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Query No. 25
Subject:
Determination of depreciation in case of revaluation and
revision in the useful life of land and buildings. 1
A. Facts of the Case
1. A nationalised bank is covered under the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970, and is regulated by the Reserve Bank of India. The equity of the bank is listed on the Bombay Stock Exchange and the National Stock Exchange. The querist has stated that for accounting purposes, the provisions of the Banking Regulation Act, 1949, are broadly applicable to the bank.
2. The bank purchased freehold land and building in the year 1950 costing Rs. 50 lakh (land Rs. 20 lakh and building Rs. 30 lakh) and accounted for the same separately as ‘freehold land’ and ‘bank’s own premises’, respectively. On ‘bank premises’ component, the bank is charging depreciation @ 5% on written down value basis. In the year 2008, the property has been revalued at Rs. 100 lakh (land Rs. 80 lakh and building Rs. 20 lakh) and the revaluation reserve has been created for Rs. 60 lakh towards land and Rs. 18.50 lakh towards building, assuming the written down value of building at Rs. 1.5 lakh. The valuer has estimated the useful life as 25 years.
3. The bank also purchased a leasehold land in the year 1990 with lease period of 99 years and paid Rs. 99 lakh. The bank subsequently constructed building thereon in June 1992 costing Rs. 50 lakh. The cost of land is debited to ‘leasehold land’ and construction cost to the ‘bank’s own premises’. The bank is amortising lease rent @ Rs. 1.00 lakh per annum and is charging depreciation @10% on building since 31.03.1993 on written down value basis. The property has been revalued at Rs. 140 lakh (land Rs. 100 lakh and building Rs. 40 lakh).
4. The querist has also informed that the bank owns more than 200 properties purchased in different years and all the properties have been revalued in the year 2008.
B. Query
5. The querist has sought the opinion of the Expert Advisory Committee on the following issues:
(i) Under the facts described in paragraph 2 above, what should be the applicable rate of depreciation?
(ii) Under the facts described in paragraph 3 above, what should be the applicable depreciation rate on both original cost and revalued portion,
(a) if the valuer has estimated the remaining useful life as 40 years?
(b) if the valuer has not given any useful life and the management, as a policy, is not determining the useful life of the land and buildings?
(iii) Whether different rates of depreciation will be applicable on the 200 properties purchased in different years and revalued in the year 2008. If yes, what is the mechanism to be followed for implementation?
C. Points considered by the Committee
6. The Committee has considered only the issues raised by the querist in paragraph 5 above and has not touched upon any other issue that may arise from the Facts of the Case, such as, treatment of revaluation reserves, etc. Further, while formulating its opinion, the Committee has restricted itself to describing the accounting principles that should be considered for determining the rate of depreciation and has not gone into the calculation of depreciation rate for various assets.
7. The Committee notes that the Reserve Bank of India, vide its circular No. DBOD. No. BP. BC. 89 /21.04.018/2002-03 dated March 29, 2003 regarding Guidelines on compliance with Accounting Standards (AS) by banks, has advised all scheduled commercial banks to ensure strict compliance with the accounting standards issued by the Institute of Chartered Accountants of India, with effect from the accounting year ending March 31, 2003. Accordingly, the Committee is of the view that the Accounting Standards, issued by the Institute of Chartered Accountants of India (ICAI) and other generally accepted accounting principles (GAAPs) would be applicable to the bank in the present case.
8. The Committee notes the introduction paragraph and the definition of the term ‘depreciable assets’ as contained in Accounting Standard (AS) 6, ‘Depreciation Accounting’, issued by ICAI, as below:
“Introduction
1. This Statement deals with depreciation accounting and applies to all depreciable assets, except the following items to which special considerations apply:-
…
This statement also does not apply to land unless it has a limited useful life for the enterprise.”
“3.2 Depreciable assets are assets which
(i) are expected to be used during more than one accounting period; and
(ii) have a limited useful life; and
(iii) are held by an enterprise for use in the production or supply of goods and services, for rental to others, or for administrative purposes and not for the purpose of sale in the ordinary course of business.”
9. From the above, the Committee notes that a depreciable asset should essentially have a limited useful life. As per the GAAPs prevalent in India, freehold land is considered to be having an unlimited life and, therefore, cost thereof is not depreciated. In the context of the leasehold land which is recognised as a fixed asset by the bank keeping in view the existing practice of reflecting leases of land in the balance sheets of the lessees, as such leases are scoped out of Accounting Standard (AS) 19, ‘Leases’, the Committee notes that the land in question has a lease period of 99 years. Thus, it has a limited useful life for the bank. Accordingly, the upfront amount of Rs. 99 lakh paid by the bank for the same should be amortised over its useful life, i.e., 99 years, on a systematic basis. The Committee also notes that in this case, the life of the leasehold land is predetermined by the lease agreement. Therefore, there is no question of revision of its estimated useful life unless the lease agreement is renewed or the lease terms undergo a change.
