1.2        Query

Real estate accounting.

 1A city and industrial development corporation of a state, is a company incorporated under the Companies Act, 1956. It is a wholly owned public limited company of the State Government within the meaning of Section 617 of that Act.

 2 The State Government, in exercise of its powers under sub-section 3A of section 113 of the relevant Regional & Town Planning Act, 1966, has declared the corporation as the New Town Development Authority for a new town ‘X’. To undertake this work, the corporation was established in 1970.

3. The corporation is acting as an agent of the State Government, in-so-far as development of ‘X’ is concerned, and is receiving an agency remuneration of Rs. 5 lakhs, p.a., through adjustment in the accounts. As per the terms, the Government acquires the land required for the project and vests the same in the corporation for the purpose of development. The expenditure on land acquisition is debited in Government Accounts. The corporation undertakes all the development work, provides physical and social infrastructure on behalf of the State Government and disposes of land, houses, commercial and social structures and collects service charges etc. In short, the expenditure incurred by the corporation on land development, construction of houses, shops etc., is debited to ‘X Project Account’ and the receipts realised by way of disposal of land, houses etc. is credited to ‘X Project Account’ in the books of the corporation. The net balance, i.e., excess of expenditure over income is shown under the head ‘X Project Account’ and the same is classified under the head ‘Loans and Advances’, in the balance sheet of the corporation, since the amount stands recoverable from the State Government.

4. In view of the agent-principal relationship, so far, the corporation has not prepared profit and loss account of ‘X Project Account’. Similarly, the cost of land acquired by the State Government and vested in the corporation for development is not reflected in the books of account of the corporation under ‘X Project Account’, but receipts realised by way of sale of land are shown in this account. The stock of land is also not shown in the accounts of the corporation under ‘X Project Account’.

5.As stated in para 3 above, this corporation gets agency remuneration of Rs. 5 lakhs from the Government for development of X Project. The expenditure incurred on following items is adjusted against this remuneration in the profit and loss account:

(a)        salary and allowances of managing director, company secretary and staff of corporation office;

(b)        statutory fees;

(c)        honorarium paid to chairman, and

(d)        directors fees

The Government has approved this arrangement.

(a) The project reports provide for incorporating all expenditure in the following three categories:

- Sectoral level of expenditure;

- Nodal level of expenditure; and

- City scale level of expenditure.

The entire expenditure while developing a sector is not incurred simultaneously under all the three categories, indicated above, even though lands are disposed of in a particular sector. In other words, a part of the expenditure remains to be incurred even though corresponding receipts are realised and credited in the accounts. There are also few instances where nodal level/city level expenditure is incurred in advance before sale proceeds of related lands are realised. In either case, the related expenditure/receipt, as the case may be, needs estimation.

(b)The sale entries for disposal of lands/plots are passed in the accounts on the basis of realization of sale proceeds and on the basis of letters of offer, since execution of agreements in the cases of public sector undertakings/government departments take considerably long time. This is irrespective of the fact that the related expenditure is actually not incurred for the development of the said land/plot.

8. The corporation prepared the profit and loss account, for the first time, for the year upto 1984-85, at the instance of the C & AG. For this purpose, the cost of land was worked out on average basis taking into consideration the expenditure incurred upto 31 March 1985 and to which the future expenditure likely to be incurred on land development, based on project report, was added. The total expenditure thus arrived at was divided by entire useable/saleable land. On this basis, the unsold stock of land was valued and provided in the profit and loss account. The unsold stock of tenements and shops was valued at cost of land (as per above method) plus cost of construction including the cost of overheads and interest and unsold completed constructions were valued at lower of cost or sale price.

9. The profit and loss account prepared on the above basis, brought out an anomalous position of profit/loss due to following reasons:

(a) In some cases expenditure was incurred for the entire city in advance irrespective of sale of corresponding land.

(b) Sometimes, receipts were realised for sale of plots wherein all the corresponding expenditure was not incurred.

(c) Cost of developed and undeveloped land could not be ascertained.

(d) Land was sold at different rates during the past years and that the expenditure to be incurred was provided at present day basis.

10.The C & AG also commented that the projected/future cost of land development which was yet to be incurred was provided for and included as expenditure in the profit and loss account which was not in accordance with the commercial practices. The position was, therefore, again reviewed and following principles were adopted for the preparation of profit and loss account during 1985-86.

