Should buildings be depreciated?

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This a contentious question in the minds of several accountants over many years. The short answer to this question is yes. Accountants sometimes argue that the property normally increases in value. The truth actually is that it is not the buildings that increase in value but rather the land component of the property.

In accordance with IFRS for SMEs land and buildings should be accounted for separately (IFRS for SMEs, par 17.6) because buildings do have a limited useful life whilst land normally has an indefinite useful life.  If the property is classified as “property, plant and equipment (PPE)” land is there not depreciated but the buildings are.  When land, however, is used as a quarry, under exceptional cases, it shall be depreciated because the land is going to be depleted over time.

Buildings are therefore depreciated, just as in the case of other PPE items. The depreciable amount is depreciated/allocated on a systematic basis over the useful life of the building. The depreciable amount represents the difference between the carrying amount of the building and its residual value (IFRS for SMEs, Appendix B). Please note that the residual value is not the amount that can be obtained at the end of the useful life, but rather what the entity can currently obtain for an asset if it was already of age as at the end of its useful life. Please refer to the glossary of terms for residual value (IFRS for SMEs, Appendix B).  For example, If the fair value of a building is estimated at R120 000 at the end of its useful life of 20 years and R150 000 can currently be obtained for a 20 year-old building, the residual value will be estimated at R150 000.

Should buildings then always be depreciated? The answer is no, there are circumstances where PPE items are not depreciated. If the residual value of a building, as determined at reporting date, is higher than the carrying amount, the depreciation charge to the statement of profit or loss will result in a credit and this is not allowed. Under such a circumstance, where the residual value is higher than the carrying amount, the depreciation will be zero. So it is technically possible not to depreciate buildings.  Depreciation on a building is therefore recognised only if the residual value of the building (not of the land) is less than its carrying amount.

If buildings, however, are classified as Investment Properties, an entity may use the fair value model. Under such circumstances the property (building and land) is measured at its fair value with remeasurement adjustments recognised in the statement of profit or loss.  If the fair value model for investment properties is not adopted, because the fair value can’t be measured reliably, such property items shall be accounted for as PPE (IFRS for SMEs par 16.4).

In summary, properties are classified as “investment properties” or as “property, plant and equipment (PPE)”.  If classified as PPE, the building component is depreciated if the residual value is lower than the carrying amount.

Prof HA van Wyk is the Programme Director at the School of Accounting at the University of the Free State.