Many real estate development companies and funds had purchased huge parcels of land across various cities to develop residential, commercial, SEZ, hotel and township projects during the last few years when the real estate industry was in a high growth phase. Apparently, these land parcels were acquired at a high cost in anticipation that the fully developed property would fetch adequate return to the developer after covering the high cost of land acquisition.

As the financial year 2008-09 ended on March 31, real estate companies are required to report the land inventory, investment property and fixed assets in their books.

CLASSIFICATION OF PROPERTY

The land parcels along with the associated project-work-in-progress could be classified as inventory, investment property or fixed assets depending on the ultimate disposition of these assets. Typically, a real estate company would classify a property as inventory where the fully developed property is ultimately intended to be sold with the transfer of ownership to the buyer. In case, where the fully developed property is ultimately intended to be leased or held for long term appreciation, it will be classified as investment property. Further, in case where the fully developed property is ultimately intended to be operated by the Company, it is classified as fixed assets. For example, a hotel property owned and operated by a real estate company is classified as ‘fixed asset’, whereas if the hotel is leased to a third party, then it should be classified as ‘investment property’.

The classification of property is not always straight forward. Take the instance of SEZ projects where developers can not legally transfer the ownership to the buyer. In such a case, a developer could structure the sale of residential or commercial project on long-term lease of say 90 years wherein the developer collects the entire current market value of the property as upfront lease premium. The recurring lease payment for 90 years could be very nominal. For example, if the prevailing capital and rental rate of commercial office space in a SEZ is Rs 3,000 per sq ft and Rs 30 per sq ft per month respectively. The developer could sign a long-term lease of 90 years wherein he collects Rs 2,910 per sq ft, as upfront lease premium and a nominal lease payment of Re 1 per sq ft per annum for 90 years. One could argue that such projects should be classified as inventory as the developer has realised the entire economic benefit arising out of sale of commercial project. Another viewpoint could be that since the ownership of the property is not transferred to the buyer, the same should be classified as investment property. Accounting standards have same treatment for properties classified as investment property or fixed assets for the purpose of recording in the books. However the treatment for property classified as inventory is different.

... contd.