A REAL ESTATE SALE: A CONSTRUCTION CONTRACT OR A SALES CONTRACT?

Accountancy SA, Dec 2007/Jan 2008 by Coetzee, Stephen, Schmulian, Astrid

Every Sunday afternoon, 'show house ahead' signs litter the suburban streets of South Africa. Many of these signs lead to areas of barren land with computer generated imagery of the grand residence to be developed there soon. All that is required is that the buyer pays a refundable deposit and construction on their dream house will begin. "Don't worry", promises the realtor, "you are exposed to absolutely no risk". Although a contract is signed on this day, the deposit will be repaid should the house not be 'delivered' to the buyer, and the buyer will only have to pay the remaining purchase price on completion of the construction.

The following Monday morning the deposits are in the developer's bank account, and the accountant now needs to decide how to account for these deposits. This decision is dependent on whether the developer has entered into a sales contract in terms of IAS 18 (AC 111), Revenue or a construction contract in terms of IAS 11 (AC 109), Construction Contracts?

Disposal of property, plant and equipment in general

Property, plant and equipment are generally sold in terms of a sales contract. In determining the date of disposal for property, plant and equipment, an entity applies the recognition criteria in term of IAS 18 (AC 111), Revenue. The recognization criteria are in essence built around whether the risks and rewards of ownership of the property, plant and equipment sold have been transferred to the buyer. IAS 18 (AC 111) para. 15 acknowledges that this transfer generally occurs with the transfer of legal title, although this is not always the case.

Disposal of real estate

When considering the sale of property (real estate), two points of time become relevant, the date the sales contract is signed or alternatively the date that the contract is completed and the legal title passes to the buyer. It is likely at the time of signing the contract that all material information relating to the contract will be known, e.g. the selling price and related expenditure. Therefore, in the absence of any uncertainty, it would be possible to recognise the revenue from the disposal of the property at the time the contract is signed (International GAAP, 2007: pp. 1953).

Accordingly example 9 in the Appendix to IAS 18 (AC 111), Revenue, currently suggests that revenue from the sale of real estate should generally be recognised when the legal title of that real estate is transferred, provided the seller has no further significant acts to complete under the contract. The Appendix cautions that, depending on the specific circumstances, it might be more appropriate to recognise the revenue prior to the transfer of legal title provided that the recognition criteria in para. 14 of IAS 18 (AC 111), Revenue, have been met at this earlier date (International GAAP, 2007: pp. 1954).

Pre-completion contracts

Recognition of a real estate sale is however complicated when the contract to purchase the real estate is signed prior to, or during the construction of that real estate. The question is whether the contract signed still falls within the scope of IAS 18 (AC 111), Revenue, as discussed above or should it rather be accounted for in terms of IAS 11 (AC 109), Construction Contracts, as all the typical features of such a construction contract are now present, such as land development, architectural design, and construction?

IFRIC DRAFT INTERPRETATION D21

Real estate sales

To address this situation the International Financial Reporting Interpretations Committee (IFRIC) of the International Accounting Standards Board (IASB) has issued a draft interpretation note addressing real estate sales and when these sales fall within the scope of IAS 18 (AC 111), Revenue, or IAS 11 (AC 109), Construction Contracts. This was issued by SAICA for comment as ED 226.

The interpretation Is applicable to the sale of real estate in general and not only to residential real estate sales. It is equally applicable to commercial or industrial property sales, which may for example involve the sale of an entire development to a single buyer.

The key to the decision on which standard is applicable to the real estate sale lies in the definition of a construction contract in IAS 11 (AC 109), Construction Contracts. This definition reads as follows:

"...a contract specifically negotiated for the construction of an asset or a combination of assets..."

Therefore a contract will fall within this definition if the seller has to provide construction services to the buyer.

The draft interpretation provides examples of features that indicate that an agreement includes the provision of construction services. These are as follows:

1. The buyer is able to specify major structural elements of the design prior to construction, or to specify major structural changes once construction has commenced.

2. The seller transfers the risks and rewards of the ownership of the real estate in its current state as construction in progress. Indicators of this may include:

* the construction is taking place on land owned or leased by the buyers;