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Can a business claim advance payments received, as income from sales, in its account books? An ideal accounting practice is one, where an advance payment is a loan and not a profit. However, in Indian real estate, the prevalent revenue recognition was calculated on the basis of sales proceeds, even before the completion of the sales. The real estate sector has been calculating revenue on the basis of a ‘Percentage Completion Method’ and not the ‘Project Completion Method’. In the former, the developers treated payments received from the home buyers for purchase of under-construction flats, as turnover of the company and the net income generated from such projects, was treated as profit.
However, with the Indian Accounting Standard IND AS 115 coming into effect from April 1, 2018, real estate developers are now being forced to show the payments made by home buyers in an ongoing project, as loans and not as income from sales. This will have a profound impact on the way in which real estate developers run their businesses and showcase their fiscal performance and debt-equity ratio to raise more funds.
Purpose of the IND AS 115 accounting standard
To a large extent the IND AS 115 is also in-sync with the Real Estate (Regulation and Development) Act (RERA) that mandates the sales proceeds of an ongoing project, to be kept in a separate escrow account. Globally too, in the accounting practices in most of the developed markets, income is recognised only after the project has been delivered. This is because, before the delivery of the project, the customer may cancel his booking and ask for a refund. Hence, the new accounting standard for revenue recognition, under the IND AS 115 is likely to improve disclosures and reduce the scope for varied interpretations
According to the Ministry of Corporate Affairs, the objective of IND AS 115 is to establish the principles that an entity should apply, to report useful information to users of financial statements about the nature, amount, timing and uncertainty of revenue and cash flows, arising from a contract with a customer. From the current financial year, the other two standards IND AS 18 and 11, which are related to revenue and construction contracts, have been withdrawn.
IND AS 115 to boost transparency in revenue accounting
The Institute of Chartered Accountants of India (ICAI), in a statement, said that the new revenue standard will usher a comprehensive and robust framework for recognition, measurement and disclosure of revenue. “IND AS 115, based on IFRS 15 Revenue for Contracts with Customers, is the culmination of IFRS and US GAAP (Generally Accepted Accounting Principles) convergence project. Information about revenue is very important and is used to assess a company’s financial performance and position and to compare that company with other companies,” the institute said. IND AS 115 will make it easier to compare revenue across entities, industries and global capital markets and require ‘improved disclosures, to help investors and analysts better understand an entity’s revenue’, it added. The standard prescribes only one underlying principle for revenue recognition – transfer of control over goods/services. This replaces the ‘fair value’ concept with ‘transactions price’, which is better suited for measurement of revenue, the ICAI said.
Advantages of the IND AS 115 accounting standard
- Developers can no longer book profits on the ‘Percentage Completion Method’ and it has to be accounted as per the ‘Project Completion Method’.
- Globally, the standard accounting practice is to book profits on the ‘Project Completion Method’, because any buyer in an under-construction project can exit and seek a refund.
- Standard business accounting, calculates any payment received before the transaction as an advance payment or loan. Henceforth, buyers’ payments in under-construction projects, would be treated as loans.
- IND AS 115 is in-sync with the RERA that mandates sales proceeds of under-construction projects to be kept in a separate escrow account and not treat it as revenue.
IND AS 115: Will it help or hurt developers?
JC Sharma, VC and MD of Sobha Limited, feels that the IND AS 115 is likely to increase the paperwork of real estate developers. However, for the computation of income, the company will continue to compute and pay taxes on the percentage completion basis. This may lead to some issues over the Minimum Alternate Tax (MAT). “Companies will have additional compliance requirement. The balance sheet will look weaker than what it is. Comparative data will be difficult to analyse. However, it will not have any impact on the cash flows and the overall profitability of an organisation,” he says. Joe Verghese, managing director, Colliers International India, maintains that the government seems to be on an overdrive, to remedy all ‘perceived’ lapses in the real estate sector. According to him, the timing is not great, considering that the sector is still recovering from previously introduced policy initiatives.
Nikhil Hawelia, managing director of the Hawelia Group, believes that for a complex business like real estate, the new regulations should have been made effective for new launches, henceforth. To implement it with the current fiscal year, the problem is in calculating the already booked profits and writing it back. “A perception is gaining ground that the new accounting norms, will only erode the performance analysis of the listed companies. However, small developers with only a handful of projects but having sound account books due to good sales, will suddenly look like they are bankrupt. Their performance analysis and debt-to-equity ratio, will give an impression that the developer lacks credit reliability,” he elaborates.
Besides being a new accounting norm, the IND AS 115 may also lead to large-scale consolidation in the sector. Financially weak and over-leveraged developers, who have multiple projects and seemingly strong balance sheets, may find it increasingly difficult to get funds, without a good track record of delivery. This, ultimately, could benefit the home buyers and the overall real estate market.
(The writer is CEO, Track2Realty)