Real Estate Accounting
Agreements for the construction of real estate are widespread and may relate to residential, commercial or industrial developments. Construction often spans more than one accounting period, may take place on land the buyer owns or leases before construction begins and agreements may require progress payments.
In a common real estate arrangement a buyer enters into a sales agreement with a developer to acquire a housing unit upon the completion of the contract term. The buyer generally pays some advance payments for booking, periodic installments during the term of the contract and a final payment at the time of taking possession or transferring of title.
The accounting treatment for the said arrangement varied from one developer to another, some were doing the accounting under the IAS 11 “Construction Contracts” by recording the revenue and costs by reference to stage of completion and others were recording revenue and costs a the time of handing over of the unit to the buyer.
The International Accounting Standards Board has issued IFRIC interpretation – 15 “Agreements for the Construction of Real Estate” which deals with the accounting of revenue and associated expenses by entities that undertake construction of real estate directly or through subcontractors. The interpretation deals with two issues i.e.:
1. Is the real estate agreement is within the scope of IAS – 11 “Construction Contracts” or IAS – 18 “Revenue”?
2. When should the revenue from the construction of real estate be recognized?
The interpretation assumes that before deciding on the above issues entity should make sure that their agreement with the buyer contains the clause that the entity will retain neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the constructed real estate to an extent that would preclude recognition of some or all of the consideration as revenue.
Also check whether the contract includes any separately identifiable component, if yes than the considerations of scope and revenue recognition should be applied to both the separately identifiable component individually.
The criteria to determine whether the agreements are within the scope of IAS 11 or IAS 18 is very simple, the entity should check whether the buyer is able to specify major structural elements of the design of the real estate before construction begins and/or specify major structural changes once construction is in progress (whether or not it exercises that ability). If yes than it’s within IAS 11 and if not than it is with in IAS 18.
In case the agreement is within the scope of IAS 11, revenue will be recognized with reference to stage of completion only if the outcome can be estimated reliably.
In case of IAS 18 the contract can be either for rendering of services or for sale of goods. If the entity is not required to acquire and supply a construction material the agreement may be only an agreement for the rendering of services. In the case of rendering of services revenue associated with the transaction shall be recognized in the same way as recognised in IAS 11 i.e. with reference to stage of completion only if the outcome can be estimated reliably.
If the entity is required to provide services together with construction materials in order to perform its contractual obligation to deliver the real estate to the buyer, the agreement is an agreement for the sale of goods. In that case revenue recognition criteria for sale of goods under IAS 18 will be applied which are:
1. The entity has transferred to the buyer the significant risks and rewards of ownership of the goods;
2. The entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;
3. The amount of revenue can be measured reliably;
4. It is probable that the economic benefits associated with the transaction will flow to the entity; and
5. The costs incurred or to be incurred in respect of the transaction can be measured reliably.
Revenue can only be recognized if all the above conditions are met. If the entity intends to transfer the control and related risks and rewards to the buyer during the work in progress than revenue should be recognized with respect to the stage of completion and the requirements of IAS 11 related to recognition of revenue and its associated expenses is to be followed.
If in case the entity is required to perform further work on the real estate already delivered to the buyer, it is required to recognize a liability and an expense for the work to be performed. If the amount of expense (work) cannot be estimated reliably than any consideration already received for the sale of the real estate has to be deferred (and recognized as a liability).
IFRIC 15 was issued in July 2008 and has been effective for annual periods beginning on or after January 1, 2009. Even though we do not have highly developed / regulated real estate industry in Pakistan, however, it has had its impact on the accounting being done the established developers. The introduction of IFRIC 15 has made the developers to revisit their revenue recognition policies and analyze their agreements with the buyers, as to whether the agreements are within the scope of IAS 11 or IAS 18 and account for the revenue and costs accordingly.