMA ASIM SAHA says:

    I think assessing officer should look in to the cost compliance report which is mandatory to construction business to find out the difference of expenses charged as per financial accounts as compared to cost compliance report signed by CMA. The calculation of operating profit should start from cost audit report which will help the Assessing officer to allow other expenses in arriving taxable profit

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