In a move that will depress the top line of several leading real estate companies, an upcoming accounting change aims to reduce the discretion available to them on how to compute revenues.

The accounting regulator is working on a 'guidance note' that will, for the first time, define when and how developers should recognise revenues from a project, say two senior officials of the Institute of Chartered Accountants of India (ICAI) working on the note, on the condition of anonymity.

The new rules will be a blow to companies that adopt an aggressive tack in recognising revenues, including frontline ones like DLF and Parsvnath Developers. In the case of DLF, for example, the proposed change would have placed in question 75% of the revenues declared by India's largest developer in 2010-11.

For Parsvnath, that figure would be 79%. In India, real estate firms mostly follow the 'percentage completion' method to recognise revenues. Under this, a developer recognises revenues from a project not when it is finished, but continuously, in proportion to the spending on it.

So, in a given year, if a builder has spent 30% of the estimated project cost, it can recognise 30% revenues from it. Next year, if the spend increases to 50%, it can recognise 20% more as revenues, and so on. The absence of rules on how to compute project cost, or how much revenue to record at what stage, gives builders much accounting discretion.

Take India's top two builders, DLF and Unitech. DLF includes land in its project cost, but Unitech excludes it. DLF starts recognising revenue on incurring 30% of project expenditure, Unitech at 20%.

"The proposed guidance note will bring a common base of comparison for investors," says Saumil Daru, chief financial officer of Mumbai-based Oberoi Realty.

The two ICAI officials say the guidance note (technically, called 'exposure draft') will broadly specify three things. One, the minimum threshold of completion only after which a builder can start recognising income from a project.

Guidance note not binding on cos

Two, the percentage of land cost to be included in the project cost. Three, linking revenues booked to cash received. "We will decide on the completion threshold after receiving feedback to the proposed changes," says one of the two ICAI officials.

ICAI President G Ramaswamy confirmed the institute was planning a guidance note for real estate companies, but declined to provide further details. Unlike accounting standards, a guidance note is not binding on a company.

However, companies tend to follow a guidance note, as a deviation from it leads to their auditors making a qualification in their statement of accounts. The main objective of the note is to ensure that revenues booked by a company from a project are an accurate reflection of the work done on it and the cash received towards it.

For example, in pricey locations like Mumbai and Delhi, land accounts for almost half the total project cost. So, in some cases, immediately after starting the excavation work, companies begin recognising revenues, though customer payments, which are construction-linked, have not started coming in.

This will end in the proposed dispensation, says one of the two ICAI officials. He says, going forward, the milestones for revenue recognition will be based only on construction cost. At present, it is based on the total cost, including land cost. Say, in a project, only 5% construction work (excavation) is complete, but 50% of project cost is incurred.

Under the proposed rules, the company will be unable to recognise revenues if the prescribed threshold - which will be linked to construction work - is higher. PA Ananthanarayanan, CEO of Universal Dwellings, says the proposed changes might improve practices under the percentage completion method, but it still leaves some discretion with builders. (Economic Times)