(a)        Land development cost- Besides the actual expenditure incurred during 1985-86, the balance expenditure on awarded value of contract work of physical infrastructure as on 31^st March, 1985, was provided for.

(b)        In respect of related expenditure on physical and social infrastructure for various schemes which were executed at new towns, the expenditure on the basis of the estimated value had been worked out and the same is provided in the accounts, since receipts for the corresponding sale of plots, sale of tenements etc. were exhibited in the accounts. The items included in the estimates were based on the review of balance work of the above nature which had so far not been undertaken in various saleable areas for which necessary receipts were accounted for in the profit and loss account. The difference between the method adopted last year and this year was that the expenditure was provided for on the basis of review of balance items of work on block basis, i.e., without preparation of detailed estimates of expenditure, in specific areas, rather than the entire balance area, as was done last year.

(c)        Housing: The balance expenditure on the basis of awarded value was provided in respect of houses which are nearing completion.

(d)        Valuation of stock: The closing stock included the following items:

            Unsold tenements

            Unsold shops and stalls

            Saleable land

            Tenements under construction

            Shops/stalls under construction

            Janata Bazar under construction

- Unsold tenements and shops etc., were valued at sale price/ average price for similar tenements/shops.

                        - Saleable undeveloped land was valued at land acquisition cost including provision for payment not made divided by total saleable land.

                        - Saleable developed land was valued at average sale price approved by the Board. Land in new towns had mostly been disposed of at a fixed price based on reserve price so as to ensure that entire cost of land development, overheads, interest and other charges were fully recovered.

                        - Tenements/shops, stalls under construction had been valued at land cost plus actual cost of construction upto 31^st March plus overheads. The overheads for tenements meant for economically weaker sections and lower income group under HUDCO loan assistance schemes had been taken at 6% of capital cost and at 10 per cent in other cases.

11.In view of the above change in the policy of valuation of balance stock of land, the cost of assets had been revalued. The above method was also commented upon by the statutory auditors, as in this method, the estimated expenditure had been provided on block bases. The presentation of annual accounts, therefore, remained deficient.

12. As regards valuation of closing stock of tenements, shops, stalls under construction, it is now proposed to follow the method as under:

(a) Actual cost of construction including provision for expenditure for work done during the year 1986-87 (i.e. upto 31.3.87).

(b) Land cost will be added based on land acquisition cost plus land development cost plus provision for balance land development cost on estimated basis for on-site and off-site infrastructure. The allocation of provision for expenditure for off-site infrastructure will be on the basis of allocation of areas of total saleable land.

(c) Overheads will be charged as indicated in para 10 above, i.e., at fixed rate of 6% of capital cost for lower income category of tenements and at 10% of capital cost for others.

(d) An element of profit/surcharge based on sale price for proportionate progress of work will be added, e.g., tenements are treated to be completed as under;

(e) The querist is of the view that this method will ensure earning of profit based on sale price throughout the period of construction based on progress of work (operation cycle is usually 24 months).

(i) Where the corporation is acting as an agent of the State Government whether it is necessary to prepare profit and lost account for ‘X Project’ and in that case how to account for land acquisition cost incurred by the State Government (Refer paras 3 and 4)

(ii) Whether the provision made for related cost of development of land on block basis, i.e., without preparation of detailed estimates in respect of areas where land is sold, will be proper in terms of commercial practice, in view of large areas involved in development of new cities/towns (Refer para 10)

(iii) Whether the method of valuation of closing stock of land (developed and undeveloped), tenements, shops, stalls (completed/under construction) is acceptable under the commercial principles followed (Refer paras 10 and 11).

  Opinion2                                                                September 13, 1988

