Expert Advisory Committee
ICAI-Expert Advisory Committee
Options:

Query No. 34

Subject: Accounting for Revenue by a Real Estate Developer.[1]

A. Facts of the Case

1. A company (hereinafter referred to as ‘the company’ or ‘the Developer’) is a real estate developer, who has entered into a Joint Development Agreement with ‘Owners’ to develop villaments/row houses/duplex units (‘the project’ or ‘the units’). The Agreement between the Developer and the Owners (a copy of which has been supplied by the querist for the perusal of the Committee) defines the following terms:

A. ‘Revenue’ shall mean and include all the proceeds, including sales, advances/booking amount generated from the sale of the villaments/row houses/units subject to a minimum total built up area/saleable area of 7,50,000 sq. ft. together with proportionate percentage of undivided share in common areas and facilities, including all the receipts towards charges for car park and for usage of the common areas and facilities, garden area and also the terrace area but shall not include any amount received as deposits payable for State Electricity Supply Company and State Water Supply and Sewerage Board, back-up power arrangement, and other statutory deposits, if any, payable to the departments/boards at present or in the future.

B. ‘Revenue sharing’ – The term revenue sharing shall mean the ratio of 62:38 agreed between the Developer on the one hand and the Owners on the other hand.

2. Obligations of the Owner:

The Owners hereby irrevocably and exclusively (but subject to the terms contained in this Agreement) granted, permitted and licensed to the Developer and its agents, servants, associates and any person claiming through or under them to enter upon the ‘Schedule A Property’ as part of the ‘Total Lands’ immediately on execution of these presents for the development of the same as envisaged under this Agreement form the Effective Date. The Owner shall also grant the Developer a Power of Attorney for the purpose set out in Clause 13.2 of this Agreement. It is clarified that the Owners will continue to be in possession till such time as the contract is discharged by performance and the Developer will have only the right of entry to the Schedule A Property for the purpose of this contract. The Owners shall also grant the Developer a Power of Attorney to obtain the necessary approvals to carry out all the developmental work and to raise finance at any stage and to draw such loans on the security of the Developer’s share for the purpose of implementing the project excluding the Owners’ unimpaired and unimpeded entitlement to Owners’ revenue share of the project. The Owners shall not revoke the Power of Attorney as the agency created is one coupled with interest insofar as the Developer will be incurring expenditure for development of the Total Lands, based on the assurances, representations and permissions granted by the Owners.

3. The Owners, subject to the Developer's compliance with and adherence to the terms of the Agreement and similar Agreement with the Owners of ‘Schedule B properties’, hereby further agree and undertake not to disturb or interfere with the mechanism adopted in implementing the project or interrupt the construction activity carried out by the Developer and/or commit any act of omission that would result in stoppage or delay of the construction activity to be undertaken by the Developer under the Agreement.

4. Obligations of the Developer:

 

(i) The Developer has paid a refundable security deposit of Rs. 34.9 million on execution of the Agreement.

(ii) The Developer hereby agrees to prepare the necessary plans, drawings and designs for the implementation of the project (development plan) at its cost, subject to the terms of the Agreement and similar Agreement with the land owners of Schedule B properties as per all applicable laws and submit the same to the concerned Governmental authorities from whom licenses, sanctions, consents, permissions, no-objections and such other orders required to be procured and to take all approvals for implementation of the project, including the commencement approvals (‘approvals’). The responsibility for preparing the plans and obtaining the approvals shall be that of the Developer, however, subject to furnishing all necessary documents by the Owners as may be required from time to time by the planning/ licensing authorities.

(iii) The Developer shall not be required to consult the Owners while preparing plans/ drawings/ designs (development plan) to be submitted for approval in relation to the project subject to the condition that the Developer shall achieve the minimum total built - up/saleable area of 7,50,000 sq. ft. in the total lands. The Developer shall have the discretion in matters relating to the manner, method and design of construction of the villaments/row houses/units and the execution of the project as per the specifications specified.(Emphasis supplied by the querist.)

(iv) The Developer shall have the right to make additions, deletions and alterations to the plans/ drawings/ designs (development plans) submitted subject to such additions, deletions and alterations being permissible under applicable laws and as may be required by the concerned Government authorities and the assurances that the Developer will achieve the minimum total built up/saleable area of 7,50,000 sq. ft. in the total lands and accordingly, the Developer is entitled to carry out the constructions as may be deemed fit to give effect to the terms of the Agreement.

(v) The Owners shall co-operate with the Developer in preparation and submission of plans/ drawings/designs (development plan) whenever so called upon by the Developer in writing and; however, all the cost, howsoever, in this regard shall be borne by the Developer.

