By CA. N.K. Jain For J.B. Nagar CPE Study Circle 26th November,2011
Methods of Revenue Recognition • Project Completion Method • Percentage of Completion Method
Project Completion Method A method of recognizing revenues and costs from a
long term project in which profit is recorded only when the project has been completed. In the interim period recognises only profit say 10 % on cost incurred and the same is added to WIP
Percentage of Completion Method A method of recognizing revenues and costs from a
long term project in relation to the percentage completed during the course of project.
Accountong Standards Builders Constructing his own Property or selling after
completion AS – 9 : Revenue Recognition AS- 2 : Valuation of Inventories
If units are sold during construction : Then Revenue is
recognised As per AS - 7 (revised): Construction Contracts by applying percentage of completion method
What all to include in the project cost? Land Cost, Cost of TDR Construction Cost: Cement, Steel, Sand, Bricks Etc ,
Labour Charges Other Direct Cost: BMC Charges, Rent Paid, Compensation Paid, Architect’s Fee etc. Borrowing Cost Other Allocable Cost: Site Expenses Indirect Cost : Unallocable e.g. office Expenses, Some companies (DLF) include both land and construction cost. Others ( Unitech and Oberoi) exclude the land cost and take only the construction cost Land cost may vary from 20 % to 80% of Project Cost
Conditions to start recognising revenues from a project under construction? 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 No significant uncertainty exists regarding the amount of the consideration that will be derived from the real estate sales It is not unreasonable to expect ultimate collection
Trigger point to start recognising revenues On Completion of percentage of 20% , 25% or 40% of Estimated Cost Physical Work Surveys of Work Performed
When the Risk and Reward are Transferred? On Issue of Allotment Letter On Registration of Agreement On Receipt of Payment
In the absence of statutory guidelines from the accounting regulator, companies use their own discretion.
Accounting Policy: Unitech Ltd. Time : on Agreement costs :including land cost and total estimated cost of projects under
execution, Trigger Point: 20 percent or more of the total estimated cost incurred Insufficient evidence of buyers’ commitment to make the complete payment, revenue is recognized only to the extent of realization. The estimates of the saleable areas and costs are reviewed periodically and any effect of changes in 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. The interest on delayed payment and maintenance charges are accounted for on realization due to uncertainty of recovery of the same. The Sale proceeds of the Investments held in the Subsidiaries, Joint Ventures and Associates developing Real Estate Projects are included in real estate revenue, net of cost
Orbit Corporation Ltd. Percentage
of completion is determined as a proportion of cost incurred to date (excluding property acquisition cost) to the total estimated project cost (excluding property acquisition cost) Project becomes eligible for revenue recognition when the percentage of completion of project exceeds 25%
Oberoi Realty Ltd. Completion of construction work to a certain level
depending on the type of the project. Cost of Land and / or Development Rights is not included in computing the percentage of project completion. Revenue is recognised on execution of either an agreement or a letter of allotment. The estimates being of a technical nature are reviewed and revised periodically by the management and are considered as change in estimates and accordingly, the effect of such changes in estimates is recognised prospectively in the period in which such changes are determined. Revenue is recognised net of indirect taxes.
DLF Ltd. Total sale consideration as per the duly executed, agreements to sell
/application forms (containing salient terms of agreement to sell), is recognised as revenue subject to actual cost incurred being 30 per cent or more of the total estimated project cost Estimated project cost includes cost of land/ development rights, borrowing costs, overheads, estimated construction and development cost of such properties The estimates of the saleable area and costs are reviewed periodically and effect of any changes in such estimates is recognised in the period in which such changes are determined. However, when the total project cost is estimated to exceed total revenues from the project, loss is recognised immediately Unbilled receivables: Unbilled receivables shown in “Other Current Assets” represents revenue recognised based on Percentage of completion method over and above the amount due as per the payment plans agreed with the customers
Example of Revenue Recognition
Shares Purchased to acquire the property Company ‘A’ acquires 100 % shares of Company B
P.Ltd. :Cost of Shares Purchased: Rs. 1000 Company ‘B’ having property (Capital Asset in the books of ‘B’ P.Ltd.): Book Value Rs.10
Liquidation of Company ‘B’ Step 1. Company ‘B’ P.Ltd. will go for liquidation Step 2. Company ‘A’ will get Property as distribution of
assets against cancellation of shares on ‘B’s liquidation since ‘A’ is sole owner of ‘B’
Capital Gain Implication Company ‘B’: No Capital Gain Tax on liquidation: Sec.
46(1) Company ‘A’: To pay capital gain tax on Distribution of Asset on Liquidation Capital Gain= Fair Market Value of Property on liquidation - cost of shares paid by A to Shareholders of B FMV of Property on liquidation : Rs.1050 If FMV of Property is more than the cost of shares then Capital Gain liability will arise. If FMV is less than Cost of shares , then it will be a capital Loss and not business loss: Section 46(2) =(1050-1000)= Rs.50 Capital Gain in the hands of ‘A’
Cost of Property, part of cost of Project In the books of ‘A’ FMV of Property (Rs. 1050) will be
treated as the cost of project Investment in shares of ‘B’ will become Nil on the date of Distribution of Assets on Liquidation of ‘B’. Section 55(2)(b)
Concerns: Time and hassles of liquidation? Fair Market Value of Property on the day of
distribution? Cost will be allowed in the year of distribution of assets on liquidation?
Relevant Sections of Income Tax Act Capital gains on distribution of assets by companies
in liquidation. 46(1) Notwithstanding anything contained in section 45, where the assets of a company are distributed to its shareholders on its liquidation , such distribution shall not be regarded as a transfer by the company for the purposes of section 45. (2) Where a shareholder on the liquidation of a company receives any money or other assets from the company, he shall be chargeable to income-tax under the head “Capital gains”, in respect of the money so received or the market value of the other assets on the date of distribution, as reduced by the amount assessed as dividend within the meaning of sub-clause (c) of clause (22) of section 2 and the sum so arrived at shall be deemed to be the full value of the consideration for the purposes of section 48.
Meaning of and “cost of acquisition” 55(2) [For the purposes of sections 48 and 49, “cost of
acquisition” ,— (b) in relation to any other capital asset,—] (iii) where the capital asset became the property of the assessee on the distribution of the capital assets of a company on its liquidation and the assessee has been assessed to income-tax under the head “Capital gains” in respect of that asset under section 46, means the fair market value of the asset on the date of distribution ;
