Applying IFRS 15’s ‘no alternative use’ to real estate sales

Effective from 1 January 2018, IFRS 15, ‘Revenue from Contracts with Customers’ provides a single, principles-based five-step model that determines how and when revenue can be recognised from contracts with customers.

In this article we will look more closely at what it means for an asset to have ‘no alternative use’ when dealing with a contract for the sale of a single apartment contained within a multi-unit residential complex currently under construction.

IFRS 15 basic principles

For these types of contracts, being able to recognise revenue over time usually depends on an entity’s ability to demonstrate that it meets the criteria in paragraph 35(c), which state:

• at all times throughout the duration of the contract it is entitled to an amount that compensates it for performance completed to date (eg, costs incurred to date plus a reasonable profit margin), and
• performance does not create an asset with an alternative use to the entity.

In this article, I have assumed that the vendor enters into separate contracts with customers for the sale of each individual unit.

Contractual and practical limitations

Determining whether an alternative use exists for an asset involves significant judgment based on the facts and circumstances of each situation. As a result, you’ll find that specific guidance can be hard to locate. There are few, if any, so-called ‘bright lines’. In general, you’ll find two broad categories of facts and circumstances that will lead to a conclusion of ‘no alternative use’.

• Contractual limitations – substantive contractual terms that act to prevent the vendor from redirecting the specific unit under contract to another customer.
• Practical limitations – the vendor would need to incur significant costs in order to make the unit suitable for sale to another customer.

Substantive contractual restrictions

If a substantive contract provision makes it impossible for an entity from redirecting a specific apartment to another customer, even though other units might be similar, then that apartment does not have an alternative use to the entity because it’s legally obliged to transfer it to the original customer.

This could be accomplished by the inclusion of contractual terms naming the specific unit being sold (eg, Apartment 730) or describing its attributes in sufficient detail that substitutability is effectively restricted (eg, the southwest facing corner unit on the 17th floor). A contractual restriction may not be substantive if, for example, it represents a protective right that does not effectively restrict the vendor from physically substituting a largely interchangeable asset (eg a contractual term intended to protect the customer against the vendor’s insolvency). 

Practical limitations

A practical limitation exists if a vendor would incur significant economic losses in repurposing the asset for another use. For example, an apartment that is highly customised for a particular customer does not likely have an alternative use if the vendor would need to incur significant costs to reconfigure it for someone else or they could only sell the unit at a significant loss.

For non-customised apartments, such practical limitations may not exist. That said, while individual apartments in some complexes may be fairly standardised, contractual provisions are often present that act to restrict the vendor from redirecting a specific unit to another customer and in that case the ‘no alternative use’ criterion would once again be met.

When do I make the significant economic loss assessment?

Financial Accounting Standards Board (FASB) members of the Transition Resource Group for Revenue Recognition (TRG) generally agreed that when evaluating the ‘no alternative use’ criterion, a vendor considers whether it could sell the completed asset to another customer without incurring a significant economic loss.[1] The fact that customisation may only take place in the final 20% of construction is irrelevant.

Ultimately, there is always going to be a significant element of judgement in making this assessment, based on the specific facts and circumstances present. My hope is that these insights will help you when applying these principles to your own contracts. If you would like to discuss any of the points raised, please speak to your usual Grant Thornton contact.

[1] Financial Accounting Standards Board (FASB) paper #56 - 7 November 2016