1.With regard to ‘X Project Account’, in case of which the corporation acts as the agent of the State Government, the Committee notes that in these types of transactions, no entry is passed in respect of goods or property handed over to the agent by the principal. Thus, in present case, when land is handed over to the corporation for the purpose of development, construction of houses etc. thereon, and subsequent sale thereof, no entry needs to be passed in the opinion of the Committee. The details of land may be recorded in a register by way of a memorandum record. On sale of land, houses etc., the credit should be made to the principal’s personal account – in the present case the corporation is treating ‘X Project Account’ as the personal account of principal and accordingly credit is given to this account on such sales. Any balance in this account, if expenditure is more than the receipts should be shown as a receivable from the principal and shown in the balance sheet of the corporation. It is noted that the corporation is disclosing the same under ‘Loans and advances’. The Committee is, therefore, of the opinion that there is no need to prepare or include the receipts/expenditure on account of this project in the profit and loss account. Only the commission received from the Government should be shown as revenue in the General Profit & Loss Account, in view of the definition of ‘revenue’ given in Accounting Standard 9, ‘Revenue Recognition’, issued by the Institute of Chartered Accountants of India. The relevant extract of the said definition states: “In an agency relationship, the revenue is the amount of commission and not the gross inflow of cash, receivables or other consideration” (Para 4.1). In view of this, it is not necessary to disclose the stock of land handed over by the government to the corporation in the balance sheet of the corporation. The Committee is of the opinion that the method of accounting followed by the corporation in this regard is proper as it is broadly in accordance with the aforesaid views of the Committee.

(a)        Problem of revenue recognition, i.e., whether the entire revenue should be recognised on sale of land /plots irrespective of the fact that corresponding expenditure is actually not incurred for the development of said land/plots. If revenue is so recognised whether provision should be made for the future expenditure to be incurred on development of such land/plots on the basis of block level estimates or some other basis, in order to obtain proper matching of costs and revenues.

(b)        In case of city scale level and nodal level, expenditure has been incurred in advance, i.e., before the sale proceeds from land/plots.

(c)        Valuation of stock of undeveloped and saleable land, houses, tenements etc.

3. The Committee notes that it is generally accepted that revenue should be recognised when the performance is substantially completed in respect of an item of sale. If performance is not substantially complete, any receipts from customers in respect of such items, should be treated as revenue in advance. In order to determine whether performance has been substantially completed, all relevant factors should be taken into consideration; for example, in case of land development work, the factors could be the proportion that costs incurred to date bear to the total estimated costs, surveys which measure work performed and completion of substantial proportion of the contract work. Thus, in case of receipts on account of sale of land/plots where the land/plots have not substantially reached the saleable condition, the recognition of revenue should be postponed in order to obtain proper matching of costs with the revenue, i.e., future developmental costs should not be provided for to achieve this end.

4.City scale level and nodal level of expenditure incurred in advance, i.e., before the sale proceeds from land/plots, in view of the Committee, should be allocated to plots of land on appropriate basis and should be carried forward to the next accounting period as part of the cost of the land/plots.

5.In the opinion of the Committee, the stock of undeveloped land/plots etc. should be valued at acquisition cost plus portion of the city level/nodal level expenditure incurred during the period, if any, plus land development cost at sectoral level incurred during the period. In other words, such land/plots should be valued at actual cost and should not include the estimated future developmental expenditure on whatever basis. The Committee is also of the opinion that the stock of saleable land should be valued at lower of historical cost and net realizable value.

6.Regarding the valuation of closing stock of tenements, shops, stalls under construction, the opinion of the Committee is, that these structures should be valued at cost, i.e., actual cost of construction including provision for expenditure for work done during the year, plus land cost based on land acquisition cost including land development cost. In determining the cost of land used/useable for construction of said buildings, the cost of entire land, i.e., including that used for providing other facilities should be allocated to the land used/useable for said construction. However, provision for balance land development cost and balance expenditure for off-site and on-site infrastructure should not be included. The allocation of expenditure for off-site infrastructure for current year should be included on appropriate basis. Allocation of overheads at fixed rates in respect of lower-income category and for others, would be appropriate if such rates are indicative of the actual overheads, i.e., they are not arbitrarily fixed. Revenue in respect of closing stock of such under-construction structures can be recognised as per ‘Proportionate completion method’ in case the following conditions are fulfilled:

(a) total revenues to be received on sale of such structures can be reliably estimated;

(b) both the costs to complete the project and the stage of project performance completed at the reporting date can be reasonably estimated;

(c) the costs attributable to the project can be clearly identified so that actual experience can be compared with prior estimates (AS-7, “Accounting for Construction Contracts”, issued by the Institute of Chartered Accountants of India).

7.The Committee however feels that the percentages specified in Para 12 (d) may be appropriate only if they have been fixed keeping in view the recommendations contained in AS-7.

8. The Committee is of the opinion that completed tenements, shops etc. should be valued at lower of cost and net real usable value.

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2 See also the opinion on query no. 1.3 for further clarification.