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M.V. Kali Prasad

Real estate can pose a considerable problem to an auditor. First is the classification as land, civil works, capital works in progress and buildings.

Land is further classified as agricultural, factory site, industrial land, vacant plots and so on.

Buildings are further classified as factory buildings, office blocks, utilities such as canteen, parking lots and so on.

While land is not a depreciable asset, building is subject to depreciation at different rates based on its classification.

Earthwork and development

How to treat expenses incurred on site development, jungle clearance, etc., must be considered.

Generally, it is capitalised as it is necessary to bring the land to a usable condition.

But if tanks are dug for aqua culture, cost of digging would constitute civil works and not land.

The cost of digging would have to be absorbed over the useful life - say 3 to 4 years. So is the case with platforms raised, landscaping, etc.

Replacement of roof

Where an entity replaces an existing tin roof with RCC roofing, the expenditure qualifies as revenue expenditure and not capital expenditure, as no new asset is formed and the life of the asset is not extended beyond the original estimate.

Such expenditure must be charged to profit-and-loss account.

Depreciation

Land and buildings are generally grouped together. Land is not a depreciable asset while building is depreciable. The building component should be determined to arrive at the proper depreciation amount. Particularly where an existing building is purchased, bifurcation of costs between land and buildings would be tough. The auditor may need to consult an expert.

Construction of additional floors

Suppose an additional floor is added to an existing building that is considerably old. When a new floor is constructed, the life of the first floor would be lesser than the ground floor structure.

The first floor of the building will collapse along with the ground floor. It would seem logical to depreciate ground floor at normal rates while for the first floor, a different rate is to be adopted.

Therefore, the first floor should be subjected to an accelerated depreciation to write it off over the remaining useful life of the ground floor. But the law does not allow for such a procedure.

For example, if the cost of ground floor is Rs 20 lakh and the estimated life of the structure is 50 years.

The entity would charge depreciation at 2 per cent on straight-line method (SLM), if no scrap value is expected at the end of the building's life.

After 20 years, the written-down value (WDV) of the building would come down to Rs 12 lakh. At this stage, when the new floor is added at a cost of Rs 30 lakh, the rate of depreciation should be worked out on an estimated future useful life of only 30 years for the first floor, as the ground floor is expected to collapse in that time. Since the entity follows SLM for depreciation, the depreciation on the first floor should be Rs 1 lakh per annum and on the ground floor at Rs 40,000 a year.

Pulling down an existing building

When an existing building is pulled down and a modern complex constructed, where should one take the cost of demolition?

This must be considered on a case-to-case basis. Consider this:

A company acquires an old building with land appurtenant thereto and demolishes the building immediately to construct a new complex.

The intention of the company was to possess land for construction. Since open land is not available in the desired location, the old building was purchased.

Accounting Standard (AS) 10 states that all cost incurred to bring the asset to a usable condition must be debited to the asset account. Unless the old structure is pulled down, the plot is not useful for the purpose for which it was acquired.

Therefore, AS 10 suggests that the cost of demolition be capitalised and added to the cost of land.

But, consider a situation where the company already owns a building for long and wants to construct a new building in its place.

The demolition of the old structure is incidental to the new construction. It is more attributed to the cost of construction and not the land. It seems justified to debit the cost of demolition to building account and not to land account as distinct from the earlier situation.

Use of building while still under construction

Quite often entity let out the ground floor for exhibitions and sales while the upper floors are still under construction.

A capital works is in progress. Where does one book the rent received from letting out the incomplete structure.

AS 16 seems to suggest that income generated by a "Qualifying Asset" should be netted off against the cost of construction.

Any income generated by borrowing during the qualifying period should be netted off against the cost of the asset. Similarly, can the income generated by letting out the building still under construction be netted off against the cost of construction?

For income tax too, does it qualify to be income from house property? Since the building is not yet complete and not inhabitable, does it become income from other sources? Or does it become a deduction from the cost of construction?

Investment property

As per AS 13, `investment property' is an investment in land or building that is not intended to be occupied substantially for use by, or in the operations of, the investing enterprise.

The entity cannot charge depreciation on such property since the asset is not "put to use" by the entity. Such a property should be disclosed separately and distinct from land and buildings.

The author is a Hyderabad-based practising Chartered Accountant.

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