as-7 & as-9, preparation of accounts for project specific ... · as-7 & as-9, preparation...

ASAS--7 & AS7 & AS--9, Preparation of accounts for Project 9, Preparation of accounts for Project specific specific SPVsSPVs, issues involved in audit of such entities, issues involved in audit of such entities

Presentation by P.R. RameshPresentation by P.R. RameshSeptember 1, 2006September 1, 2006

Seminar – Construction IndustryBombay Chartered Accountants Society

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CONTENTSCONTENTS

REAL ESTATE/CONSTRUCTION – NATURE OF BUSINESS

ACCOUNTING ISSUES

AUDITING ISSUES

GREY AREAS

3

Real Estate / Construction Real Estate / Construction ––Nature of BusinessNature of Business

Growth and developments in IndiaGrowth and developments in India

Types of BusinessTypes of Business

Contract TypesContract Types

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Growth and Developments in IndiaGrowth and Developments in IndiaIndian construction industry is an integral part of Indian econoIndian construction industry is an integral part of Indian economy. my.

When compared to the estimated annual output for the constructioWhen compared to the estimated annual output for the construction sector n sector worldwide at US $ 3,400 billion, India has a share of 1.75% and worldwide at US $ 3,400 billion, India has a share of 1.75% and is is expected to grow expected to grow (Source (Source –– Report by Confederation of International ContractorReport by Confederation of International Contractor’’s s Association and the United Nations Environment Association and the United Nations Environment ProgrammeProgramme in 2002)in 2002)

Indian construction industry accounts for more than 6% of IndiaIndian construction industry accounts for more than 6% of India’’s GDP and s GDP and is the second largest employer after agriculture is the second largest employer after agriculture (Source: Indian Infrastructure).(Source: Indian Infrastructure).

Government has prioritized growth in this sector and emphasized Government has prioritized growth in this sector and emphasized involvement of Private sector.involvement of Private sector.

Accordingly, the financing of infrastructure development has larAccordingly, the financing of infrastructure development has largely shifted gely shifted to the private sector, primarily through the use of Public Privato the private sector, primarily through the use of Public Private te Partnerships (PPP).Partnerships (PPP).

Investments in construction in India grew at a compound annual gInvestments in construction in India grew at a compound annual growth rowth rate of 12% during 1997rate of 12% during 1997--98 to 200198 to 2001--02, to nearly Rs.2467 billion in 200102, to nearly Rs.2467 billion in 2001--02 02 (Source (Source –– Indian Central Statistical Indian Central Statistical OrganisationOrganisation))..

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Types of businessTypes of business

RoadsRoads

Power Power

IrrigationIrrigation

Urban InfrastructureUrban Infrastructure

PipelinesPipelines

PortsPorts

Real EstateReal Estate

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Contract TypesContract TypesThere are different models currently being adopted for There are different models currently being adopted for PPPsPPPs in India in India which vary in distribution of risks and responsibility between twhich vary in distribution of risks and responsibility between the Public he Public and the private sectors for financing, constructing, operating aand the private sectors for financing, constructing, operating and nd maintaining assets.maintaining assets.

BuildBuild--OperateOperate--Transfer (BOT)Transfer (BOT)

BuildBuild--OwnOwn--OperateOperate--Transfer (BOOT)Transfer (BOOT)

Item rate contracts Item rate contracts

EPC/EPC/LumpsumLumpsum turnkey contractsturnkey contracts

Operations and Maintenance (Operations and Maintenance (‘‘O&MO&M’’) contracts) contracts

Front End Engineering and Designing (Front End Engineering and Designing (‘‘FEEDFEED’’) contracts) contracts

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Contract Types Contract Types -- BOTBOT

BuildBuild--OperateOperate--Transfer (BOT) Transfer (BOT) ––

–– Most commonly used contract typeMost commonly used contract type

–– Used in New Highway Projects, Energy and Port sectorsUsed in New Highway Projects, Energy and Port sectors

–– Two categories:Two categories:BOT annuityBOT annuity--based projectsbased projectsBOT toll based projectsBOT toll based projects

–– Contractor is provided with a concession to finance, build, operContractor is provided with a concession to finance, build, operate ate and maintain a facility for a concession period. and maintain a facility for a concession period.

