The IFRIC discussed real estate sales in which an agreement for sale is reached before construction is complete. Diversity in practice has been reported primarily in the context of residential real estate developments in which buyers enter binding ‘pre-completion’ agreements to purchase a specific unit within the development once it has been built. However, the IFRIC’s project is not limited to such transactions – it addresses all types of real estate transactions.
At this meeting, the IFRIC first considered whether the sales agreements would be construction contracts within the scope of IAS 11 Construction Contracts. It noted that the definition in IAS 11 requires the contracts to be ‘specifically negotiated for the construction of an asset or a combination of assets…’ The IFRIC tentatively concluded that sale agreements meet this definition only if they require the seller to provide construction services to the buyer’s specification. For ‘specific negotiation’ to be present, the buyer need not specify every detail of the design, but must have control over whether and how construction progresses. A typical residential pre-completion contract does not meet the definition of a construction contract, even if the buyer is able to specify some variations to the basic design or select from a range of house designs.
Applying IAS 18
The IFRIC considered the revenue recognition requirements for sale agreements that are not construction contracts and, hence, are sales of goods within the scope of IAS 18.
It noted that revenue should be recognised only when all the criteria in paragraph 14 of IAS 18 have been met. Two of the criteria require the seller to have transferred the significant risks and rewards of ownership and effective control of the real estate to the buyer. The IFRIC noted that these criteria were being interpreted in different ways and decided that application guidance was needed. It discussed various factors that might be relevant. It tentatively concluded that the criteria should be applied to the underlying real estate in its current state, not the buyer’s right to obtain the completed real estate at a later date.
A binding sale agreement might transfer to the buyer control over the right to acquire and then use the completed real estate and the risks and rewards of movements in the price of the completed real estate. However, in many jurisdictions, typical pre-completion contracts do not give buyers control over the existing incomplete real estate: the seller is likely to retain control until the buyer obtains possession. All types of risk, including construction risk should be taken into consideration when assessing whether the risks and rewards of ownership have been transferred to the buyer.
The IFRIC also considered situations in which IAS 18’s revenue recognition criteria are met before construction is complete, for example if the buyer obtains possession before the developer has completed internal fittings or constructed communal amenities. It noted that existing guidance on this matter in the Appendix to IAS 18 is being interpreted in ways that are inconsistent with the requirements of IAS 18. The IFRIC decided to develop new guidance, which it would propose as a replacement for the existing guidance in the Appendix.
With respect to this guidance, the IFRIC tentatively concluded that if the revenue recognition criteria have been met before construction is complete, the seller should recognise its remaining obligations either by recognising the costs to complete the construction at the same time as it recognises the sale (ie applying paragraph 19 of IAS 18) or allocating some of the sales proceeds to the outstanding work and recognising this amount of revenue only when the work is performed (applying paragraph 13 of IAS 18). The first method (application of paragraph 19) would be appropriate if the remaining work is required to finish construction of real estate already delivered into the possession of the buyer, for example to remedy minor defects. The second method (application of paragraph 13) would be appropriate if the remaining work represents goods or services (such as communal amenities) that are separately identifiable from the real estate already delivered to the buyer. The IFRIC noted that the appropriate treatment would depend on the terms of the contract and that judgement would be required.
Allocation of costs and revenues to individual units
Finally, the IFRIC considered whether it should address the way in which costs should be allocated to individual real estate units within a multiple-unit development. It noted that this issue related to measurement of work in progress and, hence, the application of IAS 2 Inventories. It concluded that the issue was peripheral to the main aims of this project (revenue recognition) and that if there were a need to interpret the measurement requirements of IAS 2, this should be done in a separate project that was not limited to real estate. Therefore it decided not to address the issue as part of this project.
The IFRIC directed the staff to prepare a draft text of a Draft Interpretation reflecting these decisions for discussion at a future meeting.