1.56 Query
Computation of Net Worth of A Company Our Corporation is a wholly owned State Government undertaking having the principal objective of accelerating the process of industrial development in the State in the medium and large scale sectors. With a view to fulfilling its objective, the Corporation has been implementing projects both in the public and joint sectors. For the implementation of a project in joint sector, the Corporation enters into a financial collaboration Agreement with co-promoter. The Financial Collaboration Agreement, inter-alia, provides that after a certain period, both the Corporation and the financial collaborator can transfer or sell whole or any part of their respective shareholding inter se. The shares are transferred inter se at par value with a stipulated minimum return, or at the price of shares computed on the basis of net worth of the company excluding the value of goodwill by the company’s auditors or an average of the stock exchange prices over two month’s period preceding the offer of sale whichever is highest.
In one of our promoted companies in the joint sector, the financial collaborator has offered to purchase the shares held by the Corporation in the company. The Corporation in terms of the Agreement asked the company to send a certificate from its auditors giving the price of the shares computed on the basis of its net worth. It was observed from the annual accounts for the year ended 30th June, 1978, submitted by the company that it switched over to written down value method for the purpose of calculation of depreciation with retrospective effect. The company had been providing depreciation on straight line method since its inception (it went into production in December, 1973). The change over to the written down value method of depreciation has resulted in the provision of additional depreciation of about Rs. 62 lakhs up to 30th June, 1978 i.e. with retrospective effect thereby reducing substantially the net worth per share as on 30th June 1978. The fall in the net worth would not have occurred had the company continued with the straight line method. We shall be grateful to have your considered opinion whether for the purpose of calculation of the net worth of the shares, the provision of depreciation on written down value method with retrospective effect as now adopted by the company should be accepted and whether it is the normal practice to provide for depreciation on written down value method for the purpose of computation of net worth of the shares. Please also let us know whether there are any cases or rulings relevant to this issue.
Opinion September 24, 1979
The Committee is of the view that the method of providing depreciation in the accounts, whether straight line method or written down value method, consistently followed by the company should be adopted for determining the net worth when such net worth is required to be calculated only with reference to book values of assets and liabilities. There is nothing in law which prohibits a company from changing the method of providing for depreciation in accounts. According to the Institute’s “Statement on Changes in the Method of Charging Depreciation in Accounts” on a change in the method of charge of depreciation, depreciation should be recalculated from the date of the asset coming into use under the new method and any resulting surplus/deficiency should be transferred to General Reserve through the appropriation part of the Profit and Loss Account. In addition, a full and suitable disclosure of the change together with its effect on the profit of the year must be made in the final accounts. Prima facie, the change-over must be necessitated by the bona fide needs of the company.
The Committee is, therefore, of the view that if the change-over from the straight line method to the written down value method for providing depreciation in accounts was duly authorised by the Board of Directors of the company and if the new method was adopted for preparation of the financial statements of the company for the year ended 30th June 1978, the net worth could be determined on the basis of a charge for depreciation on the written down value method with retrospective adjustment. In this view of the matter, the fact that the net worth of the company is lower by an amount of about Rs. 62 lakhs as compared to the net worth if the method of depreciation had not been changed is not pertinent.
It is, however, important to consider the purpose for which the net worth of the shares to be determined and whether there are any contractual stipulations regarding the manner in which net worth is to be computed. Unless it is clearly specified that net worth should be calculated only with reference to book values, it may be necessary to substitute for the book value of the assets the real value thereof, represented by current market values of assets. If a value other than book value of assets is considered, the fact of change in the method of depreciation will have no effect on the final determination of net worth. _____________________________ |