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Development project

20. Sep 2012
3

Good day,

I have a question concerning the timing of revenue from the sale of flats. We are a development company, which has built apartment buildings for sale as flats. I think we should recognized revenue when we meet the 5 conditions listed in IAS 18 for the sale of goods also in accordance with IFRIC 15 – or specifically, the date of transfer of control and risks of ownership in the CR which is the registration in the Land Registry.

Company management wants to recognize income on the date of acceptance from building inspection on the basis of firm commitment contracts for the sale of the flats. Management claims that it is more than likely that the sale will be completed given that a non-refundable deposit of 15% of the sales price (about ½ million Czech crowns) was paid.

My question is, is it appropriate to recognize revenue in a different (earlier) than the time of the transfer of ownership in the Land Register?

Thank you very much for your help.

Submitted by Mladek on Thu, 09/20/2012 - 07:08

Yes it is.

As per IFRIC 15.17 a transfer of OWNERSHIP is not necessary. Revenue is recognized on the basis of a transfer of the RISKS AND REWARDS of ownership.

If the company received a non-refundable deposit as large as you describe, would even possible that revenue may be recognized prior acceptance by the Building Inspector.

This can be supported by analogizing to IAS 23.23, which considers a building finished (for the purpose of interest capitalization) at the moment all significant physical work is complete, even routine administrative tasks have not yet been completed.

Submitted by Mladek on Thu, 09/20/2012 - 07:09
Thank you for your reply. But in my opinion, in my case, risks and benefits of ownership the transfer of on the basis of what is explicitly stated in the contract. This contracts states that the control and risk passes to the purchaser at the time that on the request is officially logged with the Land Register. A future buyer of real estate or cannot use the building. The only possible benefit / risk of a future buyer is, in my option, that the price of real estate on the market will change since the purchase price in the agreement is fixed and not subject to change.

Submitted by Mladek on Thu, 09/20/2012 - 07:10

I have a feeling that you do not fully appreciate the meaning “risks and rewards of ownership” as this term is understood by IFRS.  

What may be even worse, you are allowing yourself to be influenced by your knowledge of Czech accounting standards / legal environment.

First point

Because the developer is not free to sell the building to anyone else but the individual who paid the deposit, the developer does not have, nor ever had, the primary reward of ownership: the ability to dispose of an asset as one sees fit.

What the developer does have are risks of ownership.  The primary of these is that the developer will not complete the asset as per the agreement and not only will not be entitled to demand the balance of payment, but will be obligated to refund the deposit.  These risks, however, dissipate at the moment the building is completed and is, as per the agreement, transferable.

As to the control aspect.  As understood by IFRS, control does not mean the ability to physically manipulate with an asset.  Since IFRS is a FINANCIAL reporting system, it looks at control from the FINANCIAL perspective.  From this perspective, control means: the exclusive right to demand the economic benefits embodied by the asset.  

During construction control applies to the building being constructed because, once it is complete, the building will be sold (the funds received for the sale are the underlying economic benefit).  

Also, since at the time the building is complete, it becomes virtually (if not absolutely) certain that it will be sold, the control shifts from one asset (the building) to another asset (the receivable that is recognized at the moment of sale).

Note: this is assuming that the construction was accounted for under IAS 2 (which is common in these situations) not IAS 11 (which would, in any even, allow revenue to be recognized during construction).

This implies that at the moment the asset is complete, the conditions as per IFRIS 15.17 are fulfilled regardless of whether the property was or was not registered in the Land Registry.  Likewise, the condition outlined in IAS 18.14 have also been met, and so revenue may be recognized.

Claiming that "the risks and rewards" stem from how the situation is viewed by Czech law would not only be contrary to the nature of IFRS, but would also violate one of its basic, underlying principles: substance over form.

To wit: “Framework 35: If information is to represent faithfully the transactions and other events that it purports to represent, it is necessary that they are accounted for and presented in accordance with their substance and ECONOMIC REALITY and NOT MERELY THEIR LEGAL FORM.”

Which leads me to my second point:

According to Czech (legally formalistic) accounting standards, legal / contractual form takes precedence over economic substance.  

Thus the claim that “This contracts states that the control and risk passes to the purchaser at the time that on the request is officially logged with the Land Register” is pertinent, but ONLY in the context of Czech National Standards, not IFRS.

And it gets worse, not only would this claim violate the overriding substance over form principle, not only would it be inconsistent with both IAS 18 and IFRIC 15, but would also run counter to IAS 8.12 which states:

“In making the judgment described in paragraph 10, management may also consider the most recent pronouncements of OTHER STANDARD-SETTING BODIES THAT USE A SIMILAR CONCEPTUAL FRAMEWORK to develop accounting standards, other accounting literature and accepted industry practices, to the extent that these do not conflict with the sources in paragraph 11.”

By analogizing to CZ GAAP, which you are in effect doing, you are in violation of this paragraph because Czech standards are not set by “standard-setting bodies that use a similar conceptual framework to develop accounting standards”.

In fact, they are set by standard setters using (for all intent and purposes) an exactly opposite conceptual framework.

This also not only means that management is correct in its assertion, but also that what you suggest would be a violation of two standards, one interpretation and an error (as defined by IAS 8.5).

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