–– During the life of such concession, operator collects user fees During the life of such concession, operator collects user fees and and applies it to cover the costs. applies it to cover the costs.

–– At the end of the concession period, the facility is transferredAt the end of the concession period, the facility is transferred back back to the public authority.to the public authority.

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Contract Types Contract Types BuildBuild--OwnOwn--OperateOperate--Transfer (BOOT) Transfer (BOOT) ––

–– Similar to BOT, except that here the contractor owns the underlySimilar to BOT, except that here the contractor owns the underlying ing asset.asset.

–– Used in Hydroelectric Power Projects Used in Hydroelectric Power Projects –– Asset will be transferred to the Government after the concessionAsset will be transferred to the Government after the concession

period expires as per the concession agreementperiod expires as per the concession agreement

Item rate contractsItem rate contracts–– Also known as unit price contracts or schedule contracts.Also known as unit price contracts or schedule contracts.–– Contractor bears almost no risk in these contracts, except escalContractor bears almost no risk in these contracts, except escalation ation

in the rates of items in the rates of items –– as paid according to the actual amount of work as paid according to the actual amount of work performed. performed.

EPC/EPC/lumpsumlumpsum turnkey contractsturnkey contracts–– Contractor quote a fixed sum for the entire project including, dContractor quote a fixed sum for the entire project including, design, esign,

engineering and execution per specifications approved by the engineering and execution per specifications approved by the customercustomer

–– Contractor takes the risk of incorrect estimation for the jobContractor takes the risk of incorrect estimation for the job–– Escalation clauses might exist in some cases to partially cover Escalation clauses might exist in some cases to partially cover

overrunsoverruns

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Contract Types Contract Types

Operations and Maintenance (Operations and Maintenance (‘‘O&MO&M’’) Contracts ) Contracts ––

–– Used for operating and maintaining facilities. Used for operating and maintaining facilities. –– Used in sectors such as water, highways, buildings and powerUsed in sectors such as water, highways, buildings and power–– Contract provides for Routine and Breakdown maintenance activityContract provides for Routine and Breakdown maintenance activity–– Routine maintenance is paid based on quoted rates whereas Routine maintenance is paid based on quoted rates whereas

breakdown maintenance is paid for on a costbreakdown maintenance is paid for on a cost--plus basis. plus basis.

Front End Engineering and Designing (Front End Engineering and Designing (‘‘FEEDFEED’’) contracts ) contracts --

–– FEED work is carried out as a part of consultancy to enable the FEED work is carried out as a part of consultancy to enable the Project owner to take a decision for tenderProject owner to take a decision for tender

–– FEED is also a preFEED is also a pre--requisite to enable a contractor to bid for EPC requisite to enable a contractor to bid for EPC projectsprojects

–– A FEED project can be independent consultancy project or a part A FEED project can be independent consultancy project or a part of EPC contract. of EPC contract.

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Accounting in Real Estate Accounting in Real Estate –– Unregulated ?Unregulated ?

Although one generally associates real estate dealings with mafiAlthough one generally associates real estate dealings with mafia a and its glamorous depiction in films, accounting for real estateand its glamorous depiction in films, accounting for real estate also also requires regulationrequires regulation…… as some firms are resorting to as some firms are resorting to mafia mafia accountingaccounting in terms of in terms of revenue recognitionrevenue recognition..

Accounting guidelines as they stand Accounting guidelines as they stand -- are evolvingare evolving

Tremendous growth potential has attracted Tremendous growth potential has attracted –– huge investments huge investments ––Government, Private & PPP Government, Private & PPP –– Domestic & ForeignDomestic & Foreign

Investment Climate to be sustained by transparency and good Investment Climate to be sustained by transparency and good accounting practicesaccounting practices

There is a need for prescribing robust accounting principles forThere is a need for prescribing robust accounting principles forrecognition of revenue arising from the real estate sales. recognition of revenue arising from the real estate sales.

