Real Estate - Building transparency, brick by brick: Edelweiss

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In the absence of mandated guidelines, Indian real estate developers have been following different policies for recognition of revenue/expenses, making comparisons among sectoral players difficult. ICAI recently issued a draft guidance note for recognition of revenue by real estate developers effective FY13. If recommendations of the exposure draft are adopted in the current format, the initial revenue recognition for most real estate companies will be delayed. Further, the draft contains stringent norms for de-recognition of revenues in case payments are not recognised from customers.

Lack of uniform guidelines makes financials incomparable

In the absence of specific guidelines for recognition of revenues, real estate companies follow different methodologies for accounting revenues, varying from determining threshold levels for initial revenue recognition and inclusion of land cost for calculating the stage of completion. This makes the comparison of financials among various real estate developers unwieldy.

New norms to clear ambiguity, make revenue recognition stringent

Once accepted, new norms will mandate real estate companies to recognize revenue as per the percentage of completion method (PoCM). Initial revenues as per new norms can be  recognised only - when all critical approvals for projects are in place, a minimum of 25% of the total construction cost has been expensed and 25% of the project has been sold (with at least 10% of revenues as per contractual agreement realised ). 

Revenue de-recognition becomes strict as cash flow holds key

In the current scenario, real estate developers continue to recognise revenue from transactions irrespective of whether the actual cash flow is being realised from the customer or not. New norms provide for more stringent accounting norms which state that in case of a default by the customer in making payments as per the contractual agreement, revenues with respect to such a transaction must be derecognised. Hence all companies which today have a significant amount of debtors outstanding as a percentage of revenue will be adversely impacted.