Revenue Recognition in Joint Development Agreements Under AS Framework

1. Query

Aristotle LLP (hereinafter referred to as the “Land Owner”), formed upon conversion from a private limited company, owns a parcel of land which has been contributed for development under a Joint Development Agreement (JDA) entered into with a real estate developer (hereinafter referred to as the “Developer”) for the construction and sale of residential units.

Under the terms of the arrangement, the Land Owner has granted the Developer an irrevocable and exclusive license to enter the land and undertake development activities. However, the legal ownership of the land continues to vest with the Land Owner until the completion of the project and the execution of a conveyance in favour of the ultimate purchasers. A Power of Attorney has also been executed in favour of the Developer, authorising it to obtain regulatory approvals, enter into sale agreements, and carry out all activities necessary for execution of the project. The Developer is responsible for planning, obtaining approvals, construction, marketing, and sale of units, and bears all costs relating to the project.

The revenue from unit sales, including advances and booking amounts, is deposited into a jointly operated escrow account and shared between the Land Owner and the Developer in an agreed ratio. The Land Owner retains involvement in key decisions, such as pricing and terms of sale, and also possesses step-in rights in the event of non-performance by the Developer. Further, conveyance of property in favour of the ultimate buyers is executed by the Land Owner, with the Developer acting as a confirming party, only upon completion of the project and receipt of the entire sale consideration.

The land has been classified as inventory in the LLP’s books. In this context, the LLP is uncertain about the appropriate timing and method of recognising its share of income arising from the JDA, particularly whether such revenue should be recognised during the course of construction, based on collections or receipts, or only upon completion of the project. The LLP has also sought clarification on the accounting treatment in a situation where consideration is receivable for the constructed area that remains unsold.

2. Relevant Provisions

Accounting Standard 27 – Financial Reporting of Interests in Joint Ventures

Para 3 of AS 27

A joint venture is a contractual arrangement whereby two or more parties undertake an economic activity, which is subject to joint control.

Para 12 of AS 27

In respect of its interests in jointly controlled operations, a venture should recognise in its separate financial statements and consequently in its consolidated financial statements:

(a) the assets that it controls and the liabilities that it incurs; and

(b) the expenses that it incurs and its share of the income that it earns from the joint venture.

Accounting Standard 9 – Revenue Recognition

Para 10 of AS 9

Revenue from sales or service transactions should be recognised when the requirements as to performance set out in paragraphs 11 and 12 are satisfied, provided that at the time of performance it is not unreasonable to expect ultimate collection. If, at the time of raising any claim, it is unreasonable to expect ultimate collection, revenue recognition should be postponed.

Para 11 of AS 9

In a transaction involving the sale of goods, performance should be regarded as being achieved when the following conditions have been fulfilled:

(a) the seller of goods has transferred to the buyer the property in the goods for a price or all significant risks and rewards of ownership have been transferred to the buyer and the seller retains no effective control of the goods transferred to a degree usually associated with ownership; and

(b) no significant uncertainty exists regarding the amount of the consideration that will be derived from the sale of the goods

3. Guidance Note on Accounting for Real Estate Transactions

Para 3 of Guidance Note

Revenue recognition in real estate transactions depends upon transfer of significant risks and rewards of ownership, which is to be determined based on the terms of the agreement and substance of the transaction. It further provides that where the transaction is akin to construction contracts, revenue may be recognised using the percentage of completion method; otherwise, principles of AS 9 apply.

Para 4.2 of Guidance Note

The completion of the revenue recognition process is usually identified when the following conditions are satisfied:

(a) The seller has transferred to the buyer all significant risks and rewards of ownership, and the seller retains no effective control of the real estate to a degree usually associated with ownership

(b) The seller has effectively handed over possession of the real estate unit to the buyer forming part of the transaction;

(c) No significant uncertainty exists regarding the amount of consideration that will be derived from the real estate sales; and

(d) It is not unreasonable to expect ultimate collection of revenue from buyers.

Para 4.3 of Guidance Note

Where transfer of legal title is a condition precedent to the buyer taking on the significant risks and rewards of ownership and accepting significant completion of the seller’s obligation, revenue should not be recognised till such time legal title is validly transferred to the buyer.