The Impact of IFRS on Indian Real Estate Industry

Authors: Bharti Chhatre and Mamta Mittal from Evalueserve

Executive Summary

Indian real estate companies are booking revenues even before they start the construction. This is possible under the currently used percentage of completion method of accounting, which allows companies to book revenues provided an agreement of sale has been signed with the buyer and a specified percentage of the project cost has been incurred. As a result, Indian real estate companies’ revenues are higher by as much as 30% as compared to the work done by them.

Evalueserve believes that adoption of International Financial Reporting Standards (IFRS) will reflect more appropriately the revenues of Indian real estate developers and their ability to deliver projects. We also believe that IFRS deals with market risks that are related to real estate projects more effectively than the percentage completion method.

Current Revenue Recognition Policies Allow Revenue Booking Ahead Of Construction

According to the percentage of completion method, developers can recognise revenues in proportion to the construction cost incurred in a year, provided the ownership of the apartment has been transferred to the buyer. Furthermore, land cost is allowed to be part of construction cost and the agreement of sale between buyer and seller is supposed to transfer the ownership to the buyer.

Let us consider the following example to understand the percentage of completion accounting method. For a project, which has total cost of $100 (of which $30 is the land cost) and revenue of $120, if a developer has incurred 30% of the total cost ($30), he/she can recognise 30% of revenue (i.e., $36). Since the land costs are usually a part of the construction cost, developers can recognise this revenue even prior to starting any construction. Hence, it is not surprising that developers have started using this provision to their advantage and have started booking revenues for projects even before any construction commenced. Table 1 shows that in 2008, revenues recognised by leading Indian real estate companies were significantly higher than the cash received from customers. Ideally, revenues should be close to the cash received from customers especially because most customer payments are construction-linked but they can exceed the cash received from customers when

• Revenues have been booked but no invoice has been raised to the customer because the company has not reached any construction milestone.
• The customer has been invoiced but the builder has yet to receive payments. Such instances were rare because during FY 08, real estate investments were appreciating and customers did not have any reason to delay payments.

Table 1: Revenues Booked versus Actual Cash from Customers

(Sources: Annual reports of companies and Evalueserve analysis)

•Cash from customers has been calculated in the following manner :

•Revenues (FY 08)-( Receivable (FY 08)-Receivable (FY 07))+ (customer advances (FY 08)-customer advances (FY 07))

For Unitech cash from customers – Gross customer advances FY 08-Gross customer advances FY 07