AaRVF’S BI-MONTHLY JOURNAL I VALUERS’ BULLETIN

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 VOLUME - 3 / ISSUE NO. - 1 I DEC-JAN, 2024 I VIEW POINT

KIRIT P. BUDHAPATI 1.0 Valuation of assets offered as security for

BE (E), Grad.IS (Val.), FIS, FIV, FCVSRTA, MIE(C) loans or advances must be carried out by
considering the following denition of
DIRECTOR 'Secured loan or advance' as per S.5(n) of
BUDHBHATTI AND ASSOCIATES
Banking Regulation Act, 1949.

Secured loan or advance:

Kirit Budhbhatti is a practicing valuer with over 40 years
experience in valuation of tangible assets - property and “A loan or advance made on the
plant, machinery and equipment. security of the assets the market
value of which is not at any time less
He has provided his valuation services by to large
than the amount of such loan or
corporates and multinational companies like -
advance.”
• Unilever
• Lever Johnson It is clear from the above denition that while
• Lever Gist Brocade advancing loan or for monitoring security
• Henkel offered against loan, the market value of
• Fiber Glass Pilkington (FGP) assets offered as security must be examined.

He is the author of following books: Market Value is dened by the International

1. Valuation of Plant and Machinery : Theory and Valuation Standards Council (www.ivsc.org)
Practice as under:
2. Valuation of Tangible Assets : For Mergers and Take-
Overs, Dis-investment and Restructuring
'Market Value is the estimated amount for
which an asset or liability should exchange on
3. Real Estate Valuation in Practice : For Fiscal and
Non Fiscal purposes
the valuation date between a willing buyer
and a willing seller in an arm's length
transaction, after proper marketing and
where the parties had each acted
knowledgeably, prudently and without
compulsion.'

Note: It will be observed that in the

Paper on denition of market value given by
IVSC the words used are asset or

Valuation of Plant liability. This seems to be mainly

because the International Valuation

and Machinery Standards are prepared for

tangible, intangible and nancial

For Bank Finance assets and business valuers have to

quite often assess liabilities also.

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 AaRVF’S BI-MONTHLY JOURNAL I VALUERS’ BULLETIN
2.0 The banks in India are directing the valuers to report
following values for the valuation of plant and
machinery:
• Fair Market Value
• Book Value
• Realizable Value
• Distress Sale Value
Fair Market Value is the same as Market Value.
Book value means purchase price (Gross Book Value)
less cumulative depreciation.
Realizable Value and Distress Sale Value are not dened
under IVS - 2017, 2020 and 2022. IBA Handbook 2011 has
dened these two values by adopting the denition of
IVS 2007. Orderly Liquidation Value and Forced Sale
Value dened under IVS 2007 have been adopted as
Realizable Value and Distress Sale Value respectively by
IBA.
Indian Overseas Bank in their latest policy (2020) has
dened realizable value as 85% of market value for
immovable property.
There is also another term Fair Value. The Fair Value and
Market Value/Fair Market Value are used
interchangeably which is not correct as explained
below.
Fair Value means the amount for which an asset could
be exchanged, or a liability settled, between
knowledgeable willing parties in an arm's length
transaction.
Fair value requires the assessment of a price that is fair
between two specic parties, considering the
respective advantages and disadvantages that each
party will get from the transaction. For example,
synergies between two parties may mean that the price
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that is fair between them is higher than the price that
might be obtainable in the market. Therefore, Fair Value
is often interpreted as a form of special value.
An example of Fair Value is given below:
There was a cement plant (X) for sale and the same was
valued scientically by a valuer and market value as of
31st December 2021 works out to say, (A). This value is
estimated in a such way that it can also be used for
secured lending.
The owners of the cement plant (Y) were interested in
buying the plant (X). The sellers were tough bargainers,
and they were aware of the urgent needs of the
purchasers. The owner of cement plant (Y) purchased
the plant at 1.75 (A).
Here the price paid is 1.75A and the same is a special
price paid by a party with its subjective consideration.
This transaction at a price of 1.75A falls under the
category of Fair Value dened earlier. However, market
value remains at A only, and therefore fair value and
market value cannot be used interchangeably In India,
under Direct Tax Acts, the words used are 'Fair Market
Value' and not 'market value', and hence there is a
general feeling that 'Fair Market Value' indicates market
value without unaccounted money. This is not correct at
all. Because in USA and Canada the term used is 'Fair
Market Value' (not the market value) where there is
hardly any problem of unaccounted money.
Market Value/Fair Market Value/Open Market Value
which satises the criteria of 'willing buyer' and 'willing
seller' has the same meaning as Market Value dened
by the Law Commission of India/IVS.
In case any different denition is given in any statute,
then in that case the denition given in the statute
becomes market value for that statute.
 VOLUME - 3 / ISSUE NO. - 1 I DEC-JAN, 2024 I VIEW POINT
The dictionary of Real Estate Appraisal of Appraisal
Institution USA denes net realizable value as under:
Net Realizable Value means Market Value less all costs
related to:
• Holding costs during the expected marketing
period,
• All selling costs related to the disposition of the
property, and
• The cost of funds or rent loss during the anticipated
marketing period.
Holding costs include; but are not limited to, real estate
taxes, property insurance, liability insurance, utilities, and
normal repairs and maintenance.
Selling costs include; but are not limited to, brokerage,
commissions, closing costs, title work, and surveys.
It is pertinent to point out that holding costs and selling
costs are not limited to mentioned above but any other
legitimate costs also need to be considered.
The author is of the opinion that the Realizable Value (RV)
is the net amount available in the hands of the owner
after meeting all the liabilities/costs in respect of the sale.
When an owner sells his right in an asset, he creates the
liability of payment of capital gains tax as per the law time
being in force.
The amount remaining in the hands of the owner after
meeting all the above expenses is subject to capital gains
tax. The net amount that remains with the owner after
considering all the costs referred to above including
payment of capital gains tax is actually net realizable
value.
Therefore, net realizable value is Market Value/Fair
Market Value less all the costs referred to above.
The author is also of the opinion that it would be
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appropriate to term it as a realizable amount/realizable
price rather than a realizable value.
3.0 RICS has done pioneering work in developing
guidelines/manuals on valuation for the benet of their
valuer members. These guidelines can even be useful to
practitioners across the globe after duly modifying them
to suit local requirements.
In the early seventies, guidelines were prepared in a book
having a red cover and hence it is referred to as the 'Red
Book'.
In the early nineties, the guidelines were revised, and the
red book was known as Statement of Asset Valuation
Practice (SAVP).
There was a crisis of loans and savings after revising the
'Red Book' in the nineties.
The bankers could not realize money as per the valuer's
report on the sale of properties. The lender banks led the
suits against valuers for damages running into several
million pounds. Due to this, there was a big hue and cry in
the profession and RICS immediately appointed a
committee under the chairmanship of their former
President, Mr. Mallinson known as the Mallinson
Committee (MC). The committee gave its detailed report
and recommended sweeping changes in the 'Red Book'
and in the year 1996, the 'Appraisal and Valuation
Manual' was published. The revised 'Red Book' was very
heavy in terms of content and number of pages
compared to SAVP published in the early nineties.
The terms 'Open Market Value (OMV)', 'Estimated
Realization Price (ERP)', and 'Estimated Restricted
Realization Price (ERRP)' were included in Appraisal and
Valuation Manual prepared by RICS. (Www.rics.org)
It is worthwhile to mention that the 'OMV' denition
included a willing seller and both the parties (i.e., a
 AaRVF’S BI-MONTHLY JOURNAL I VALUERS’ BULLETIN