(vi) The Developer shall commence construction of the project immediately upon receipt of all the commencement approvals, including the commencement certificate issued by the concerned Governmental authority. The Developer shall immediately on the execution of the Agreement, be entitled to carry out civil works such as, conducting surveys, installing security mechanism (including placing security personnel) and laying roads, drains, pathways, etc.

(vii) The Developer shall be entitled to engage architects, engineers, contractors and other professionals and workmen as it deems fit to execute the construction work. The Developer shall be solely liable for penalties levied by the Government authorities, any defect in quality of construction and shall also be liable for all actions and proceedings, commenced, prosecuted and continued in the event of any deviations in constructions or quality of construction.

(viii) All the costs in relation to developing and implementing the project, including the costs of obtaining the approvals, fees payable to Government authorities, the architects, contractors, staff and workmen, the cost of constructions and to complete developments shall exclusively be borne and paid for by the Developer.

(ix) The Developer shall secure project completion within a period of 42 months from 31st December, 2012. The Developer shall be entitled to a period of 6 (six) months beyond the period of 42 months as ‘grace period’.

(x) Minimum sale price - The Developer shall determine the sale price of the villaments/row houses/units subject to the condition that the minimum sale price of the villaments/row houses/ units shall not be less than Rs. 5,500/- (Rupees five thousand five hundred only) per sq. ft. The Developer shall take all necessary measures/steps to market the villaments/row houses/units at the rate of Rs. 5,500/- (Rs. Five Thousand five hundred Only) per sq. ft. or at higher rate and in such event the revenue shall be shared as agreed above.

(xi) The Developer and the Owners undertake and declare that· all the revenue received from the sale of the villaments/row houses/units shall be solely and only deposited into/ credited to the joint escrow account opened with the bank by mutual consent till the date of completion of the sale of all the villaments/row houses/units in the project.

(xii) The Developer and all the Owners/the Adjacent Land Owners together shall simultaneously with the opening of the escrow account instruct the bank to transfer by RTGS/NEFT (or such bank transfer) to the Developer’s and the Owners'/Adjacent Owners’ designated accounts every fortnight in their respective revenue sharing ratio.

5. Default by Developer:

The Developer agrees and covenants with the land owners to comply with and deliver the following to ensure project completion as envisaged under this Agreement within a period of 24 months from the effective date:

  • To obtain all permissions, sanctions, approvals, clearances, commencement certificate, including necessary sanctioned building plan from all concerned departments/ boards/authorities and Government agencies;
  • To commence construction of villaments / row houses / units in the total lands as per plans/drawings sanctioned by the competent authorities;
  • To appoint appropriate banks as ‘escrow agent’ and to conclude the tripartite escrow agreement as contemplated under this Agreement;
  • To set-up marketing office in the total lands and to put in place all marketing strategies and practices for the effective marketing of the villaments/row houses/units; and
  • To commence sale of the villaments/row houses/units.

    That in the event of such default by the Developer, the land Owners shall be entitled to insist upon the Developer to execute necessary Sharing Agreement demarcating and allotting the villaments/row houses/units to each of the individual land Owners in proportion to the percentage as mentioned in clause 8.1 of the Developer’s undertaking to complete such villaments / row house/units identified for each of the land Owners on priority and deliver possession of such villaments/ row houses/units to the individual land Owners within 42 months and a grace period of 6 months from the effective date as mentioned in this Agreement.

    The Developer shall be exclusively liable and responsible towards Governmental authorities for compliance of any of the statutory requirements in relation to development of the lands.

    The Developer shall be exclusively liable and responsible for any damage/injury caused to any human being or labours/employees due to the negligence or any other reasons while executing the project/construction and the Owners shall not be liable for any of the aforesaid acts.

    The Developer shall complete the project in accordance with the terms of this Agreement. Any dispute between the Developer and their contractors, sub-contractors, labour, agents, employees, Government authorities etc., shall be settled at the earliest by the Developer at its own cost and the Developer shall keep the Owners completely indemnified against all losses, claims and consequences that the Owners may be exposed.

6. The company has also entered in to a General Power of Attorney (GPA) with the land Owners which has the following key clauses:

 

  • To appear and represent the Owners before various Government authorities and apply for and to obtain necessary construction approvals;
  • To entrust/assign the development work to such person(s) or companies as deemed fit by the Attorney.
  • To apply for and to obtain from the concerned authorities, Plan Sanctions, No Objection Certificates, Commencement Certificate, Occupation Certificate, Completion Certificate and other Certificates, Permissions, Orders etc. as may be required, in respect of the building/buildings to be constructed and completed on the Schedule Properties.

