Today, we continue our review of the newly converged revenue recognition guidelines as it relates to India.
In 2015, the country’s Ministry of Corporate Affairs (MCA), along with other government departments, issued a road map for implementation of Indian Accounting Standards (IndAS) converged with International Financial Reporting Standards (IFRS).Upon its release, the new guidance spotlighted several industries likely to see substantial effects of the rules. The most highlighted and noted one on that list was, undoubtedly, the real estate sector.
At present, there isn’t a separate accounting standard in India for recognition of revenue from the sale of real estate transactions. Currently, accounting principles for such transactions has been based on specifications in AS 9, Revenue Recognition and AS 7, Construction Contracts, as supplemented by the Guidance Note (2012 GN) on Accounting for Real Estate Transactions, as issued by the Institute of Chartered Accountants of India in 2012. According to 2012 GN, it is compulsory to apply the Percentage of Completion (POC) method in most of the cases for determining eligibility of real estate transactions for revenue recognition. This was a huge change for some real estate developers at that time.
The new guidance means more big changes are on the way. However, based on the convergence roadmap MCA announced earlier this year (IFRS Convergence Roadmap for Indian Companies), the IndAS are only to be applied by the listed companies/unlisted companies with more than INR250 crores (a unit in the Indian numbering system equal to ten million) of net worth in two phases beginning with the fiscal year 2016-17.
The revenue recognition standard under IndAS (IndAS – 115) is in line with IFRS 15 on Revenue from Contracts with Customers. IFRS 15 and its equivalent standard under U.S. GAAP, which are likely to be deferred by one year, (FASB moves forward on One Year Delay) are set to replace the revenue recognition practices across the globe. These rules are expected to be applied by companies following IFRS or U.S. GAAP from 2018 onwards. Whereas, IndAS 115 has already been informed and is applicable to companies in India converging with IndAS from FY 2016-17.
One of the noteworthy changes in IndAS 115 as compared to the current revenue recognition practices of real estate developers is the absence of bright lines in IndAS 115. IndAS 115 introduces a new principle-based approach to determine whether revenue should be recognized over time (same as POC) or at a point in time (same as completed contract type accounting).
Appropriate criteria for real estate developers to recognize revenue over time is when the seller creates an asset which could not be directed to another customer. In that case, the customer has an obligation to pay for the entity’s work to date.
The following part of such criteria is more challenging to meet and in the event a contract is cancelled by the customer, at that point in time the developer must have a right to collect costs incurred plus a profit margin. Let’s say, for example, a buyer does cancels the contract. If the developer takes back the property and forfeits part of the deposit paid by the buyer, then the criteria described isn’t satisfied, resulting in revenue recognition at a point in time.
As you can see, IndAS 115 will require a very thorough evaluation of contract terms. Small differences in these terms could have a significant impact on the pattern of revenue recognition.
Even after an entity concludes revenue should be recognized over time under IndAS 115, it would still need to consider how to measure progress toward completion. The main issue in IndAS 115 is the lack of free choice in measuring POC based on input vs. the output method. That method also requires exclusion of any goods and services for which the entity does not transfer control to the customer. Hence, the POC may be affected by whether or not control of the land on which the property is being constructed is transferred to the buyer (and the timing of that transfer).
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