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REAL ESTATE / CONSTRUCTION – NATURE OF BUSINESS

ACCOUNTING ISSUES

AUDITING ISSUES

GREY AREAS

CONTENTSCONTENTS

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Accounting IssuesAccounting Issues

Issues relevant to the nature of BusinessIssues relevant to the nature of Business

Substance over formSubstance over form

Current practicesCurrent practices

Accounting guidanceAccounting guidance

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Types of Accounting IssuesTypes of Accounting Issues

Revenue Recognition Revenue Recognition –– Real Estate and ConstructionReal Estate and Construction–– TimingTiming–– Extent Extent –– measurementmeasurement–– ReRe--measurementmeasurement

Profit recognitionProfit recognition

Unbundling revenues and profitsUnbundling revenues and profits

Accounting for Financing CostsAccounting for Financing Costs

Finance Lease/Operating LeaseFinance Lease/Operating Lease

Service Concession Service Concession

Continuing involvement Continuing involvement

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Types of Accounting IssuesTypes of Accounting Issues

Liquidated DamagesLiquidated Damages

Variation costsVariation costs

Joint ventures, Joint ventures, SPVsSPVs

Name lending, subName lending, sub--contracting contracting

Warranty Warranty

Disclosure and ReportingDisclosure and Reporting

Accounting guidanceAccounting guidance

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Real Estate/Construction Real Estate/Construction –– Revenue Accounting Revenue Accounting matrixmatrix

REAL ESTATE/CONSTRUCTION

FIXED ASSETS INVESTMENTSINCOME

(the main business activity -real estate developer

Based on the Based on the activities of activities of the the enterprise, enterprise, Real Estate Real Estate may bemay be

Revenue Revenue will be in will be in the form ofthe form of

PROFIT/LOSS

ON SALE OF PROPERTY

PROFIT/LOSS

ON SALE OF

INVESTMENTS

REAL ESTATE SALES/

CONSTRUCTION

Accounting Accounting guidelineguideline Accounting for

Fixed Assets AS -10

Accounting for

Investments AS-13AS- 7 +/ AS 9?

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Real Estate Revenue Real Estate Revenue –– Timing Timing

Critical to accounting for real estate transactions be it:Critical to accounting for real estate transactions be it:–– Profit/loss on sale of propertyProfit/loss on sale of property–– Profit/loss on sale of investmentsProfit/loss on sale of investments–– Real estate salesReal estate sales

is is whenwhen should the revenue be recognized, i.e.should the revenue be recognized, i.e.

-- WHEN IS THE SALE CONSUMMATED ?WHEN IS THE SALE CONSUMMATED ?

-- when are Significant Risks and Rewards of when are Significant Risks and Rewards of Ownership (Ownership (SiRROSiRRO) transferred?) transferred?

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When registration oftitle deeds takes

Place?

When consideration/payment

is realised?

When agreement to

sell is signed?

When contract periodExpires?

At Crossroads

Real Estate Real Estate ––When is sale consummated?When is sale consummated?

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Real Estate Sales Real Estate Sales –– RecognitionRecognition

Guidance Note* recommends recognition of real estate sales Guidance Note* recommends recognition of real estate sales when when allall the following conditions are satisfied:the following conditions are satisfied:

Transfer Transfer –– the seller has transferred to the buyer all the seller has transferred to the buyer all SiRROSiRRO(significant risks and rewards of ownership) and the seller (significant risks and rewards of ownership) and the seller retains no effective control of the real estate to a degree retains no effective control of the real estate to a degree usually associated with ownership. usually associated with ownership. Certainty of consideration Certainty of consideration –– no significant uncertainty no significant uncertainty exists regarding the amount of the consideration that will exists regarding the amount of the consideration that will be derived from the real estate sales and;be derived from the real estate sales and;Certainty of collection Certainty of collection –– it is not unreasonable to expect it is not unreasonable to expect ultimate collection. ultimate collection.

* Guidance Note on Recognition of revenue by Real Estate Develop* Guidance Note on Recognition of revenue by Real Estate Developers [GN(A) 23 (Issued 2006)]ers [GN(A) 23 (Issued 2006)]

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Real Estate Sales Real Estate Sales –– RecognitionRecognition

Recognition Indicators:Recognition Indicators:Agreement to sell Agreement to sell –– Terms:Terms:–– Conditions Conditions –– Timing of transfer of significant risks and rewards of ownershipTiming of transfer of significant risks and rewards of ownership–– Price risk being a significant riskPrice risk being a significant risk

Obligation to perform substantial acts Obligation to perform substantial acts –– Continuing Continuing involvement involvement -- Recognition of revenue in a situation where the Recognition of revenue in a situation where the seller is obliged to perform any substantial acts seller is obliged to perform any substantial acts after the after the transfertransfer of all of all SiRROSiRRO..