'willing seller' and a 'purchaser' but not a 'willing value to ascertain whether the security (machines)
purchaser'). comply with the requirement of Banking Regulation
Act,1949 or not.
The author discussed with valuer friends in UK about the
'OMV' denition and especially to know the reasons why The format for valuation of plant and machinery
'willing purchaser' is not included in the denition. The prescribed under the valuation policies framed by the
answer was that: banks requires valuer to furnish the following information
for plant and machinery:
If 'willing purchaser' is there in the denition, then
it is likely that the valuer may make unrealistic • Description of machine
assumptions.
• Factory sr. no. if any
The mode of computation of 'ERP and 'ERRP' was • Function
discussed with valuer friends in the UK, but the author • Name of manufacturer/supplier and country of
was not satised. origin
• Sr. no. of machine, model no. identication mark
After a few years, the author got a message from a
• Quantity
valuer friend from London – intimating that – “your
problem is solved, because 'OMV', 'ERP' and 'ERRP' are • Year of make

no more in Appraisal and Valuation Manual of RICS (Red • Year of purchase

Book). Valuers are now only required to report 'market • Technical specications of machine
value' as per IVS even for bank purposes”. • Condition of the machine/maintenance (new,
old, reconditioned)
In our country also for bank nance purposes, valuers
• Residual life of the machine
need to be asked to report market value only.
• Purchase value/original cost

4.0 Illustration on Valuation satisfying Banking • Fair market value

Regulation Act, 1949 and shortfalls in Valuation Policies • Depreciation

of Public Sector Banks. • WDV
• Current replacement cost
Let us consider a case of a borrower who had
established a spinning section of a textile mill 5 years
back for spinning of superne yarns of 100s count as per
the demand prevailing at that time. Now, he has
approached a bank for advance on machines installed
in the plant. These machines are ve years old. Total
economic life of such machines is considered to be 20
years.

