“WORK IN PROGRESS & REVENUE RECOGNITION IN THE CASE OF BUILDERS & DEVELOPERS”

TAX TALK-14.01.2013-THE HITAVADA

TAX TALK  

BY CA. NARESH JAKHOTIA

Chartered Accountant

“WORK IN PROGRESS & REVENUE RECOGNITION IN THE CASE OF BUILDERS & DEVELOPERS”

Query 1]

I have a question about how to calculate WIP (Work in Progress) in case of Builder and Developers business. Please provide any illustration if possible for the revenue recognition in the case of Builders & Developers. I have read AS 7 but could not understand. Whether WIP in first year of developers business = Land Purchase for Development + Direct Expenses incurred on such land? What will be the treatment in next year if some of the flats sold out in second year?

For example,

1.      In 2010: Rs. 20 Lacs (Land Cost) (having 10 flats), Rs. 1 Lacs (Direct Exps such as stamp duty etc), what will be WIP?

2.      In 2011: Rs. 50 Lacs sale of Flats (5 flats sold), WIP in this year? Please elaborate. [Rajesh -advrajesh_3706@hotmail.com]

Opinion:

1.      A real estate project normally get spreads over for more than one accounting period. The revenue recognition and accounting in such cases still remains a complex issue.

2.      Accounting Standard-7 issued by the Institute of Chartered Accountants of India (ICAI) in 1983 is related to the accounting for Construction Contract. Old AS-7 recognized two methods, i.e., percentage of completion method or completed contract method and an enterprise had an option to follow either of the two methods. AS-7 has been revised now and it recognizes only the Percentage Completion Method. “Completed Contract method” no longer finds mention in the Revised AS-7. However, it may be noted that the said Accounting Standard is related to accounting for construction contracts and it would not have normally applied to builders or developers as nature of their business is not of executing construction contracts but of sale of the constructed units.
[In the opinion of Expert Advisory Committee of the ICAI reported in The Chartered Accountant (Vol. 52, No. 3) at page 232, revised AS 7 would not apply to builders carrying on construction on their own account for sale of constructed units; rather AS 9 would apply].

3.      Revenue in the case of Real estate may be recognized as per AS-9 which is related to Revenue Recognition. As per AS-9, revenue should be accounted when significant risk and rewards of ownership are transferred to the buyer. The Accounting standard on revenue recognition (AS 9) does not provide adequate clarity on timing and basis for recognizing revenue for the real estate transaction. To provide detailed guidelines, a Guidance note was issued by the ICAI in May-2006 on Recognition of Revenue by Real Estate Developers. It has been suitably revised by ICAI in February 2012 to provide for the detailed mechanism for recognizing the revenue in the case of builders & developers.

4.      As per the revised guidance note:
a] If the economic substance of the transaction is similar to construction contracts, principles of AS-7 should be applied.
b] If real estate transaction is in principle similar to sale of goods and services, principles of AS-9 should be applied.
In short, the Guidance note permits a developer to follow either percentage completion method or sale method depending on the nature of the transaction.

5.      In quite a few judgments the only issue was whether percentage completion method or completed contract method is appropriate for a builder and it has been held that completion method is appropriate, if regularly followed by assessee.

6.      For ease of reference and access, I have uploaded the revised “Guidance Note on Accounting for Real Estate Transactions” at www.nareshjakhotia.blogspot.com.

7.      On the basis of information and data provided by you, in your specific case,
a] In the first year, WIP would be land cost plus direct expenses incurred thereon i.e., Rs. 21 Lacs.
b] In the second year, subject to AS-9, the profit on 5 Flats sold will be recognized and the balance proportionate amount of WIP would be carried forward.

Query 2]

I have a demat a/c with ICICI Bank for a long period. I have made transaction in this A/c up to financial year 2011-12 only. There is no transaction whatsoever in the financial year 2012-13. Am I eligible for deduction under section 80CCG if I invest Rs. 50,000/- in RGESS scheme in the current financial year? If not, what is the alternative to get this benefit?

[S.C.Singh- s_ch_singh@yahoo.co.in]

Opinion:

Deduction u/s 80CCG (RGESS) is available only to New Retail Investors, identified on the basis of their PAN numbers.

Following residents Individual shall be considered as “New Retail Investor” under the RGESS:  

a.       any individual who has not opened a demat account and has not made any transactions in the derivative segment as on the date of notification of the Scheme;

b.      any individual who has opened a demat account before the notification of the Scheme but has not made any transactions in the equity segment or the derivative segment till the date of notification of the Scheme, and

c.      any individual who is not the first account holder of an existing joint demat account shall be deemed to have not opened a demat account for the purposes of this Scheme

In your specific case, since you already have a demat account and have done the transactions as well, you will not be considered as “New Retail Investor” and will not be entitled for deduction u/s 80CCG.