what are the two types of leasing arrangements and their primary differences 613283

Applying IFRIC 15 to commercial real estate

An entity buys a plot of land for the construction of commercial real estate. It designs an office block and applies for building permission. The entity markets the office block to potential tenants and signs conditional lease agreements.

(a) It then markets the office block itself to potential buyers and signs with one of them a conditional agreement for the sale of land and the construction of the office block. The buyer cannot put the land or the incomplete office block back to the entity. When the entity receives the building permission and all agreements become unconditional, it constructs the office block.

The agreement should be separated into a component for the sale of land and a component for the construction of the office block. The component for the sale of land is a sale of goods within the scope of IAS 18.

Because all the major structural decisions were made by the entity and were included in the designs submitted to the planning authorities before the buyer signed the conditional agreement, it is assumed that there will be no major change in the designs after the construction has begun. Consequently, the construction of the office block is not a construction contract and is within the scope of IAS 18. Construction takes place on land the buyer owns before construction begins and the buyer cannot put the incomplete office block back to the entity. This indicates that the entity transfers to the buyer control and the significant risks and rewards of ownership of the work in progress in its current state as construction progresses. Therefore, the entity recognises revenue from the construction of the office block by reference to the stage of completion using the percentage of completion method.

(b) Alternatively, assume that the construction of the office block started before the entity signed the agreement with the buyer. In that event, the agreement should be separated into three components: a component for the sale of land, a component for the partially constructed office block and a component for the construction of the office block. The entity should apply the recognition criteria separately to each component. Assuming that the other facts remain unchanged, the entity recognises revenue from the component for the construction of the office block by reference to the stage of completion using the percentage of completion method.

In this example, the sale of land is a separately identifiable component but this will not always be the case. IFRIC 15 notes that in some jurisdictions, a condominium is legally defined as the absolute ownership of a unit based on a legal description of the airspace the unit actually occupies, plus an undivided interest in the ownership of the common elements (that includes the land and actual building itself, all the driveways, parking, lifts, outside hallways, recreation and landscaped areas) that are owned jointly with the other condominium unit owners. The undivided interest in the ownership of the common elements does not give the buyer control over the significant risks and rewards of the land. The right to the unit and the interest in the common elements are not separable. [IFRIC 15.IE5].