1.3 Query
(a) Accounting Treatment of Special Depreciation Reserve.
After coming into force of the companies Act, 1956, a company had determined the amount of depreciation provided in excess of requirements and shown such depreciation as a “Special Depreciation Reserve”. The company now wishes to transfer such Special Depreciation Reserve to the Profit & Loss Account. The question for consideration is whether it would be in order for the company to do so and whether such procedure would not amount to revaluation of the fixed assets.
Opinion November 29, 1961
The Committee felt that the Directors of the Company had come to the conclusion that certain amounts provided for depreciation were in excess of the requirements and had themselves shown them separately as a ‘Reserve’. Such excess came out of the profits of past years. The fact that the Reserve Account was designated as ‘Special Depreciation Reserve’ is not of any special significance, as it is customary in this country to have a large number of reserve accounts under various designations. The Committee was also informed that subsequent to the transfer of the excess depreciation to the Reserve, the Company did not utilize the Reserve for the purpose of reducing the normal charge for depreciation in future years. In the circumstances, the committee was of the opinion that the company was not precluded from utilizing such a revenue reserve for transfer to the Profit & Loss Account, to be appropriately disclosed and shown “below the line”. The Committee was also of the view that this procedure was warranted by the decision of the English Courts in Stapley vs. Read Bros. Ltd. (1924) (2 Ch. 1). Query (b) Provision of Depreciation for Revalued Assets.
The Company had carried out a revaluation of its fixed assets and wished to incorporate such revalued figures in its books as at the end of its accounting year. The surplus resulting from the revaluation was intended to be credited to a Capital Reserve Account. The question for consideration was whether depreciation on the fixed assets should hereafter be provided on the original cost of the assets or whether it should be provided on the revalued figures.
Opinion November 29,1961
The Committee is of the definite view that such depreciation must be provided for on the basis of the revalued figures and not on the basis of the original cost. On generally accepted accounting principles it was necessary that this should be done in order to present a “true and fair” view. The view of the Committee was confirmed by the following statement by the Institute of Chartered Accountants in England & Wales in paragraph 13 of its recommendation No. 15 on “Accounting in relation to changes in the purchasing power of money”: - “If fixed assets are written up, the subsequent charges for depreciation will be the amounts required to amortise the written-up amount of the assets over their remaining life.” The American Institute of Certified Public Accountants had also expressed its views on this subject in Chapter 9 of Accounting Research Bulletin No. 43, as under: - “When appreciation has been entered on the books, income should be charged with depreciation computed on the written-up amounts. The company should not at the same time claim larger property valuations in statements of assets and provide for the amortization of only smaller amounts in its statement of income. When a company has made representations, as to increased valuation of plant, depreciation accounting and periodic income determination thereafter should be based on such higher amounts.” The Committee’s attention was drawn to Circular No. C/293 A (584) dated 5th October, 1961, issued by the Department of Company Law Administration dealing with the computation of depreciation under Section 350 of the Companies Act, 1956. In response to question No. 3, the Circular states that any addition arising out of a revaluation subsequent to 1st April, 1956, should not be taken into account for the purpose of providing depreciation under Section 350. The Committee was in respectful agreement with this opinion expressed by the Company Law Department in so far as it concerned the computation of depreciation for the limited purpose of calculating the managing agent’s commission. However, the Department’s views on Section 350 also have a bearing to Section 250 (2) (a), under which depreciation can be provided for as computed by Section 350. Apart from the fact that Section 205 represents the legal minimum of depreciation which may be provided, there is nothing to preclude a company from providing higher depreciation if it is considered necessary. In our view of general accounting principles, it would be necessary for the company to provide depreciation on the basis of the revalued figures in its accounts. _________________________ |