New interpretations on construction contracts

Recently, the International Accounting Standards Board (IASB) issued two IFRIC (International Financial Reporting Interpretations Committee) interpretations that seek to clarify accounting treatments for two critical areas of accounting — construction contracts and net investment in a foreign operation with effect from January 1, 2009.
IFRIC 15
IFRIC 15 standardises accounting practice across jurisdictions for the recognition of revenue by real-estate developers for sales of units, such as apartments or houses, ‘off plan’ — that is, before construction is complete.
The fundamental issue is whether the developer is selling a product (goods) — the completed apartment or house — or a service — a construction service as a contractor engaged by the buyer.
The revenue from selling products is normally recognised at delivery. And the revenue from selling services is normally recognised on a percentage-of-completion basis as construction progresses.
IFRIC 15 provides guidance on how to determine whether an agreement for the construction of real estate is within the scope of IAS 11 ‘Construction Contracts’ or IAS 18 ‘Revenue’ and, accordingly, when revenue from the construction should be recognised:
An agreement for the construction of real estate is a construction contract within the scope of IAS 11 only when the buyer is able to specify the major structural elements of the design of the real estate before construction begins and/or specify major structural changes once construction is in progress (whether it exercises that ability or not).
If the buyer has that ability, IAS 11 applies.
If the buyer does not have that ability, IAS 18 applies.
If IAS 11 applies, the revenue is recognised on a percentage-of-completion basis provided that reliable estimates of construction progress and future costs can be made.
Even if IAS 18 applies, the agreement may be to provide construction services rather than goods.
This would likely be the case, for instance, if the entity is not required to acquire and supply construction materials.
If the entity is required to provide services together with construction materials in order to perform its contractual obligation to deliver real estate to the buyer, the agreement for the sale of goods falls under IAS 18.
IFRIC 16
IFRIC 16 clarifies that the presentation currency does not create an exposure to which an entity may apply hedge accounting.
Consequently, a parent entity may designate as a hedged risk only the foreign exchange differences arising from a difference between its own functional currency and that of its foreign operation.
IFRIC 16 concludes that the hedging instrument(s) may be held by any entity or entities within the group.
IFRIC 16 concludes that while IAS 39 must be applied to determine the amount that needs to be reclassified to profit or loss from the foreign currency translation reserve in respect of the hedging instrument, IAS 21 must be applied in respect of the hedged item.
Construction contracts have always proved tricky to both accountants as well as the taxman.
In a recent judgment in the Magus Construction Pvt. Ltd vs Union of India (2008-TIOL-321-HC-GUW-ST) case, the Guwahati High Court held that the activity of construction of flats by a builder for their subsequent sale was not chargeable to service tax under construction of complex services.
Although the POC (percentage of completion) method is popular and acceptable to the realtor, auditor as well as the taxman, the agreement entered into by the parties to a transaction assumes importance and could alter accounting and tax treatments.