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IFRS 15 — Pattern of revenue recognition in a real estate contract

Date recorded:

Background

This is a new issue.

The IC received a request to clarify whether revenue from the sale of pre-completion residential units in a multi-unit condominium (‘off-plan sales’) should be recognised over time or at a point in time.

The submitter provided the following specific fact pattern which takes into account the common contractual terms and legislative framework applicable to the submitter’s jurisdiction regarding off-plan sales:

  • a) The entity, being a real estate developer, and the customer enter into a contract for the sale and purchase of a real estate unit before the entity constructs the unit.
  • b) On signing the contract, the entity is obliged to deliver the completed unit as specified in the contract—it cannot change or substitute the unit agreed to in the contract. The entity retains legal title to the unit (and any land attributed to it) until construction is complete.
  • c) The customer generally pays 20%-30% of the purchase price of the unit as it is being constructed, and pays the remainder of the purchase price to the entity after construction is complete.
  • d) The customer may resell or pledge the unit while it is being constructed. However, the customer cannot change the structural design of the unit or cancel the contract, except as noted in (f) below.
  • e) If the entity is in breach of its obligations under the contract, the buyers of the units of the condominium have the right, as a group, to decide to remove the entity and hire another real estate developer to complete the construction of the property.
  • f) Although the contract is irrevocable under local law, the courts have accepted requests to cancel a contract in specific circumstances, mainly when it has been proven that the customer is not financially able to fulfil the terms of the contract. In this situation, the customer can cancel the contract and is entitled to receive most, but not all, of the payments it has already made to the entity. The remainder is retained by the entity as a termination penalty. The entity may also auction off the unit if the customer defaults on payments.

Staff analysis

The Staff believe that revenue from the sale of off-plan units, based on specific fact pattern as described in the submission, should be recognised at a point in time because none of the IFRS 15.35 criteria for recognition of revenue over time is met. The Staff focused their analysis on the application of paragraphs 35(b) and 35(c) of IFRS 15.

Paragraph 35(b) specifies that to recognise revenue over time, the customer must control the asset as it is created or enhanced. Control refers to the ability to direct the use of, and obtain substantially all of the benefits from, the asset. The Staff observe that although the customer can resell or pledge the unit under construction and is exposed to market value changes of the unit, it does not have legal title to the unit, nor does it have any ability to direct the construction or structural design of the unit as the unit is being constructed. Furthermore, the customer’s legal right to replace the entity in the event of the entity’s failure to perform as promised is protective in nature and is not indicative of control.

Paragraph 35(c) specifies that to recognise revenue over time, the asset created by an entity’s performance must not have an alternative use to the entity and the entity must have an enforceable right to payment for performance completed to date. The Staff observe that in this case, even though the entity is contractually restricted from directing the partly constructed unit for another use, the entity does not have an enforceable right to payment for performance completed to date upon termination.

Staff recommendation

The Staff recommend that the IC not add this issue to its agenda on grounds that the requirements in IFRS 15 provide an adequate basis for an entity to determine whether to recognise revenue over time or at a point in time for the fact pattern described in the submission.

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