The latest guidance note brought out by the Institute of Chartered Accountants of India (ICAI) on accounting in real estate transactions may delay revenue bookings by realty companies and erode their profitability.
According to the note, initial revenues from a project can be recognised only when all critical approvals are in place, and 25 per cent of the project is sold. At least 10 per cent revenue realisation is yet another recommendation by ICAI.
The note applies to revenue recognition in projects which will commence on or after April 1, 2012, and also to projects which have started but revenue recognition will start on or after Arpil 1,2012.
Although such GNs are recommendatory in nature, they become accounting norms by default, auditing firms say.
“In most cases the revised GN may require deferral of revenue until the stated criteria are met. Hence for companies with a lot of projects at nascent stage, top line and bottom line may get impacted considerably,” said V Venkataramanan, partner, accounting advisory services at global audit and advisory firm KPMG.
At present, property developers start recognisng revenues at different stages of construction. The range is anything between 20 and 30 per cent of completion of a project. While the country’s largest realty developer DLF starts recognising revenues after 30 per cent of construction is complete, Unitech starts it at 20 per cent.
The different methods followed by realty companies rendered it difficult for investors to compare the financials of those companies. The new threshold of 25 per cent is expected to bring uniformity in accounting practices and bridge the gap in comparison, say analysts.
“Now all real estate companies have to adhere to the new norms,” said a senior executive of Godrej Properties which used to start booking revenues after 20 per cent of the project is constructed.
The note also excludes land costs in the calculation of minimum threshold of 25 per cent. This too is likely to impact the revenue recognistion of real estate companies such as DLF, Parsvnath Developers and others who include land costs while recognising revenues in their books.
“Unless your project is 25 per cent complete, you can not include land costs in the recognition of revenues,” says S Bhaskaran, chief financial officer at Bangalore-based Sobha Developers.
Adds a senior finance executive at DLF: “It is a question of phasing of your revenues. It will be lower at the beginning and higher at the middle and at the end,” the executive said.
According to property developers, the delay in recognition of revenues coupled with fixed costs such as salaries, interest charges, depreciation and marketing, which constitute 20-25 per cent of revenues, could erode profitability of companies.
“When you recognize less revenues and costs remain the same, profits will be lesser,” said a CFO of a Mumbai-based developer who did not want to be quoted.
At a time when real estate developers are battling falling sales, declining profits and rising costs, the new note could put more pressure on developers.
“Generally, the revised GN is expected to impact most of the real estate developers adversely and overall, could put pressure on most real estate developers,” says KPMG’s Venkataramanan.
However, Vishal J Shah, executive director, PricewaterhouseCoopers India, believes that though there could be a short term impact, in the long run, the removal of accounting discretion will set in a common base of comparison and evaluation for investors, lenders, customers and the other stakeholders.
“This would bring in a lot more confidence and greater interest from the stakeholders, particularly from foreign private equity and REIT (real estate investment trust) investors. The GN could become a key catalyst in bringing a positive image makeover for the Industry hit by the overall economic slowdown,” he said.
