NBFC Provisioning under RBI Regulations – Residual Value in RBI SBR

1. Query

Delta Private Limited (hereinafter referred to as “the company”) is a Non-Banking Financial Company (NBFC) engaged in financing and leasing activities, including leasing of electric vehicles. The leases entered into by the company are classified as finance leases in accordance with Accounting Standard (AS) 19, Leases, and accordingly, lease receivables are recognised based on the net investment in the lease, including residual value components.

As per the Scale-Based Regulations (SBR) issued by the Reserve Bank of India (RBI), the company is required to create minimum provisions in respect of its lease portfolio. The provision is computed with reference to total dues, reduced by the depreciated value of the underlying asset. The regulations issued by RBI prescribe that such depreciated value should be computed notionally using the original cost of the asset and applying depreciation at a specified rate on a straight-line basis.

However, the regulations do not clarify whether any adjustment should be made for salvage value (or residual value) while computing such depreciated value. The company is of the view that, since AS 10 requires the deduction of residual value in determining the depreciable amount, a similar approach may be considered for this purpose.

Further, in many lease arrangements, the company has exposure to guaranteed residual values or purchase options, which raises an additional question regarding the determination of an appropriate salvage value, if considered.

The management of the company, while finalising the books of account, was in a dilemma as to whether salvage value should be considered while computing notional depreciated value under the SBR Regulations?

2. Relevant Provisions

AS 10 – Property, Plant and Equipment

Para 55 of AS 10

The depreciable amount of an asset is determined after deducting its residual value.

AS 19- Leases

Para 26 of AS 19

The lessor should recognise assets given under a finance lease in its balance sheet as a receivable at an amount equal to the net investment in the lease.

Preface to the Statements of Accounting Standards

The Accounting Standards, by their very nature, cannot and do not override the local regulations that govern the preparation and presentation of financial statements in the country. However, the ICAI will determine the extent of disclosure to be made in financial statements and the auditor’s report thereon.

Scale-Based Regulations – RBI

NBFCs engaged in leasing or hire purchase are required to compute minimum provisions based on total dues reduced by:

(a) Unmatured finance charges; and

(b) Notional depreciated value of the asset, computed using straight-line depreciation at a prescribed rate

3. Analysis

The issue under consideration is whether principles relating to residual value under AS 10 can be extended to the computation of the notional depreciated value prescribed under the SBR Regulations.

Under AS 10, residual value is an integral component in determining the depreciable amount of an asset for financial reporting purposes. The standard requires that depreciation be computed after deducting the estimated residual value, irrespective of the method of depreciation used. This principle, however, applies specifically in the context of accounting for property, plant and equipment.

In contrast, the present case involves the computation of a notional depreciated value for the limited purpose of determining provisioning requirements under a regulatory framework. The SBR Regulations prescribe a specific methodology for such computation, based on original cost and a fixed rate of depreciation on a straight-line basis. The regulations do not provide for any adjustment on account of salvage or residual value.

Further, AS 19 governs accounting for finance leases and introduces the concept of residual value, including guaranteed and unguaranteed components, for the purpose of determining lease receivables. However, such concepts are relevant for the measurement of net investment in the lease and do not extend to provisioning requirements. Notably, AS 19 does not prescribe any provisioning mechanism that incorporates residual value.

In the present case, the provisioning requirement arises from the SBR Regulations, which constitute a specific regulatory framework applicable to NBFCs. As per the Preface to the Statements of Accounting Standards, accounting standards cannot override regulatory requirements where inconsistencies exist. Therefore, where the SBR Regulations prescribe a particular method for computing provisions, such method must be followed as it stands.

Accordingly, the principle of deducting residual value under AS 10 cannot be imported into the computation of notional depreciated value under the SBR Regulations.