Let us carry out valuation as per the valuation policy

framed by public sector banks and estimate the market

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It is worth mentioning that the following vital issues to be

taken into consideration for the valuation of plant and
machinery are not found in the valuation formats of
valuation policies of the banks:

• Valuation maxims which include demand and

supply
• Tec hnol ogi c a l , f unc ti ona l , a nd ec onom i c
obsolescence
• Value subject to potential protability
• Value in existing use in situ/ex situ
• Value in alternative use in situ/ex situ
• Specialized/custom-built plant and machinery
suffering from limited marketability
• Effect of imbalance in the various production- These machines are ve years old. The total economic life
sections on value of each of the machines is considered to be 20 years,
• Effect of non-compliance of regulatory measures scrap value is considered to be 10% of the replacement
on value cost new.

This means according to the valuation policies of the

Banks in order to estimate value of machinery used for Depreciation per annum = 100-10 = 4.5
20
superne counts of 100 mentioned earlier - replacement
cost new based on the technical specications for each Depreciation for 5 years = 22.5%
machine, depreciation for age and depreciated
Depreciated replacement cost = 100-22.5 x 69.04
replacement cost are to be estimated and the same will
100
be as under:
= 0.775 x 69.04
Name of machine Quantity Replacement cost new
= Rs. 53.5 million
(Rs.in million)
Blow room & mixing 1 9.40
Cards (high production) 4 7.60 The market value as per valuation policies shall be
Draw frame 2 1.55 reported at Rs. 53.5 million.

Comber preparation 1 1.55

The above machines installed in the plant are utilized for
Comber 2 3.30
manufacture of yarn of 100s count.
Speed frame 2 2.84
Ring frame 24 21.60
As per the present market condition on date of valuation,
Winding 2 21.20 yarn of superne counts of 100s is not in demand but yarn
Total 69.04 of 30s count is in demand.

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In order to manufacture yarn of 30s count, the
additional machines are required.
The statement showing the names of additional
machines with their replacement cost as well as the
price of second-hand machines is given below.
obsolescence and also imbalance in different
production sections by installing additional machines.
This expense is a liability and needs to be deducted from
the depreciated replacement cost of Rs. 53.5 million. In
order to calculate the deduction, the following fact
needs consideration:

Name of Quantity Replacement Price of A proper deduction will depend on the future
Machine cost new Second Hand
Machines market of the 30s count. If the market is
(Rs. in million)
(Rs.in million) estimated to be of 5 years or more duration and
second-hand machines are in good condition
Cards (high 4 7.60 3.80 and also capable of working for the next ve
production)
years or more without the heavy cost of repairs,
Draw frame 2 1.55 0.80
Comber 5 8.25 3.00 then the deduction of Rs.15.6 million from the
Speed frame 2 2.84 0.80 depreciated replacement cost of Rs. 53.5
Winding 2 21.20 6.00
million will be appropriate. If new machines are

Miscellaneous
required, the liability would be Rs.42.94 million.
expenses for 1.50 1.20
conversion
5.0 Important considerations for bankers

Total 42.94 15.60

In view of the facts mentioned above, a prudent buyer
will not pay Rs. 53.5 million (depreciated replacement
cost estimated as per valuation policies of the banks) as
it is not capable of generating sufcient return in the
current market condition due to demand of 30s count
as on the date of valuation and not of 100s count. The
machines used for manufacture yarn of 100s count are
now suffering from functional obsolescence (for
manufacture of 30s count) and economic
obsolescence (as current demand is for 30s count) and
there is also imbalance in different production sections
to manufacture yarn of 30s count which are in demand
as additional equipment mentioned above are
required to manufacture the yarn of 30s count. In order
to generate sufcient income, it is necessary to incur an
expense to cure functional and economic
The above illustration establishes that the value i.e.,
depreciated replacement cost (DRC) worked out as
per the valuation policies of the Banks is not the market
value. Earning capacity, demand of products,
functional obsolescence, economic obsolescence,
and imbalance in different production sections are the
major considerations in estimating the market value. The
market value estimated after consideration of these will
satisfy S.5(n) of the Banking Regulation Act,1949.
However, the same is not prescribed under the
valuation policies of Banks.
'Willing buyer' and 'willing seller' will certainly take into
consideration earning capacity, demand of the
product, functional obsolescence, economic
obsolescence, and imbalance in the different
production sections because the future cash ow is

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dependent on these aspects. Moreover, if buyers and

sellers do not fall in the category of a willing buyer and
willing seller then the value estimated is not the market
value. It is also pertinent to point out that for an asset to
fall in the category of secured assets under S.5(n) of the
Banking Regulation Act,1949, the criteria of 'willing buyer'
and 'willing seller' must be satised.

Imagine the fate of a bank advancing loan on the above

machines on DRC of Rs. 53.5 million!

In the event of default by the borrower the bank will

realize in the range of (Rs.53.5 -Rs.42.94) to (Rs.53.5 –
Rs.15.6) i.e. in the range of Rs.10.56 million to Rs.37.9 million
instead of estimated depreciated replacement cost
(DRC) amounting to Rs.53.5 million

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