Certainty of collection Certainty of collection -- Recognition of revenue to be Recognition of revenue to be postponed to the extent it is unreasonable to expect ultimate postponed to the extent it is unreasonable to expect ultimate collection.collection.

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Obligation to perform substantial acts after transfer of Obligation to perform substantial acts after transfer of SiRROSiRRO

After the seller has transferred all the After the seller has transferred all the significant risks and rewards of significant risks and rewards of ownership to the buyer, any further ownership to the buyer, any further acts on real estate performed by the acts on real estate performed by the seller are, in substance, seller are, in substance, performed on performed on behalf of the buyer in the manner behalf of the buyer in the manner similar to a contractor.similar to a contractor.

Accordingly, revenue is recognised Accordingly, revenue is recognised by by applying the percentage of completion applying the percentage of completion method as per ASmethod as per AS--7 Construction 7 Construction Contracts.Contracts.

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Construction contracts Construction contracts –– Revenue Recognition Revenue Recognition --Percentage Completion MethodPercentage Completion Method

Para 21 (AS 7) Para 21 (AS 7) -- ““When the outcome of a When the outcome of a construction contract can be estimated construction contract can be estimated reliably, contract revenue and contract costs reliably, contract revenue and contract costs associated with the construction contract associated with the construction contract should be recognised as revenue and should be recognised as revenue and expenses respectively by reference to the expenses respectively by reference to the stage of completionstage of completion of the contract activity at of the contract activity at the reporting date. An expected loss on the the reporting date. An expected loss on the construction contract should be recognised as construction contract should be recognised as an expense immediately.an expense immediately.””

Under the percentage completion method, Under the percentage completion method, contract revenue is recognised in the Profit contract revenue is recognised in the Profit and loss account in accounting periods in and loss account in accounting periods in which the work is performed.which the work is performed.

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Construction contracts Construction contracts –– Revenue Recognition Revenue Recognition --MeasurementMeasurement

Stage of completion of a contract may be Stage of completion of a contract may be determined in a variety of methods; determined in a variety of methods; –– Proportion of contract costs incurred to Proportion of contract costs incurred to

the estimated total contract costs; orthe estimated total contract costs; or–– Surveys of work performed; orSurveys of work performed; or–– Completion of a physical proportion of Completion of a physical proportion of

the contract work.the contract work.

Progress payments and advances Progress payments and advances received from customers may not received from customers may not necessarily reflect the work performed.necessarily reflect the work performed.

If outcome of a construction contract If outcome of a construction contract cannot be estimated reliably then cannot be estimated reliably then revenue should be revenue should be recognisedrecognised only to the only to the extent of extent of contract costs incurred of which contract costs incurred of which recovery is probable.recovery is probable.

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Construction contracts Construction contracts –– Revenue Recognition Revenue Recognition -- ReRe--measurementmeasurement

ReRe--measurement arises due to initial estimation of measurement arises due to initial estimation of total coststotal costsProbability of recovery of costs if outcome of Probability of recovery of costs if outcome of construction contract cannot be reliably estimated. construction contract cannot be reliably estimated. Stage of completion may vary accordinglyStage of completion may vary accordingly

Changes in estimates Changes in estimates -- Para 37 (AS 7) Para 37 (AS 7) -- ““The The percentage of completion method is applied on a percentage of completion method is applied on a cumulative basis in each accounting period to the cumulative basis in each accounting period to the current estimates of contract revenue and contract current estimates of contract revenue and contract costs. Therefore, the effect of a change in the costs. Therefore, the effect of a change in the estimate of contract revenue or contract costs, or estimate of contract revenue or contract costs, or the effect of a change in the estimate of the the effect of a change in the estimate of the outcome of a contract, is accounted for a change outcome of a contract, is accounted for a change in accounting estimate (AS in accounting estimate (AS --5)5)……..

