Financial Daily from THE HINDU group of publications
Sunday, Sep 11, 2005
Industry & Economy
Real Estate & Construction
Corporate - Accounting Standards
Know the ground rules
M.V. Kali Prasad
The ICAI has standards for various issues in accounting but none on acquisition of real estate.
Real estate can be acquired either as a personal property (non-business) or for business as stock-in-trade or as a fixed asset. It can also function as an investment option.
Accounting for real estate depends upon the purpose of acquisition. In the absence of any standard, generally accepted accounting principles have to be followed.
Under the Transfer of Property Act, the property title does not pass to the vendee unless the sale is `conveyanced', that is, the sale deed is registered in the buyer's name (subject, however, to exceptions under section 53 A of the Act).
Cost of property
Includes the following expenses incurred:
Real estate as stock-in-trade
When a builder builds several blocks for sale, some sections may remain unsold as on the balance-sheet date. Such unsold stocks will be treated as current assets and not fixed assets. Therefore, the provisions applicable would be AS 2, and not AS 10. Any semi-finished building would merit disclosure as works in progress. Compliance with AS 7 would be more appropriate.
Revenues received by builder
Any advance payment from prospective customers will attract AS 7. AS 9 specifically excludes revenue from construction contracts.
AS 7 offers the option to choose a percentage completion method for recognising revenues. Here the accounting for contract revenue and expenses depends upon the stage of completion on the reporting date. An expected loss should, however, be recognised immediately based on prudence.
Real estate as fixed asset
Here the cost of building must be capitalised till the building is ready for occupation. All revenue expenditure, such as salaries paid to supervisors, watch and ward, etc., should be capitalised and charged to the cost of construction. Under AS 16 the interest costs on loan must also be capitalised to truly represent the cost of acquisition.
If an entity constructs a road over-bridge to help employees reach the factory on time, the expenditure must be treated as revenue and debited to staff welfare account (Panyam cements case), as no exclusive asset is formed by the entity. Similarly, if an entity uses one's own output, such as cement, to construct one's building, the cement should be charged to the building account at production cost and not at selling price.
Depreciation on land and building
It is common knowledge that land is not a depreciable asset. Land and buildings are generally clubbed together. Depreciation can be claimed only on buildings and not on land.
Real estate as investment
AS 13 dealing with accounting for investments coins a word "investment property". Here the asset should be evaluated according to the requirements of AS 13.
Real estate on lease
Real estate includes farmlands, mines, quarries, etc. When such assets are taken on lease, the accounting would depend on the type of lease. If there is an intent to transfer the property in the name of the lessee at the end of the lease period, it is called finance lease. When there is no such intent, it is called operating lease. The lessor can claim depreciation in the case of operating lease, while the lessee can claim depreciation in the case of a finance lease. But for income tax, only the lessor can claim depreciation irrespective of the type of lease.
Real estate transfers can occur during mergers and acquisitions too. AS 14 requires that all the assets of the transferor company be taken over at book value to constitute a merger. The transfer deed must be executed by the transferor company in favour of the transferee. Stamp duty depends on market rate. Whether this should be based on the book value (which would be considerably lower) or the prevailing market rate must be carefully decided by the transferee company.
AS 10 requires any profit or loss on transfer of fixed assets, irrespective of its nature, whether capital or revenue, to be transferred to the profit and loss account of the company. The Companies Act empowers a company to pay dividends out of current year profits, the nature of profits notwithstanding. Therefore, a company can well declare dividends out of profits arising on sale of real estate property.
The author is a Hyderabad-based Chartered Accountant.
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