GAAP for real estate transactions – Part 4

Our final part in this series looking at accounting for real estate transactions from our resident CPA, Hardik Shah, considers the appropriate handling of retail land sales.

Retail land sales normally consist of large amounts of residential lot sales which are subdivisions of large tracts of land. The developer of the land will normally provide the buyer with financing terms that require a lower down payment than would be possible if the buyer attempted to obtain the financing from outside financial institutions. In this situation, financial institutions would require the buyer’s note be purchased only at a significant discount. There is also often a legal requirement for the land developer to provide the buyer with a refund period in which a full refund would be received and the sales contract would be considered null and void if the buyer retracted.

ASC 976-605-25-4 requires that a single method is used to recognize profit from all sales transactions within a retail land sales project. However, when certain conditions change for the entire project, the method of recognizing profit should be changed to reflect the new conditions.

Accounting for retail land sales

The following is a discussion of the methods used to account for profits from retail land sales:

1. Full accrual method ASC 976-605-25-4 requires that the full accrual method of accounting is applied to a retail land sale if all of the following conditions are met:

• The period of cancellation with refund has expired.
• Cumulative payments equal or exceed 10% of the contract sales price.
• The receivables are collectible.
• The receivables are not subject to subordination.
• The development is complete.

A down payment of at least 20% is considered an acceptable indication of the collectability of receivables. Because all other conditions are met, the full accrual method should be used if the development has been completed

In accounting for the full accrual method, sales must be recognized at the amount contracted for, an allowance of doubtful collectibles must be provided for, the cost of the lots that are sold must be transferred from the seller’s inventory account, and an allowance for discounts (contra contracts receivable account) must be recorded to reduce the receivable account to the present value of all required payments. If the seller has initiated programs that are designed to accelerate the collection of receivables, any profit on the sale should be reduced by the charges for anticipated discounts being offered as a result of incentives. Sales discounts as a result of infrequently offered incentives should be debited against income in the period in which they are granted.

2. Percentage-of-completion method For a retail land sale that satisfies all the conditions for the accrual method except that the seller has not met its obligation to complete all improvements or construction on the lots that are sold, the percentage-of-completion method should be used if the two following conditions are met:

• It is believed that the land can be developed for the purposes expected and that the properties can be used for these purposes at the end of the expected payment period.
• The improvements and construction that are required on the property have been initiated and are in progress. There is every reason to believe, based on the work that has already been performed, that all improvements and construction will be completed according to the agreed-upon plan. There do not appear to be any extenuating circumstances, such as delays or additional costs, which would mean the project will not be completed as expected.

Accounting for the percentage-of-completion method is as one would expect. Revenue should be recorded by computing the ratio of costs incurred to date to the total estimated costs expected to be incurred. This fraction is then multiplied by the net sales number. Costs incurred and total cost to be incurred include the following: land cost, interest and project carrying costs incurred prior to the sale (previously charged to expense), and selling costs associated with the project. Estimates for future improvement costs should be based on amounts that are expected in the construction industry in the area. Estimates of future improvements should be reviewed yearly and the percentage-of-completion should be recalculated when cost estimates are revised.

3. Installment Method
If a retail land sale has gone beyond its refund period, has had its cumulative payments equal no less than 10% of the full contract price, and does not meet any of the other criteria for the full accrual method or percentage-of-completion methods, it should be accounted for under the installment method if the following two conditions are met regarding the financial condition of the seller:

• The seller is able to provide both land improvement and any offsite construction that was committed to in the contract.
• The seller is satisfying all other commitments made in the contract, including ensuring the completion of the improvements of the project.

A seller originally accounting for a retail land sale by the installment method may adopt the percentage-of-completion method if the land sale subsequently satisfies all the conditions required of this method. In this situation, the seller may utilize the percentage-of-completion method for the whole project (both prior and current sales) and account for the change in methodology as a change in accounting estimate.

4. Deposit Method A retail land sale that fails to satisfy the conditions required for the full accrual method, percentage-of-completion method, and the installment method should be accounted for under the deposit method.

If you have missed any of the previous articles on GAAP for real estate transactions,check Part 1 to understand what GAAP means for CPAs specializing in real estate, check Part 2 to understand different methods of sales of real estate and check Part 3 for different forms of continuing involvement with the property and the accounting methods that should be used.

We do hope that this series of articles has been of assistance to you. Hardik Shah has over 12 years’ experience within real estate accounting. If we can help with your real estate accounting in the future, then please do not hesitate to make contact with us on +551 227 8165 or email us: [email protected]