As per a report published in the Economic Times dated 23rd June 2011 titled ‘No standards, so real estate numbers remain a riddle’ in absence of any regulations in this regards, revenue recognition by real estate companies places question marks over the accuracy of reported revenue numbers and makes any comparison across peer group redundant. The report doubts the way ‘percentage completion’ method of revenue calculation is used by builders. As per the report, DLF has reported a total revenue of ₹ 9,560 crore for the year 2010–11. As against this, the company has ‘unbilled receivables’ of ₹ 7,200 crore, that is, over 75% of the total revenue. Similarly for the year 2009–10, the company reported consolidated revenue of ₹ 7,423 crore and unbilled receivables under ‘other current assets’ at ₹ 4,367 crore. 

Revenue from constructed properties is generally recognized on the percentage of completion method. Total sale consideration as per the duly executed agreement to sell/application (containing salient terms of agreement to sell), is recognized as revenue based on the percentage of actual project costs incurred thereon to total estimated project cost, subject to such actual cost incurred being 30% or more of the total estimated project cost. Project cost includes cost of land, cost of development rights, estimated construction and development cost, and borrowing cost of such properties. The estimates of the saleable area and costs are reviewed periodically and effect of any changes in such estimates is recognized in the period such changes are determined. However, when the total project cost is estimated to exceed total revenues from the project, the loss is recognized immediately. 

The difference between the revenue recognized on the basis of percentage of completion method and payment plan agreed with the customers is recorded as ‘unbilled receivables’ and the same are shown under ‘other current assets’. The use of percentage completion method avoids spiking of revenue when the project gets completed as the revenue recognition is spread over the construction period. There is no merit in deferring income to the end of the project. It is better to show income and profit periodically as they come. It also facilitates quarterly reporting says the group chief financial officer of DLF. 

The revenue recognition using percentage completion method will depend upon some key questions. What constitutes cost to determine percentage completion? For example, DLF includes cost of land in the project cost, whereas other builder may exclude the same. As a result, DLF will be able to book more revenue upfront. Secondly, at what stage of project completion revenue can begin to be recognized. DLF starts revenue recognition once 30% of the estimated project cost has been incurred. Other builders may use a higher of lower percentage. Thirdly, who will certify as to how much of a project has been completed. 

In the current environment where significant costs and time overruns in the construction projects are being witnessed, the accounting for revenue becomes even more complex.

Questions for Discussion

1. Why do real estate companies use percentage completion method?

2. What is unbilled revenue?

3. What will be the impact on the financial results of these companies if revenue is allowed to be booked only upon completion of the project?

4. List out your comments on the issues raised regarding use of percentage completion method.