10. With respect to the building purchased/constructed by the bank, the Committee is of the view that since it fulfills the definition of the term ‘depreciable assets’ reproduced above, it is a ‘depreciable asset’. In this context, the Committee notes paragraphs 5, 7, 11, 20 and 23 of AS 6 which provide as follows:
“5. Assessment of depreciation and the amount to be charged in respect thereof in an accounting period are usually based on the following three factors:
(i) historical cost or other amount substituted for the historical cost of the depreciable asset when the asset has been revalued;
(ii) expected useful life of the depreciable asset; and
(iii) estimated residual value of the depreciable asset.”
“7. The useful life of a depreciable asset is shorter than its physical life and is:
(i) pre-determined by legal or contractual limits, such as the expiry dates of related leases;
(ii) directly governed by extraction or consumption;
(iii) dependent on the extent of use and physical deterioration on account of wear and tear which again depends on operational factors, such as, the number of shifts for which the asset is to be used, repair and maintenance policy of the enterprise etc.; and
(iv) reduced by obsolescence arising from such factors as:
(a) technological changes;
(b) improvement in production methods;
(c) change in market demand for the product or service output of the asset; or
(d) legal or other restrictions.”
“11. The quantum of depreciation to be provided in an accounting period involves the exercise of judgement by management in the light of technical, commercial, accounting and legal requirements and accordingly may need periodical review. If it is considered that the original estimate of useful life of an asset requires any revision, the unamortised depreciable amount of the asset is charged to revenue over the revised remaining useful life.”
“20. The depreciable amount of a depreciable asset should be allocated on a systematic basis to each accounting period during the useful life of the asset.”
“23. The useful lives of major depreciable assets or classes of depreciable assets may be reviewed periodically. Where there is a revision of the estimated useful life of an asset, the unamortised depreciable amount should be charged over the revised remaining useful life.”
11. From the above, the Committee is of the view that the rate of depreciation to be applied to a fixed asset would depend on the depreciable amount of the asset and its useful life. With respect to the ‘useful life’, the Committee notes that paragraph 8 of AS 6 states that determination of the useful life of a depreciable asset is a matter of estimation and is normally based on various factors, including experience with similar types of assets. Further, from the above reproduced paragraph 23 of AS 6, the Committee is of the view that useful lives of buildings may be reviewed periodically. If the bank does not have a policy to re-estimate the remaining useful lives of buildings periodically, the depreciable amount (as determined in accordance with paragraph 12 below) should be written off over the remaining useful life in accordance with the original estimate. The review of the useful lives should be done for a class of depreciable assets and not for randomly selected assets. In case of building constructed on the leasehold land, the useful life of the building cannot exceed the remaining lease period of land.
12. With respect to the depreciable amount of an asset, the Committee is of the view that ordinarily, the depreciable amount would be the cost thereof less the estimated residual value. In the context of revaluation of buildings by the bank, the Committee notes the following paragraphs of Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’, issued by the ICAI:
“27. When a fixed asset is revalued in financial statements, an entire class of assets should be revalued, or the selection of assets for revaluation should be made on a systematic basis. This basis should be disclosed.”
“29. When a fixed asset is revalued upwards, any accumulated depreciation existing at the date of the revaluation should not be credited to the profit and loss statement.”
The Committee further notes paragraph 26 of AS 6, which is reproduced below:
“26. Where the depreciable assets are revalued, the provision for depreciation should be based on the revalued amount and on the estimate of the remaining useful lives of such assets. In case the revaluation has a material effect on the amount of depreciation, the same should be disclosed separately in the year in which revaluation is carried out.”
From the above, the Committee is of the view that while revaluing the buildings, paragraphs 27 and 29 of AS 10 as reproduced above should be kept in mind. The depreciable amount after revaluation would be the revalued amount less the estimated residual value of the building.
13. The Committee notes that AS 10 does not apply to assets under leasing rights (paragraph 5). The Committee has not examined the appropriateness of revaluation of leasehold land held by the bank as that issue has not been raised by the querist.
D. Opinion
14. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 5 above:
(i) Under the facts described in paragraph 2 above, the rate of depreciation on building should be determined on the basis of the depreciable amount and its remaining useful life. In case the building has been revalued, the depreciable amount would be the value assigned to the building upon revaluation less its estimated residual value, provided revaluation has been done in accordance with AS 10. The useful life should be determined as explained in paragraph 11 above. Freehold land is not a depreciable asset and, therefore, the question of determination of rate of depreciation for such land does not arise (see paragraph 9 above).
(ii) Under the facts described in paragraph 3 above, with respect to determination of rate of depreciation of the building constructed on leasehold land, the principle stated in (i) above would apply. The cost of the leasehold land acquired on lease for 99 years should be amortised over its lease term on a systematic basis (see paragraphs 9 and 13 above).
(iii) The rate of depreciation of a building depends on the depreciable amount of the building and its expected useful life. Depending on the factors mentioned in paragraphs 10 and 11 above, the useful life may vary in case of each building. The depreciable amount may also vary depending on its cost of purchase/construction or its revalued amount, as the case may be, and its estimated residual value. Accordingly, the rate of depreciation may vary for each of the buildings and, therefore, should be determined individually for each property.
1Opinion finalised by the Committee on 15.12.2009
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