How to account for revenue in a transfer of land

Here the questions raised is how to account for revenue in a transfer of land. Or to put it more formally how to account for revenue recognition in a real estate contract that includes the transfer of land (as per IFRS 15 Revenue from Contracts with Customers) as per the same 2018 IFRS Interpretations Committee Agenda Decision.

The case

An entity has obtained a piece of land to construct a building on. How should the entity account for the sale of the land and the building to be constructed on the land. How to account for revenue in a transfer of land

The contract includes the following features: How to account for revenue in a transfer of land

  • The entity and the customer enter into a non-cancellable contract for the sale of a building yet to be constructed by the entity.
  • At contract inception, the entity irrevocably transfers to the customer legal title to the land on which the entity will construct the building. The contract specifies a price for the land, which the customer pays on signing the contract.
  • The entity and the customer agree upon the structural design and specification of the building before the contract is signed. As the building is being constructed:
    • If the customer requests changes to the structural design or specification, the entity prices the proposed changes based on a methodology specified in the contract; the customer then decides whether to proceed with the changes. The entity can reject the customer’s request for changes only for a limited number of reasons, such as when the change would breach planning permission.
    • The entity can request changes to the structural design or specification only if not doing so would lead to an unreasonable increase in costs or delay to construction. The customer must approve those changes.
  • The customer is required to make milestone payments throughout the construction period. However, these payments do not necessarily correspond to the amount of work completed to date.

IssuesHow to account for revenue in a transfer of land

Centre to this are the following two issues: How to account for revenue in a transfer of land

  1. Does the sale of land and construction represent one or two performance obligations?; and
  2. Is revenue recognised at a point in time or over time for each performance obligation?

Issue 1: What are the performance obligations in the contract?

An entity identifies performance obligations by applying IFRS 15 22 – 30. A performance obligation is a good or service (or bundle of goods or services) that is distinct, or a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer. How to account for revenue in a transfer of land

Distinct goods or services criteria

IFRS 15 27 specifies that a good or service promised to a customer is distinct if: How to account for revenue in a transfer of land

  1. The customer can benefit from the good or service on its own or together with other resources readily available to the customer (i.e. the good or service is capable of being distinct); and How to account for revenue in a transfer of land
  2. The entity’s promise to transfer the good or service is separately identifiable from other promises in the contract (i.e. the promise to transfer the good or service is distinct within the context of the contract).

Obviously the assessment of these criteria requires judgement. How to account for revenue in a transfer of land

Common opinion

In a contract for the transfer of an area of land and of an entire building to be constructed on the land, the common opinion is that the land and the building are each capable of being distinct and therefore the condition in IFRS 15 27 is met. The reasoning behind this is that the customer could hire another developer to construct a building were the land would have to be purchased on its own.

In reaching this conclusion, it was noted that IFRS 15 BC100 explains that an entity disregards any contractual limitations that might preclude the customer from appointing a different contractor to carry out the construction.

Individual or combined transfer

It was then considered that the criterion in IFRS 15 27(b), and its underlying objective (explained in IFRS 15 29), is to consider whether the nature of the entity’s promise is to transfer the land and building individually or, instead, to transfer a combined item to which the land and buildings are inputs. In IFRS 15 BC105, BC116J and BC116K, it is explained that the notion of whether two or more promises are distinct within the context of a contract is influenced by whether the risk an entity assumes to fulfil one obligation is separable from the risk relating to others. This requires an assessment of the level of integration, interrelation or interdependence among the promises. Rather than considering whether one item by its nature, depends on the other, it is necessary to evaluate whether there is a transformative relationship between two promises in the process of fulfilling a contract.

Considerations

From the context of a contract for the sale of land and construction services, and drawing on two of the three examples of factors in IFRS 15 29, it was concluded that it is necessary to consider if: How to account for revenue in a transfer of land

  • The entity provides a significant service of integrating the land and building into a combined output. This might be the case if there is a transformative relationship between the transfer of land and the construction of the building in the process of fulfilling the contract or if the entity’s performance in constructing the building would have been any different if it had not transferred the land, and vice versa. Although there is a functional relationship between the land and the building (the building cannot exist without the land because its foundations will be built into the land) this does not necessarily mean the risks to which the entity is exposed in transferring the land to the customer are inseparable from the risks of constructing the building.
  • The land and building are highly interdependent or interrelated. For example, would the entity be able to fulfil its promise to transfer the land even if the customer purchased the construction services from another developer, and would the entity be able to fulfil its promise to construct the building had the customer purchased the land from another party?

Conclusion

It was concluded that the promise to transfer land would be distinct in the context of the contract, and therefore the criterion in IFRS 15 27(b) would be met, if the entity concluded that: How to account for revenue in a transfer of land

  • Its performance in constructing the building would be the same regardless of whether it had transferred the land;
  • It would be able to fulfil its promise to construct the building even if the customer had purchased the land from another party; and
  • It would be able to fulfil its promise to transfer the land even if the customer had purchased the construction services from other providers.

It was also noted that IFRS 15 BC116N noted that the factors in IFRS 15 29 are not intended to be a series of criteria that are evaluated independently from the ‘separately identifiable’ principle in IFRS 15 27. How to account for revenue in a transfer of land

In some cases, one or more of the factors in IFRS 15 29 may be less relevant in the context of the overall objective of the principle.

Issue 2: Should revenue be recognised at a point in time or over time?

IFRS 15 35 sets out three circumstances when revenue should be recognised over time: How to account for revenue in a transfer of land

  1. The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs;
  2. The entity’s performance creates or enhances an asset (for example work-in-progress) that the customer controls as the asset is created or enhanced; or
  3. The entity’s performance does not create an asset with alternative use to the entity and the entity has an enforceable right to payment for performance completed to date.

Transfer of land

Regarding the promise to transfer the land, the land is not consumed immediately (hence the criterion in IFRS 15 35(a) is not met), and the entity’s performance does not create or enhance the land (hence the criteria in IFRS 15 35(b) and 35(c) are not met). Therefore, assuming the entity concludes that the sale of land is a separate performance obligation, revenue from the transfer of land is recognised at a point in time.

Construction services

Regarding the construction services, it was concluded that the criterion in IFRS 15 35(b) is met because the customer has the ability to:

  • Direct the use of the building as it is being constructed through its control of the previously transferred land, by being able to change the structural design and specification of the building as it is constructed. The customer is also able to prevent others from directing the use of the building; and How to account for revenue in a transfer of land
  • Obtain substantially all of the remaining economic benefits from the building as a result of signing the contract because the entity cannot redirect the building for another use or to another entity.

It was also noted that, in IFRS 15 BC129, it was observed that ‘in the case of a construction contract in which the entity is building on the customer’s land, the customer generally controls any work in progress arising from the entity’s performance.’

See also: The IFRS Foundation

How to account for revenue in a transfer of land

How to account for revenue in a transfer of land How to account for revenue in a transfer of land How to account for revenue in a transfer of land How to account for revenue in a transfer of land 

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