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ASAS--7 Construction Contracts 7 Construction Contracts ––Percentage Completion Method Percentage Completion Method -- ExampleExample

A fixed price construction contract for Rs.900 Million (Mio.) tA fixed price construction contract for Rs.900 Million (Mio.) to construct a bridge. o construct a bridge. Initial amount of revenue agreed is Rs.900 Mio. Initial amount of revenue agreed is Rs.900 Mio. It is estimated that it will take 3 years to construct the bridIt is estimated that it will take 3 years to construct the bridge.ge.By end of year 1, the contractorBy end of year 1, the contractor’’s estimate of contract costs has increased to Rs.805 s estimate of contract costs has increased to Rs.805

Mio.Mio.

820820617617209209Contract costs incurred Contract costs incurred uptoupto reporting periodreporting period

--203203596596Contract costs to completeContract costs to complete

920920920920900900Total contract revenueTotal contract revenue

820820820820805805Total estimated contract costsTotal estimated contract costs

1001001001009595Estimated profitEstimated profit

100%100%74%74%26%26%Stage of completionStage of completion

20202020--VariationVariation

900900900900900900Initial amount of revenue agreed in contractInitial amount of revenue agreed in contract

Year 3Year 3((RsRs. Mio.). Mio.)

Year 2Year 2((RsRs. Mio.). Mio.)

Year 1 Year 1 ((RsRs. Mio.). Mio.)

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ASAS--7 Construction Contracts 7 Construction Contracts ––Percentage Completion Method Percentage Completion Method –– Example (Contd.)Example (Contd.)

494925257474ProfitProfit

Year 3Year 3

239239681681920920Revenue (900 x 1.00)Revenue (900 x 1.00)

213213607607820820Expenses Expenses


Year 2Year 2

209209209209Expenses (805 x .26)Expenses (805 x .26)

447447234234681681Revenue (900 x .74)Revenue (900 x .74)

398398209209607607Expenses (805 x .74)Expenses (805 x .74)


234234234234Revenue (900 x .26)Revenue (900 x .26)

Year 1Year 1

Recognised in Recognised in the Current the Current Year Year ((RsRs. Mio.). Mio.)

Recognised in Recognised in Prior YearsPrior Years((RsRs. Mio.). Mio.)

UptoUpto the the Reporting Reporting DateDate((RsRs. Mio.). Mio.)

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Construction contracts Construction contracts –– Profit RecognitionProfit Recognition

Matching costs to revenueMatching costs to revenue

Contract costs should comprise:Contract costs should comprise:–– Direct costs specific to a contractDirect costs specific to a contract–– Overheads Overheads –– attributable to contract activity in attributable to contract activity in general and can be allocated to the contractgeneral and can be allocated to the contract

–– other costs attributable to the customer under the other costs attributable to the customer under the contract contract

If outcome of a construction contract cannot be If outcome of a construction contract cannot be estimated reliably then:estimated reliably then:–– contract costs should be contract costs should be recognisedrecognised as a Period as a Period costcost

–– expected lossexpected loss on construction contract to be on construction contract to be accounted immediately i.e. when probable that total accounted immediately i.e. when probable that total contract costs exceed total contract revenuecontract costs exceed total contract revenue

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Construction contracts Construction contracts –– Unbundling revenues and Unbundling revenues and ProfitsProfits

START

ASSET UNDER

CONSTRUCTION

CONTRACT

SINGLE

ASSET

(viz., bridge,

dam etc.,)

INDICATORS

• Separate proposals for each

asset

• Separate negotiations

• Costs and revenues can

be identified

TREAT CONSTRUCTION OF

EACH ASSET AS A

SEPARATE CONTRACT –Apply AS 7

END

No

Yes

INTERRELATED

ASSETS

(viz., refineries etc.,)

SEGMENTING CONSTRUCTION CONTRACTS

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Construction contracts Construction contracts –– Unbundling revenues and Unbundling revenues and ProfitsProfits

Issues involved:

• Contracts which are fixed price contracts/lumpsum contracts

• Involve sale of moveable assets and also rendering of services

• Recognition of revenue and profits have fiscal implications in terms of:

