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Here is how new accounting standard will affect real estate companies
KV Prasad Jun 13, 2022, 06:35 AM IST (Published)
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Summary
Being a chartered accountant, I know that accounting standards is one of the first and most important subject that is taught in the field. They basically are a guide to true and fair presentation of financial statements. Over the years, accounting standards have undergone a lot of changes. When I studied, we were taught Accounting …
Continue reading “Here is how new accounting standard will affect real estate companies”
Being a chartered accountant, I know that accounting standards is one of the first and most important subject that is taught in the field. They basically are a guide to true and fair presentation of financial statements. Over the years, accounting standards have undergone a lot of changes. When I studied, we were taught Accounting Standards (AS) which have now changed to IND-AS (Indian Accounting standards).
While the whole subject was pretty exciting, I was intrigued by a particular standard and that was AS-7 “Construction Contracts”. I was specifically amused by this one because companies could not account for revenues in spite of receiving the money or completing the project unless certain conditions laid down by this standard were not met. You see, its accrual world.
And then I started tracking the real estate sector and realised why this sector is analysed in a manner different than the others and how we do not look only at the P&L in case of real estate developers to analyse the performance.
This particular sector has already seen numerous accounting changes in other areas (accounting for JVs, SPVs, effective control, etc.) in FY16-17 and looks like there is room for more.
Under International Financial Reporting Standards(IFRS), revenue from contracts with customers (IFRS 15) is applicable for accounting periods beginning on or after January 1, 2018. In India, the equivalent standard to IFRS 15 is IND-AS 115. The Ministry of Corporate Affairs (MCA), on 28 March 2018, notified Ind AS 115, revenue from contracts with customers. The new standard is effective for accounting periods beginning on or after 1 April 2018.
As of now, real estate companies report accounts based on percentage of completion method. So as the projects approach particular levels of completion, revenue is recognised accordingly (usually 25% is the initial threshold).
Now, the companies will have to report accounts based on completion method. The accounting standard says, “Revenue should be recognised when (or as) an entity transfers control of goods and services to a customer at the amount to which the entity expects to be entitled.”
That basically means, revenue should be recognised once the real estate company performs all its obligations i.e. completes the project and delivers it to the buyer.
There is a five step model as stated in the standard:
- Identify the contract with the customer
- Identify the performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price to the performance obligations
- Recognize revenue when (or as) the entity satisfies its performance obligations
Brigade enterprises told CNBC-TV18 that receipt of occupancy certificate is not a pre-condition for completion of project as per the accounting standard.
What could be the possible impact on financials of real estate developers?
Financial statements will be impacted in a lot of ways, starting with their balance sheets as delay in revenue recognition will lead to bloated customer advances. P&L will be hit as developers will need to write back profits booked for on-going projects which are not 100% complete as per the standard.
In some years, we will see huge profits and in some, huge losses. This will impact the taxation payments also for these developers.
But will it impact how analysts rate the real estate companies?
Mostly no, while revenues is an important factor, performance of a real estate company is largely judged by the cash flows, collections and the construction cycle reported by the companies. Most of the listed companies have improved the disclosure standards by publishing quarterly cash flows, collections, construction spends, land/capex and approval costs.
CLSA says, adoption of the method could potentially increase the time lag between project launch/sale and revenue recognition to 4-6 years vs the current 1-3 years. Companies with higher mix of lease income will not get impacted and completed project inventory will see the least impact.
While ICICI Securities says they do not see any major impact in the net asset value calculations as these are cash flow driven depending on the collections and construction cycle of a project.
Prestige Estates in an interview to CNBC-TV18 had said that a lot of representations are made to the government authorities to let the current regime be as is, but clarity is still awaited on the same.
Till the clarity is received, real estate developers will present accounts under this standard, the impact of which will be seen starting from Q1FY19 earnings.
On a lighter note, with so many changes or modifications to the accounting standards, an accountant is bound to suffer from something an ordinary person doesn’t, i.e., depreciation.
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