Indian Accounting Standard 115 comes to haunt realty firms
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.