• Direct taxation

• Indirect taxation

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Construction contracts Construction contracts –– Combining Construction Combining Construction ContractsContracts

Group of contracts, with a single customer or with several customers, to be treated as a single contract if:

• the group of contracts negotiated a single package

• contracts so interrelated that they are part of a single Project WITH OVERALL PROFIT MARGIN

• contract performed concurrently in a sequence

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Obligation to perform substantial acts Obligation to perform substantial acts –– Continuing Continuing involvement involvement

Continuing involvement Continuing involvement -- If Seller has not transferred significant risks If Seller has not transferred significant risks and rewards of ownership and substantial acts as per contract arand rewards of ownership and substantial acts as per contract are to e to be performed be performed

Nature and extent Nature and extent –– to be assessed to determine whether the seller to be assessed to determine whether the seller retains effective controlretains effective control..

In some cases, the real estate may be sold with a degree of In some cases, the real estate may be sold with a degree of continuing involvement by the seller such continuing involvement by the seller such that the risks and rewards that the risks and rewards of ownership are not transferred.of ownership are not transferred.Examples: Examples:

1.1. Sale and repurchase agreements with put and call options.Sale and repurchase agreements with put and call options.2.2. Agreements whereby the seller guarantees occupancy of the Agreements whereby the seller guarantees occupancy of the

property for a specified period. property for a specified period.

In the Indian context, there is no specific accounting guidance In the Indian context, there is no specific accounting guidance on on how such situations of continuing involvement should be dealt wihow such situations of continuing involvement should be dealt with.th.

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Real Estate Sales Other than Retail Land Sales Real Estate Sales Other than Retail Land Sales **

Seller has an obligation to repurchase the property; then the Seller has an obligation to repurchase the property; then the transaction shall be accounted as transaction shall be accounted as financing or profit sharing financing or profit sharing arrangement rather than a salearrangement rather than a sale

Seller is a general partner which acquires an interest in the Seller is a general partner which acquires an interest in the property sold; shall be accounted as property sold; shall be accounted as financing or profit sharing financing or profit sharing arrangement rather than a salearrangement rather than a sale

Seller guarantees the return on buyers investment or return on Seller guarantees the return on buyers investment or return on that for a limited or extended period; if limited period then that for a limited or extended period; if limited period then should be accounted under deposit method, if extended period should be accounted under deposit method, if extended period then as then as financing or profit sharing arrangement rather than a financing or profit sharing arrangement rather than a salesale

* Accounting guidance from US GAAP FAS 66* Accounting guidance from US GAAP FAS 66

Continuing involvement Continuing involvement –– EgEg: Finance Lease/Operating : Finance Lease/Operating LeaseLease

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Seller is required to initiate or support operations or Seller is required to initiate or support operations or continue to operate the property at its own risk; continue to operate the property at its own risk; then profit is then profit is recognisedrecognised based on the service level based on the service level agreements i.e. the nature of the support obligation,agreements i.e. the nature of the support obligation,

–– BOTBOT–– BOOTBOOT–– O&MO&M

Continuing involvement Continuing involvement –– Service ConcessionsService Concessions

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VariationVariation –– changes in scope of work and may changes in scope of work and may increase/decrease contract revenueincrease/decrease contract revenueClaimsClaims –– recovered from customer as recovered from customer as reimbursement of costs, not included in contract reimbursement of costs, not included in contract pricepriceIncentivesIncentives –– on meeting specific performance on meeting specific performance standards/early completion.standards/early completion.

Recognition Principle:Recognition Principle:–– if probable to if probable to realiserealise i.e. customer approves the i.e. customer approves the

variationvariation–– Capable of measurementCapable of measurement–– Negotiations at an advanced stage confirm the Negotiations at an advanced stage confirm the

status of the variation/claimstatus of the variation/claim

Liquidated damages, which are evidenced by Liquidated damages, which are evidenced by claims from the customer, should be provided for claims from the customer, should be provided for on a conservative basis / when there are early on a conservative basis / when there are early signs of delay not attributable to the customersigns of delay not attributable to the customer

Variations, Claims and IncentiveVariations, Claims and Incentive

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Joint venture: Joint venture: If construction activity is If construction activity is structured as a joint venture then, to assess structured as a joint venture then, to assess whether:whether:–– Jointly Controlled OperationsJointly Controlled Operations–– Jointly Controlled AssetsJointly Controlled Assets–– Jointly Controlled EntitiesJointly Controlled EntitiesAccounting for the above is governed by Financial Accounting for the above is governed by Financial

Reporting of Interests in Joint Ventures Reporting of Interests in Joint Ventures -- ASAS--27.27.

