Inventory and accounting records in property development activities

The detailed principles of accounting for costs incurred in property development activities and revenues from such activities are not standardised in the Accounting Act. Accounting entities may use the guidance set out in National Accounting Standard No. 8 “Development activity” in this regard.

The subject of NAS No. 8 are the main principles for the recognition, measurement and presentation of assets, liabilities, income and expenses and profit or loss of development activities, regardless of the legal form of these activities, including those carried out by continuing special purpose vehicles (SPV).

Definition of property development activity

Property development activity is a business activity involving the performance of one or more development projects involving the construction or alteration (improvement) of buildings and their resale in whole or in part (e.g. premises); projects may be one-off or renewed.

The NAS 8 standard notes that a developer may develop a given development project:

• by commissioning, as an investor, the construction of a new building and related infrastructure or the improvement of a pre-acquired finished building by the contractor;
• by constructing the building and the associated infrastructure or improving the building himself (on his own), in which case the developer is both the investor and the general contractor of the construction, which may also be carried out using subcontractors.

This distinction is crucial for the recognition of income and expenses related to the project. The principle of economic substance over form applies here.

Classification of development contracts

Under balance sheet law, the timing of revenue and expense recognition is different for the sale of long-term services and for the sale of goods. NAS 8 notes that development agreements relating to the subject matter of a development project can be classified as:

• contracts for the sale of a finished product,
• construction contracts to which special accounting arrangements apply.

Contract for the sale of a finished product

A development contract is classified as a contract for the sale of a finished product if, under it, the developer is obliged to construct and purchase the main (basic) building materials in order to supply the purchaser with a property – a building or premises with the associated infrastructure – and the conditions for a construction contract do not apply.

Construction contract

A development agreement is deemed to be a construction contract if the purchaser bears the main part of the risks of the development project. For example, this is the case if the purchaser has the opportunity to determine the basic structural and architectural elements of the property development project prior to its commencement and/or to cause the basic structural and architectural changes in the course of construction (whether or not the purchaser takes advantage of such opportunity). It considers a development contract to be a construction contract if the purchaser has the obligation to provide and pay for the main (basic) construction materials.

Costs of property development activities

For each development project commenced, the costs of its execution and revenues from the sale of items arising from the execution of the project – buildings and/or premises – are recognised separately. Revenues related to a development project – depending on the nature of the development agreement or agreements concluded – may arise at different times. For this reason, it is necessary to adopt and apply such principles of recognising revenue connected with a development project and costs of production of sold buildings and/or premises charged to the developer, which enable compliance with the matching principle.

Cost accounting

Development costs are accumulated for each development project separately until completion. When a development contract has been classified as a sale of finished goods in the balance sheet, they are shown under “Work in progress” regardless of whether the construction has been commissioned to a general contractor or whether it is carried out by the developer’s own forces. These costs include all components of the cost of production.

Initial recognition

Until the date of commencement of a specific development project, the land or its perpetual usufruct right at the disposal of the developer, depending on its purpose at the time of purchase, should be shown in the accounts as:

• stock (goods) – when the developer purchased it for the performance of a specific project,
• investment in real estate – when the developer purchased it without any prior intention to implement a specific project, or
• fixed asset – when the land purchased was originally intended to be used for the developer’s own purposes.

Period costs

The cost of a development project does not include the cost of:

• the sale of the subject of the development project, including: information, promotion, marketing and agents’ commissions,
• related to construction disruptions due to lack of materials, lack of an up-to-date project, lack of buyers – these are other operating expenses,
• maintenance and protection of the property between its construction and sale,
• management, including legal, financial and accounting services, salaries of management and administrative staff, maintenance of administrative premises, vehicles, office supplies, etc.

These expenditures are charged to the costs and financial result of the period in which they are incurred.

Valuation of inventories in property development activities

Inventories are valued at the lower of cost and net selling price.

Net selling price is the selling price obtainable at the balance sheet date, net of value added tax and excise duty, less discounts, rebates and the like, and costs associated with making the item ready for sale and making the sale.

Goods

The acquired land or right of perpetual usufruct of the land is shown at the purchase price, with the following price until the start of the development project:

• is increased by the costs of making the land fit for use or marketing,
• is increased by the borrowing costs associated with the purchase and decreased by the proceeds of the purchase,

with the proviso that the value of the land or the right of perpetual usufruct of the land determined in this way may not be higher than its net selling price as at the balance sheet date.

Work in progress

On the date of commencement of a new project, the value of the land or the value of the right of perpetual usufruct of the land on which the development project will be carried out, as shown in the accounts, is charged to the cost of work in progress (shown in the balance sheet under “Work in progress”).

Work in progress is valued at the lower of cost and net realisable value.

Property tax or fees for perpetual usufruct of the land on which the property constituting the subject of the development task is located, incurred after the date of commencement of the construction until the date of its completion, may be included in the cost of production of the development project. Borrowing costs of the property under construction incurred after the date of commencement of construction until the date of its completion increase the cost of the development project.

Costs and income from exchange rate differences related to external financing of commenced construction are included in the costs of the development project according to the rules applied to external financing costs, except that negative exchange rate differences increase these costs, while positive exchange rate differences decrease them (they are treated as a reduction of costs).

Finished products

Finished buildings (real estate) held for sale valued at the cost of these properties, including also the purchase price of the land or the right of perpetual usufruct of the land, are recorded in the accounts as finished goods inventories.

Finished goods are valued at the lower of cost and net realisable sales price.

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