Large real estate companies will be forced to give elaborate details of their assets and land banks from the first quarter of the next financial year as they come under International Financial Reporting Standards (IFRS) regime from April 2011.
Big real estate companies with a net worth of more than Rs 1,000 crore such as DLF, Unitech, Peninsula Land and Puravankara Projects, among others, will report the June quarter numbers under IFRS as per the schedule approved by the government.
Other BSE Realty index constituents such as HDIL, Indiabulls Real Estate, DB Realty, Anantraj Industries, Sunteck Realty, Sobha Developers, Phoenix Mills, Parsavnath Developers, Orbit Corporation and Ackruti City will also be migrating to the regime as per the net worth criteria.
Accounting firms advising companies on IFRS believe real estate companies would face severe accounting hurdles during the transition phase.
“Real estate companies are the ones that are actually going to face a lot of problems in terms of disclosures under the IFRS regime,” Shailesh Haribhakti, chairman, BDO Consulting, told Financial Chronicle.
Jamil Khatri, executive director and head of accounting advisory services at KPMG, said only delivery-based sales and profits would be recognised under IFRS. "In certain cases, where builders have sold ongoing projects and collected a part of the money for the work completed, they will not be able to report any sale or profit in their books of account,” he said.
For tax purposes, the income-tax department has directed real estate companies to report sales using the percentage of completion method (POCM) but that will not be acceptable under IFRS, Khatri said. “Such transactions will affect the dividend distribution capability of some real estate companies and even the remuneration of managers,” he said.
“The impact on revenue recognition is surely one of the main concerns at the moment for Indian real estate companies involved in phase one of the convergence process, as accounting for construction agreements is different,” said Nicolas Ribollet, national IFRS leader at Mazars India, an accounting and IFRS consultancy firm.
“Under IFRS, sale of residential units will in most instances be accounted for as sale of goods, not as a construction contract. It means that revenue will only be recognised when the property is completed and the transfer of title and rights of ownership is done,” he said.
However, there are some real estate companies that are happy to adhere to elaborate disclosure requirements under IFRS, even when they too feel revenue recognition is an issue.
“We welcome disclosures as mandated under IFRS as we ourselves, every quarter, disclose fully audited accounts. Our disclosures are very elaborate, showing all details, and we are only concerned with the revenue recognition methodology under IFRS,” Ravi Ramu, director-finance, Puravankara Projects, said. “This is a matter that has gone to the IFRS board as this is a problem faced globally and it has to be sorted out at the highest level,” he said.
Khatri, however, said revenue recognition had been acknowledged as a problem but so far it was not on the agenda of the International Accounting Standards Board (IASB), the body that deals with IFRS norms.
Khatri told FC that the transition to IFRS was disruptive in Europe and “one may be sympathetic to the situation.” He said the government needed to respond and take a middle path.
Kumar Gera, chairman, Confederation of Real Estate Developers Association of India (Credai), said, “There will be significant change in revenue and profit reporting of listed companies who follow quarter-to-quarter financial reporting.”
“After IFRS come in, there will be a change in the perception of the people, which will in turn lead to a change in the valuation of companies,” Gera said. He, however, looked unperturbed about the proposed changes and their implementation.
“You can show surplus cash flow based on bookings and you don’t have to do profit declaration, as per IFRS norms,” Gera said, adding “many unlisted companies in the country are now following the methodology where financials are being reported on the basis of completed projects”.
There will also be inconsistency in reporting revenues and profits in the June quarter next year among listed real estate firms because only large real estate companies will adopt IFRS while smaller listed firms such as Godrej Properties and Sobha Developers will still report as per the existing accounting norms.
Khatri said the first quarter of the next financial year would see a lot of new disclosures regarding land banks and assets owned by the companies.
“A lot of real estate companies set up special purpose entities for the purpose of acquiring land, where share capital is owned by somebody else (lawyers or a legal firm) but are funded by these companies themselves. Such assets are not shown in the books of the companies unless transferred to them after the aggregation of smaller parcels of land (agricultural or otherwise) is completed,” said Khatri. “You will see that a lot of land owned by real estate companies which have not been disclosed so far in their respective books (but shown as a loan given to, say, a legal entity) will have to be disclosed much earlier now under the IFRS regime,” he said.
Also private equity investments in a “project entity” floated by real estate companies, where the PE firm agrees to exit by selling the shares back at a fixed price plus a percentage of the principle amount after a certain period, will be considered as a “borrowing” and not a sale to a third party under IFRS, said Khatri.
Such disclosures will multiply the problems faced by real estate companies as they will worsen their high debt levels. In such cases, banks will take extra caution while lending to real estate companies because debt-equity ratio would go up, leading to a possible breach of the debt agreement.
The principal objectives of the IFRS Foundation, the body that is promoting IFRS, is to develop a single set of high quality, understandable, enforceable and globally accepted financial reporting standards. IFRS are in practice in more than 100 countries. IFRS aim to enhance the efficiency of capital markets and improve the quality of information reported by entities.
The Indian government has chalked out a three-phase transition for companies to move to the IFRS regime. In the first phase, Sensex and Nifty constituents as well as both listed and unlisted companies having net worth of more than Rs 1,000 crore have to migrate to IFRS from April 2011. Indian companies whose shares are listed on stock exchanges outside India will also have to migrate to the new regime from April.
However, the Insurance Regulatory and Development Authority has given insurers an extended deadline of April 2012. Similarly, the Reserve Bank of India has directed banks to move to IFRS by April 2013.
Companies not covered in phase one and having a net worth of Rs 500 crore and above have to move to IFRS by April 2013. Other companies -- with a net worth less than Rs 500 crore -- have to migrate to IFRS by April 2014.