If an SPV has been floated then accounting for If an SPV has been floated then accounting for the investments will be as per:the investments will be as per:–– Investments under ASInvestments under AS--13 or13 or–– Subject to consolidation under AS Subject to consolidation under AS --21 or 21 or –– Accounting for investments in Associates AS Accounting for investments in Associates AS ––

2323

Revenue and profit recognition principles will apply Revenue and profit recognition principles will apply to the transactions in so far as the activities of to the transactions in so far as the activities of the enterprise are concerned.the enterprise are concerned.

Joint ventures, Joint ventures, SPVsSPVs etc.,etc.,

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Accounting policy regarding revenue Accounting policy regarding revenue arising from real estate salesarising from real estate salesMethods used to determine contract Methods used to determine contract revenuerevenueMethods used to determine the stage of Methods used to determine the stage of completion completion WIP WIP -- For contracts in progress, For contracts in progress, aggregate amount of costs incurred and aggregate amount of costs incurred and recognisedrecognised profitsprofitsReceivablesReceivablesUnbilled revenueUnbilled revenueAdvances received from customersAdvances received from customersRetentionsRetentions

Real Estate and Construction Real Estate and Construction -- Disclosure and ReportingDisclosure and Reporting

36

Substance over formSubstance over form

Transfer of Property Act, 1882Transfer of Property Act, 1882–– Sales of immovable property Sales of immovable property –– Sale is a transfer of Sale is a transfer of

ownership tangible immovable property can be made ownership tangible immovable property can be made only a registered document.only a registered document.

–– Per section 53Per section 53--A A –– Notwithstanding where there is an Notwithstanding where there is an instrument of transfer and the transfer is not completed, instrument of transfer and the transfer is not completed, if there is an agreement to sell, the transferor shall be if there is an agreement to sell, the transferor shall be debarred from enforcing against the transferee any right debarred from enforcing against the transferee any right in respect of the property of which the transferee has in respect of the property of which the transferee has taken or continued in possession, other than a right taken or continued in possession, other than a right expressly provided by the terms of contract.expressly provided by the terms of contract.

Power of Attorney transactionsPower of Attorney transactions

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Current Practices Current Practices ––Snapshots of Revenue accounting policies and issuesSnapshots of Revenue accounting policies and issues

ABCxxx Developers Limited

Extract of the Notes forming part of the restated summary statements

Accounting Policies

e. Revenue Recognition

i. Revenue from Projects is recognized on the “Percentage of Completion Method’of accounting. Revenue is recognized, in relation to the sold areas only, on the basis of percentage of actual cost incurred thereon including land as against the total estimated cost of the project under execution subject to such actual costs being 30% or more of the total estimated cost. The estimates of saleable area and costs are revised periodically by the management. The effect of such changes to estimates is recognized in the period such changes are determined.

ii. Income from construction contracts is recognized by reference to the stage of completion of the contract activity at the reporting date of the financial statements. The related costs there against are charged to the profit and loss account of the year.

iii. Income from license fee is recognized on accrual basis in accordance with the terms of agreement with the sub-licensee.

(Source Red Herring Prospectus - 2006)

38

ABCxxxx Developers Limited

Extract of the Notes forming part of the restated summary statements

4. Qualifications in auditors report

The Statutory Auditors of the Company TTT & Co.Chartered Accountants for the year ended 31 March 2005 have included qualification in their auditors report on the accounts. This is reproduced below:

“In term of long term contracts and building projects, we have relied upon the Management’s estimates of percentage of completion and cost of completion owing to the technical nature of such estimates on the basis of which revenue has been recognised.”

