Prime Residencies revenue recognition policy overly conservative

Monday, 10 May 2021 00:14 -     - {{hitsCtrl.values.hits}}

With regards to the recent IPO for Prime Lands Residencies, it can be noted that the company has an overly conservative revenue recognition policy. The company only recognises revenue on the sale of an apartment when over 25% of construction is complete and over 20% of payments are handed in. Even then the company only recognises the lower of these two figures in its books.

Now many would prefer a company to understate than overstate its books but this raises huge questions on cost recognition. We see huge rises in advances paid to contractors from 2018 onwards and it is probably representative of apartments already constructed.

Though the accounting standard and auditor might allow for the recognition of these costs in the year that the apartments are to be sold; management and the investor community must question if this accounting policy gives a true reflection of the company. None of the investor analysis seems to allow for a decrease in the value of apartments which, given the glut in the market and the absence of ex-pat tenants, would be prudent.

Though operationally the company seems to be doing well, the cash flow and balance sheet seem to be raising questions that it would be in the interests of the company to answer. 

The Prince of Kandy

Acuity Partners responds 

Prime Lands Residencies Ltd.’s IPO managers and financial advisors Acuity Partners Ltd. issued the following clarification to the above.

The company (Prime Lands Residencies) has adopted the revenue recognition policy keeping in line with the accounting standards as well as the auditor’s concurrence for the same. This prudent revenue recognition policy has been adopted by the company in order to ensure that the revenue is maintained on a consistent basis by avoiding the possibility of any re-sale adjustments, which is quite a common occurrence in the residential real estate industry. 

In the event a re-sale adjustment is required, it would have an impact on the already-recognised revenue, which reflects an inconsistency and also could be used for financial statement manipulation, which the company is keen to avoid. 

To further elaborate, in the company’s experience, the possibility of a unit resulting in a re-sale after the initial reservation advance is quite high, but once a customer has paid 20% or more of the total amount, then this possibility reduces drastically. The 20% threshold with regard to the customer advances for revenue recognition has been selected on this basis. 

Furthermore, with the advances paid to contractors being illustrated clearly in the financial statements, any discerning investor could carry out a thorough analysis in order to analyse the possibility of the realisation of future profit.

The reason for the significant increase in the advances paid to contractors since 2018 is mainly owing to The Grand project, which is a significantly larger project in value terms and is also a project that takes a longer than average time to complete. On this basis, the large portion of the revenue and the corresponding cost will be recognised only towards the latter stages of the project as evident from the recent financial statements.

The views on the reduction in the apartment values are subjective and would be based on individual viewpoints, however, since the company recognises revenue on units, which are actually sold and the payment plans are in progress, any increases or reductions in apartment values will not have a retrospective effect on the past financials. 

Furthermore, we believe that residential real estate investors are long-term investors with a long-term investment horizon, which means that the current state, which is global, would only have a relatively low short-term impact on the investment decisions. Furthermore, the company is confident of its ability to sell the units developed and is able to withstand any short-term slowdowns.