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Guidance Note on recognition of revenue by real estate developers


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Guidance Note on Recognition of Revenue by Real Estate Developers .

The following is the text of the Guidance Note  on Recognition of Revenue by Real Estate  Developers, issued by the Council of the Institute of Chartered Accountants of India.

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INTRODUCTION

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  1.  The term ‘real estate’ refers to land as well as building.              This Guidance Note recommends 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’).

 

APPLICATION OF REVENUERECOGNITION PRINCIPLESPRESCRIBED IN AS 9 TO REAL ESTATE SALES

 

  1. For recognition of revenue in case of real estate sales, it is necessary that all the conditions specified in paragraphs 10 and 11 of Accounting Standard (AS) 9, Revenue Recognition, as reproduced below, are satisfied:

 

“10. Revenue from sales or servicetransactions should be recognisedwhen the requirements as to performance set out in paragraphs 11 and 12are satisfied, provided that at the timeof performance it is not unreasonableto expect ultimate LED Lighting Wholesale collection. If at the time of raising of any claim it is unreasonable to expect ultimate collection, revenue recognition should be postponed.

 

11. In a transaction involving the sale of goods, performance should be regarded as being achieved when the following conditions have been fulfilled:

 

  1. the seller of goods has transferred  to the buyer the property in the  goods for a price or all significant  risks and rewards of ownership  have been transferred to the  buyer and the seller retains no  effective control of the goods  transferred to a degree usually  associated with ownership; and

 

  1. no significant uncertainty exists regarding the amount of the  consideration that will be derived  from the sale of the goods.”

 

  1. The real estate sales take place in a variety of ways and may be subject to different terms and conditions as specified in the agreement for sale. Accordingly, the point of time at which all significant risks and rewards of ownership can be  considered as transferred, is required to be determined on the basis of the terms and conditions of the agreement for sale. In case of real estate sales, the events, such as, transfer of legal title to the buyer or giving possession of real estate to the buyer under an agreement for sale, usually, provide an evidence to the effect that all significant risks and rewards of ownership have been transferred to the buyer.

 

It may, however, be noted that in case of real estate sales, the seller usually enters into an agreement for sale with the buyer at initial stages of construction. This agreement for sale is also considered to have the effect of transferring all significant risks and rewards of ownership to the buyer provided the agreement is legally enforceable and subject to the satisfaction of all the following conditions which signify transferring of significant risks and rewards even though the legal title is not transferred or the possession of the real estate is not given to the buyer:

 

  1. The significant risks related to the real estate have been transferred to the buyer; in case of real estate sales, price risk is generally considered to be one of the most significant risks.

 

  1. The buyer has a legal right to sell or transfer his interest in the property, without any condition or subject to only such conditions which do not materially affect his right to benefits in the property.

 

  1. Once the seller has transferred all the significant risks and rewards of ownership to the buyer and other conditions for recognition of revenue specified in paragraphs 10 and 11 of AS 9 are satisfied, any further acts on the real estate performed by the seller are, in substance, performed on behalf of the buyer in the manner similar to a contractor. Accordingly, in case the seller is obliged to perform any substantial acts after the transfer of all significant risks and rewards of ownership, revenue is recognised by applying the percentage of completion method in lighting wholesale the manner explained in AS 7,  Construction Contract.

 

  1. Paragraph 9.2 of AS 9 provides as follows:

 

“9.2 Where the ability to assess the ultimate collection with reasonable certainty is lacking at the time of raising any claim, e.g., for escalation of price, export incentives, interest etc., revenue recognition is postponed to the extent of uncertainty involved. In such cases, it may be appropriate to recognise revenue only when it is reasonably certain that the ultimate collection will be made. Where there is no uncertainty as to ultimate collection, revenue is recognized at the time of sale or rendering of service even though payments are made by installments.”

 

Accordingly, in case it is unreasonable to expect ultimate collection, the revenue recognition is postponed to the extent of uncertainty involved.

 

  1.  

 

  1. Revenue in case of real estate sales should be recognised when all the following conditions are satisfied:

 

  1. 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;

 

  1.  no significant uncertainty exists regarding the amount of the consideration that will be derived from the real estate sales; and

 

  1.  it is not unreasonable to expect ultimate collection.

 

  1. The determination of point of time when all significant risks and rewards of ownership are transferred depends on the facts and circumstances of each case considering the terms and conditions of the agreement.  In case of real estate sales, all significant risks and rewards of ownership are normally considered to be transferred when legal title passes to the buyer (e.g., at the time of the registration, with the relevant authorities, of the real estate in the name of the buyer) or when the seller enters into an agreement for sale and gives possession of the real estate to the buyer under the agreement. All significant risks and rewards of ownership are also considered to be transferred, if the seller has entered into a legally enforceable agreement for sale with the  buyer and all the following conditions are satisfied even though the legal title is not passed or the possession of the real estate is not given to the buyer:

 

  1. The significant risks related to real estate have been transferred to the buyer. In case of real estate, price risk is generally considered to be one of the most significant risks.

 

  1. The buyer has a legal right to sell or transfer his interest in the property, without any condition or subject to only such conditions which do not materially affect his right to benefits in the property.

 

  1. When the seller has transferred to the buyer all significant risks and rewards of ownership, it would be appropriate to recognise revenue at that stage subject to fulfillment of other conditions specified in paragraph 6 above, provided the seller has no further substantial acts to complete under the contract. However, in case the seller is obliged to perform any substantial acts after the transfer of all significant risks and rewards of ownership, revenue should be recognised on proportionate basis as the acts are performed, i.e., by applying the percentage of completion method in the manner explained in Accounting Standard (AS) 7, Construction  Contracts.  An example is a building or other facility on which construction has not been completed though all significant risks and rewards of ownership have been transferred pursuant to the fulfillment of conditions stated in paragraph 7 above. Another example is of a land which is yet to be developed though the seller has transferred all significant risks and rewards of ownership of the land to the buyer through an agreement for sale as per paragraph 7 above

 

  1. Whether the seller retains no effective control of the real estate transferred to a degree usually associated with ownership also depends on the facts and circumstances of  each case considering the terms and conditions of the agreement. The nature and extent of continuing involvement of the seller should be assessed to determine whether the seller  retains effective control. In some cases, real estate may be sold with a degree of continuing involvement by the seller such that the risks and rewards of ownership are not transferred. Examples are sale and repurchase agreements which include  put and call options, and agreements whereby the seller guarantees occupancy of the property for a specified period.

 

  1. In case of real estate sales, since normally the amount of consideration is specified in the agreement, no significant uncertainty exists regarding the amount of the consideration that will be derived from the sales.

 

  1. For determining whether it is not unreasonable to expect ultimate collection, a seller should consider the evidence of the buyer’s commitment to make the complete payment. Where the ability to assess the ultimate collection with reasonable certainty is lacking at the time all significant risks and rewards of ownership are transferred to the buyer, revenue recognition is postponed to the extent of uncertainty involved. For example, when the aggregate of the payments received, including the buyer’s initial down payment, or continuing payments by the buyer, provide insufficient evidence of the buyer’s commitment to make the complete payment, revenue is recognised only to the extent of realisation of the consideration provided other  conditions  for recognition of revenue are satisfied.

 

  1. An enterprise should disclose the accounting policy regarding recognition of revenue arising from the real estate sales, including the timing of transfer of significant risks and rewards of real estate which is the subject matter of sale

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