    To apply for and secure from the concerned authorities, electricity, water and sanitary connections, any other requirements to the buildings to be constructed in the Schedule Properties.
  • To raise, borrow funds from banks, financial institutions and other public by creating equitable and other mortgages on security of the Developer's revenue share in terms of the Development Agreement, and to sign and execute requisite mortgage deeds and other conveyances required thereof.
  • To consequently sign and execute any agreement(s) to sell, sale deed/s, amalgamation deed and other conveyance(s) in favour of the aforesaid purchaser(s) and/or transferee(s) or his/her/their nominee(s) or assignee(s) on such terms and conditions as our attorney(s) deem(s) it fit in respect of Developers' undivided share in the schedule properties with or without Developers' share of villaments/row houses.

 

7. Recognition of Revenue:

The company proposes to account for the gross revenue realised from the sale of villaments/row houses/units as revenue in its books. Subsequently, the obligation of the company to pay the land Owners would be accounted as cost in its books (emphasis supplied by the querist).

8. The company proposes to account for gross revenue realised due to the reason that in substance, goods and services have been received in exchange for goods and services supplied (land received and villaments sold as quid pro quo) and also there is no agency relationship between the Developer and the Owners.

9. The company places reliance on the following:

A. Paragraph 73 of the Framework for the Preparation and Presentation of Financial Statements, issued by the Institute of Chartered Accountants of India spells out as follows:

“The definition of income encompasses both revenue and gains. Revenue arises in the course of the ordinary activities of an enterprise and is referred to by a variety of different names including sales, fees, interest, dividends, royalties and rent.”

B. Paragraph 76 of the Framework spells out as follows:

“Various kinds of assets may be received or enhanced by income; examples include cash, receivables and goods and services received in exchange for goods and services supplied. Income may also result in the settlement of liabilities. For example, an enterprise may provide goods and services to a lender in the settlement of an obligation to repay an outstanding loan.” (Emphasis supplied the querist.)

C. Paragraph 4.1 of Accounting Standard 9 states that

“Revenue is the gross inflow of cash, receivables or other consideration arising in the course of the ordinary activities of an enterprise from the sale of goods, from the rendering of services, and from the use by others of enterprise resources yielding interest, royalties and dividends. Revenue is measured by the charges made to customers or clients for goods supplied and services rendered to them and by the charges and rewards arising from the use of resources by them. In an agency relationship, the revenue is the amount of commission and not the gross inflow of cash, receivables or other consideration.” (Emphasis supplied by the company.)

10. The company believes that there is no agency relationship between itself and the Owners due to the following reasons:

 

(a) The company is responsible for providing the goods and services desired by the ultimate customer, and takes responsibility for fulfillment of an order.

(b) The company has risks and rewards of ownership, such as the risk of loss for collection (credit risk other than for the commission or fee).

(c) The company has general inventory risk before delivery or after return, or inventory risks during shipping.

(d) The company has discretion in establishing price.

(e) The company changes the product or performs part of the service.

(f) The company has discretion in supplier selection.

(g) The company is involved in the determination of product or service specifications.

Further, it is Developer who fully executes the project, incurs costs, obtains certificate of completion, and fixes the sale price. The Agreement specifically mentions that no agency is created. There is a reference in paragraph 4 of AS 9 as to the treatment of sale proceeds distinguishing an agency situation. The Developer has risks and rewards. The querist is of the view that only the gross realisation in the statement of profit and loss will reflect the total efforts of the Developer who has ‘complete control’ over the land and the amount he passes on to the Owner is only a ‘cost’ and must be shown as an expenditure as a separate item. The Schedule VI to the Companies Act, 1956 also requires that full value of sales should be shown – notwithstanding any overriding requirement that any expenditure in the nature of revenue sharing is to be incurred by the Developer. The Developer is a substantial stakeholder as it has been given full control over the land which is in effect ‘possession’ coupled with interest on the land.

B. Query

11. The querist has sought the opinion of the Expert Advisory Committee as to whether or not the method of accounting for gross revenue realised is appropriate as the company has the obligation by virtue of the agreement to effect sales, credit the proceeds to an escrow account and is incurring risks and obtaining rewards.

C. Points considered by the Committee

12. The Committee restricts itself to the issue raised by the querist in paragraph 10 above regarding the accounting for the gross revenue as the revenue of the Developer. The Committee has not touched upon any other issue that may arise from the Facts of the Case, such as, the method of accounting followed by the Developer for the development project, i.e., the ‘Completed Contract Method’ or the ‘Percentage of Completion Method’ as enunciated in Accounting Standard (AS) 7, ‘Construction Contracts’, notified under the Companies (Accounting Standards) Rules, 2006, (hereinafter referred to as the ‘Rules’) and the Guidance Note on Accounting for Real Estate Transactions (Revised 2012), issued by the Institute of Chartered Accountants of India, timing of recognition of revenue, etc.

