Real Estate Accounting

Real-estate accounting is a complicated business! It is difficult to comprehend and understand. Needless to say, real estate companies in India have been criticized by analysts for a lack of transparency in their property dealings and in how they account for projects.


As the industry struggles, investors are scrutinizing companies' accounting methods and transparency. The Institute of Chartered Accountants of India (ICAI) has, in the meantime, issued a Guidance note on Recognition of Revenue by Real Estate Developers. It has suggested that companies recognise revenues for real estate sales on the basis of the percentage of completion of the project at the time of reporting. In residential real estate projects, apartments/units are typically sold before they are constructed. A significant amount of money could also have been received even though construction might not have even commenced.

Under the percentage completion method, companies do not recognise revenues until a certain minimum cost threshold is reached, which can vary from 5-10% of total budgeted costs to as much as 25% being followed by some real estate companies. Some companies include the cost of land in estimating the progress achieved, whereas other companies do not take this cost into account in determining the percentage of work done or progress made. A change in these variables can have a significant impact on the revenues and profits reported by various real estate companies that follow the percentage completion method.

At a recent real estate seminar, I met the CFO of a large real estate company and we were discussing the intricacies of the interpretation and implementation of the percentage completion method. He gave me an interesting example. Suppose you have a project with a total size of 1,000,000 sq ft out of which 200,000 sq ft has been launched and about 50,000 sq ft has been sold. Assume that the land cost is Rs 500 sq ft, estimated construction cost is Rs 1500 sq ft and the actual cost incurred till date is Rs 200 sq ft (on the 200,000 sq ft). Now, suppose you had to compute the percentage completion, the logical way would be to compute the land cost of 200,000 sqf (Rs 100 million) add the cost incurred ( Rs 40 million) and divided it by the total estimated cost (Rs 100 million land plus Rs 300 million). This comes to approximately 35% (140/400). However, there is an another method. Since you have already paid for the 1 million sq ft of land, you can essentially include the entire land cost of 1 million (Rs 500 million) in the percentage completion computation. This means the ratio becomes (Rs 500 million + Rs 40 million)/ (Rs 500 million + Rs 300 million), ie 68% instead of 35%. Essentially, you can frontload the entire land cost on a smaller phase of the project to boost up the percentage completion ratio. This enables companies to book a higher revenue since revenue booking is directly dependent on the percentage completed. Such accounting policies are technically not incorrect and have been approved by the auditors of the company !