Since the effect of the qualification has not been quantified, it has not been possible to adjust the differences in the ‘Statement of Restated Assets and Liabilities’ and the ‘Statement of restated Profits and Losses’.(Source Red Herring Prospectus - 2006)


39

XYZxxxxx Limited

Extract of the Accounting Policies

6. Sales

Sale of land and plots is recognized in the financial year in which transfer is made by registration of sale deeds or otherwise in favour of the buyer.

Revenue from constructed properties is recognized on the ‘Percentage of Completion Method’ of accounting. Revenue comprises the aggregate amounts of sale price in terms of the agreement entered into and is recognized on the basis of percentage of actual costs incurred thereon, including land and total estimated construction and development cost of Projects under execution subject to such actual costs being 30%or more of the total estimated cost. The estimates of the saleable area and costs are reviewed periodically by the Management and any effect of changes in the estimates is recognized in the period such changes are determined. However, when the total project cost is estimated to exceed total revenues from the Project, the loss is recognized immediately. (Source Red Herring Prospectus - 2006)


40

XYZxxxxxx Limited

Extract of the Notes to the Statements of Assets and Liabilities and Profits and Losses as restated

1. Adjustments resulting from changes in accounting policies and estimates

During the year ended March 31, 2006, the Company changed the accounting policy for recognising revenue on constructed properties from converging to percentage of completion method. This change has been adopted pursuant to the Guidance Note on Recognition of Revenue by Real Estate Developers, issued by the ICAI. The cumulative effect of this change has been recorded in the year ended March 31, 2006. Accordingly, revenue for sale of constructed property has been recomputed for the years ended March 31, 2002, 2003, 2004, 2005 and 2006. Further the accumulated profit and loss balance as at April 1, 2001 has been approximately adjusted to reflect the impact of changes pertaining to the prior year till March 31, 2001. (Source Red Herring Prospectus - 2006)


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Accounting Guidance Accounting Guidance -- Real Estate Sales Real Estate Sales –– US US GAAPGAAP

Scope: Scope:

Unlike in India, where real estate sales may be governed Unlike in India, where real estate sales may be governed by different Accounting Standards depending on the by different Accounting Standards depending on the nature of sellernature of seller’’s business, per US GAAP all real estate s business, per US GAAP all real estate sales are contained in FAS 66. sales are contained in FAS 66.

FAS 66 lays down various conditions and methods for FAS 66 lays down various conditions and methods for accounting revenue.accounting revenue.

Real estate includes real estate with property Real estate includes real estate with property improvements and integral equipment e.g. office building, improvements and integral equipment e.g. office building, a manufacturing facility, a power plant, and a refinery.a manufacturing facility, a power plant, and a refinery.

42

Real Estate Sales Real Estate Sales –– US GAAPUS GAAP

FAS 66 - Decision Tree on applicability of various methods suggested for accounting real estate transactions

Decision Tree - FAS 66.doc

43


ACCOUNTING ISSUES

AUDITING ISSUES

GREY AREAS

CONTENTSCONTENTS

44

Types of Auditing IssuesTypes of Auditing Issues

Nature of evidenceNature of evidence

Geographical dispersionGeographical dispersion

Internal vs. External evidenceInternal vs. External evidence

Timing of obtaining evidenceTiming of obtaining evidence

Reliability of Management estimatesReliability of Management estimates

45

CONTENTSCONTENTS


ACCOUNTING ISSUES

AUDITING ISSUES

GREY AREAS

46

GREY AREASGREY AREASIn the Indian contextIn the Indian context……

There will be advent of new products of real estate There will be advent of new products of real estate marketing (like in US) combined with financing which will marketing (like in US) combined with financing which will increase the complexity of the nature of businessincrease the complexity of the nature of business

Unexpected that the Guidance Note in its present form Unexpected that the Guidance Note in its present form will ensure compliance as:will ensure compliance as:–– It is not a mandatory standardIt is not a mandatory standard–– It does not provide guidance on accounting if there is It does not provide guidance on accounting if there is

continuing involvement when continuing involvement when SiRROSiRRO in real estate is in real estate is not transferrednot transferred

as-7 & as-9, preparation of accounts for project specific ... · as-7 & as-9, preparation...

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