13. The Committee notes from the Facts of the Case that in the extant case, there are two parties, viz., the Owners of the land and the Real Estate Developer, who have entered into a contractual arrangement for development of real estate property in order to obtain benefits by sharing the revenue arising from the sale of units so developed in the agreed ratio. Further, the Committee notes the following key features of the Agreement between the two parties:

(a) The “Revenue” refers to “all the proceeds, including sales, advances/booking amount generated from the sale of the Villaments/Row Houses/Units…” (paragraph1.1w). Further, the Agreement contains the provision relating to “Revenue sharing” between the parties in the ratio of 62:38, which essentially indicates that there is a project involving development of property in respect of which the revenue will be shared in the agreed manner between the Owners of the land and the Real Estate Developer.

(b) The share of obligations and duties, each party has to perform, are predetermined in the sense that the Developer is to obtain the permissions and approvals to commence construction, to construct the Villaments/Row Houses/Units, to arrange for the funds, and to sell the said units constructed (paragraph 8.9.1 of the Agreement); and the Owner shall provide the total land with clear and marketable title which is free from encumbrances.

(c) Similarly, financial contribution by both the parties is also predetermined in the sense that the Developer will arrange for the financial resources required for the development of property while the Owners shall fund the project by contributing their land.

(d) As per paragraph 8.4 of the Agreement, all the revenue received from the sale of the units shall be deposited only into the Joint Escrow Account till the date of completion of the sale of all the units in the Project which will be transferred by the bank to the Developer’s and the Owners' accounts every fortnight in their respective revenue sharing ratio. In other words, none of the party has a sole control on the revenue collected.

(e) Paragraph 8.7.2 of the Agreement provides that the Developer cannot execute the sale agreement of any unit constructed without the Owners. This indicates that the Owners possess the ownership rights till the sale of property and the Developer does not have full control on the same.

(f) Paragraph 8.9.3 of the Agreement provides that in the event of default by the Developer to achieve any or all of the specified tasks, viz., to obtain permissions, to commence construction or to commence sale, etc. within specified period, the Owners can insist the Developer to execute necessary Sharing Agreement, allotting the units to the Owners in their specified proportion and undertaking to complete and deliver possession of such units within the period specified. Further, as per paragraph 8.9.6 of the Agreement, in case of unsold units, the Owners and Developer shall be entitled to execute all appropriate Agreements for their respective share as per the Agreement at the price as they may negotiate and settle with the prospective purchases. Thus, the Owners and Developer jointly share the risks and rewards associated with the developed property.

(g) Paragraph 25.6 of the Agreement provides that neither party is entitled to assign its right or obligation under the Agreement without the prior consent of the other party. Thus, none of the party can exit from the Agreement without the consent of other party.

(h) Paragraph 8.8 of the Agreement further provides that the Owners’ revenue share shall be the Owners exclusive property. Paragraph 22 of the Agreement also provides that the Developer can raise finance and draw loans on the security of the Developer’s share. These indicate that the Developer has no right and control on the share of the Owners’ revenue.

 

On the basis of the above, the Committee is of the view that in the extant case, in substance, there is a contractual arrangement between the Developer and the Owners to achieve benefits from the developed project (rather than getting benefits from the individual asset/activity) where both the parties are performing their respective obligations and are also earning revenue in lieu of such performance. While the Developer is earning the revenue for his development and marketing services, the Owners are earning revenue for their contribution in terms of land. Accordingly, in the extant case, for each party, revenue from sale of units will be its share in the gross consideration and not the entire consideration received.

14. With regard to the querist’s contention that the company (viz., Developer) has complete control over the land, the Committee is of the view that although the Developer in the extant case enjoys operational flexibility with regard to the project, it cannot be considered as complete ‘control’ over the land as he has to use the land only for the limited purpose of developing the units in the manner specified under the Agreement as well as due to other reasons as stated in paragraph 12 above. Accordingly, it is not correct to say that the revenue that is being passed on to the Owner is only a ‘cost’ for the Developer rather, the Committee is of the view that the amount that is being shared with the Owners is their share of revenue for the performance of obligation on their part as per the Agreement.

D. Opinion

15. On the basis of the above, the Committee is of the opinion that for the reasons stated in paragraphs 13 and 14 above, it would be inappropriate for the company to account for the gross revenue from the sale of units as revenue in its books. The company should account for only its share of the gross proceeds from the sale of the units as per the ‘Revenue Sharing’ arrangement between the Owners and the Developer.

 

___________________________

[1]Opinion finalised by the Committee on 22. 1.2014 and 23.1.2014.