NET REALISABLE VALUE OF LAND INVENTORY

As per accounting standard, land inventory should be recorded at the lower of cost and net realisable value (NRV). NRV is defined as estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. Although the accounting standard gives the guidance on how to calculate NRV, it does not provide detailed methodology for calculation of NRV of land inventory on fully developed basis for real estate companies. The key dilemma for a valuer while computing the NRV is whether or not to include the interest costs incurred during the project period. Since real-estate projects have a long gestation period and have a significant component of debt funding, ignoring interest costs will skew the valuation positively.

NRV as per the above method can be computed only when the management of the company can show a realistic project plan containing the development mix and schedule of the project. Considering the current market scenario, key business plan assumptions such as selling price, expected profitability and time required will always be a point of debate. Further, considering the current illiquid nature of the real estate market, it is increasingly difficult for the valuer to establish a market benchmark of the land inventory.

RECOVERABLE VALUE OF INVESTMENT

In case of land classified as investment property and fixed assets, impairment testing is done to ascertain an impairment loss. An impairment loss is the amount by which the carrying amount of investment property/fixed assets exceeds its recoverable value which is the higher of its fair value less costs to sell and its ‘value in use’. However, arriving at fair value of the land would involve a lot of subjectivity. ‘Value in use’ is the present value of the future cash flows expected to be derived from fully developed property. Since projecting future cash flows can be subjective, As it requires the management to estimate the cash flows based on reasonable assumptions. Again, a valuer faces significant challenge pertaining to the accuracy and rationale of the assumptions used in the business plan with regards to the selling price and time required to sell the fully developed property.

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