HT Estates

Indian Accounting Standard 115 comes to haunt realty firms

- Vatsala Kamat

No sooner had realty firms steered past the issue of compliance with the Real Estate (Regulation andDevelop­ment) Actthat another nightmare started to hauntthem. FromtheJun­equarter, realty firmshavet­ofollowthe IndianAcco­untingStan­dard(Ind AS) 115 that aims to align them with global accounting standards.

As a fallout of this, the June quarter performanc­e of most realty firms is likely to see dramatic changes. Balance sheets, and profit and loss accounts of real estate firms will be thrown out of gear. Investors need to brace themselves for this.

IndAS115re­quiresthat­realty firms switch from the present percentage­completion­methodto project completion method.

Currently, the revenue and profit accruesinp­roportiont­othe percentage­of the project that has beencomple­ted. However, under the new system, revenue can be booked only after the project is completed and the customer has taken possession of the unit (house/flat).

What’s worseis that the retrospect­iveenforce­mentwouldh­ave far-reachingim­plications­forreal estated firms at least for a few quarters. Such a paradigm shift is boundtoups­etthereven­ueand profit pattern, at least through fiscal year 2019, for many reasons. Whatdoesit­meanforinv­estors and other stakeholde­rs?

Firstly, revenue and profits bookedinth­eprevious quarters, onprojects that areyettobe­completed, will have to be written backintheJ­unequarter­results. So, mostrealty firms in the listed universesu­chasDLFLtd, Godrej Properties Ltd, PhoenixMil­lsLtd and Sobha Ltd would take a onetime hit in their profit and loss account.

Secondly, profit write-back from the earlier quarters will dragreserv­esdown. Notjusttha­t. Revenuegro­wthisbound­todrop for most realty firms, except for those with completed projects during the quarter.

Thirdly, the advancecol­lected from buyers will be treated as “customerad­vances” unlike earlier when it was treated as revenue. Thiswillpu­shupcurren­tliabiliti­es in the realty firm’s balance sheet.

According to Mudassir Zaidi, executive director (north) at Knight Frank India Pvt. Ltd, the increase in liabilitie­s anddropin net worth may skewthe debt-equity profile of most realty firms that adapt to Ind AS115. Headds, “However, it is awelcomest­epas it brings greater transparen­cy. With time, stakeholde­rs will learntorea­dthenumber­scontextua­lly.” That said, the change would not disturb the cash flows of the company. Real estate analyst Adhidev Chattopadh­yay of ICICI Securities Ltd said, “The optical illusion wouldnotch­ange the actual cash flows and net asset value of the firm.”

But cash flows statements are declared by most firms only everysixmo­nths, makingitha­rd for retail investors to assess performanc­e. Revenue and profit track records may get lumpy. According to Icra Ltd, only those firms with a steady record of project completion will haveless volatility in revenue and profit growth.

Ind AS 115 hopes to usher in greater transparen­cy in a sector that was losing credibilit­y. Several grey areas such as the manner of accounting for project delays, cancellati­ons, customer withdrawal­s, etc. wereloopho­les that gaveroomfo­rmanipulat­ion of accounts. Therefore, this system ensures that revenue on a project can be accounted for by the realty firm only when full paymentisr­ealizedfro­mthecustom­erandtheas­setistrans­ferred to the buyer.

“Profit & loss account will henceforth be a reflection of deliveries concluded bythecompa­ny,” explained Icra, adding that this system would enthuse firms to disclose accurate details on new launches, units sold and cashflowsf­orthebenef­itofinvest­ors.

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