1.16 Query
Accounting for depreciation consequent to introduction of Schedule XIV.
1.For the purposes of dividends and managerial remuneration, depreciation is provided in accounts in accordance with the provisions of section 350 of the Companies Act, 1956. Section 350 provides that depreciation is to be charged on the written down value of the assets as shown by the books of the company at the end of the financial year at the rates prescribed under Schedule XIV to the Act. Schedule XIV prescribes both the WDV and SLM rates for charging depreciation.
2.As per circular issued by the Department of Company Affairs (Circular No. 1/86 dated 21st May, 1986) which still holds good, the depreciation on SLM rates provided on assets purchased prior to 2nd April, 1987, can continue to be charged on the same basis, i.e., specified period calculated at the time of purchase of the assets. In other words, the assets purchased prior to the said date can continue to be depreciated at the earlier rates of depreciation on SLM basis, without recomputing the specified period and without considering the rates specified by the Government in Schedule XIV, which provides the minimum rates. It would mean that, assets purchased prior to April 2, 1987 can continue to be depreciated at lower rates than those prescribed under Schedule XIV.
3. The querist has referred the following issues for the opinion of Expert Advisory Committee:
(a) Whether SLM rates can be applied on the depreciated value of assets on which depreciation has already been charged for a number of earlier years at the rates lower/ higher than the rates prescribed in Schedule XIV to the Act. If the answer to above is in the affirmative, then:
(i) Will it not amount to changing the specified life of the asset of the company from the year in which Schedule XIV rates are adopted?
(ii) Will it not be against the established accounting principle since the straight line depreciation rates, by definition, are applicable only to be original cost of the assets and as a general rule they should not be applied to the depreciated value of the assets?
(b) What treatment is to be given to such assets in respect of which depreciation more than the rates prescribed in Schedule XIV has already been provided prior to the amendment introducing the said Schedule?
(c) (i) Whether the applicability of the depreciation rates in Schedule XIV is restricted to the additions to the fixed assets subsequent to the date of amendment or the same is applicable to all the assets of the company whether acquired after or before the date of the said amendment.
(ii) In case the view is that it is applicable only to the additions after the date of amendment, whether it will be sufficient compliance of the provisions of section 205 if depreciation is charged at rates less than Schedule XIV on assets acquired before 2nd April, 1987.
(iii) Whether it will be sufficient compliance of the provisions of section 205 if depreciation is charged at the rates of Schedule XIV or higher rates than that of Schedule XIV on additions of the fixed assets acquired after the said date.
(d) Whether it is permissible under law to recompute the specified life of an asset on the basis of rates prescribed under Schedule XIV. If yes, then, is it advisable to recompute the depreciation on the basis of revised specified period of the assets? This recomputed depreciation may be compared with the depreciation already provided till date in the accounts and the excess or short provision of depreciation in the accounts may be adjusted by writing back or writing off the same. Thereafter, the depreciation may be charged in the accounts at the minimum rates prescribed under Schedule XIV.
Opinion February 12, 1990
1. The Committee notes paragraphs 9,10, 15, 16, 22, 23 and paragraphs 27 of the “Guidance Note on Accounting for Depreciation in Companies” (First Edition, 1989) issued by the Research Committee of the Institute of Chartered Accountants of India, which recommend, inter alia:
“9. The Committee is of the view that in arriving at the rates at which depreciation should be provided the company must consider the true commercial depreciation, i.e., the rate which is adequate to write off the asset over its normal working life. If the rate so arrived at is higher than the rates prescribed under Schedule XIV the company should provide depreciation at such higher rate but if the rate so arrived at is lower than the rate prescribed in Schedule XIV, then the company should provide depreciation at the rates prescribed in Schedule XIV, since these represent the minimum rates of depreciation to be provided. Since the determination of commercial life of an asset is a technical matter, the decision of the Board of Directors based on technological evaluation should be accepted by the auditor unless he has reason to believe that such decision results in a charge which does not represent true commercial depreciation. In case a company adopts the higher rates of depreciation as recommended above, the higher depreciation rates/lower lives of the assets must disclosed as required in Note no. 5 of Schedule XIV to the Companies Act, 1956.
10. This view is supported by the Department of Company Affairs and it has clarified that “the rates as contained in Schedule XIV should be viewed as the minimum rates, and, therefore, a company will not be permitted to charge depreciation at rates lower than those specified in the Schedule in relation to assets purchased after the date of applicability of the Schedule. If, however, on the basis of bonafide technological evaluation, higher rates of depreciation are justified, they may be provided with proper disclosure by way of a note forming part of annual accounts”1.
15. Applicability of the rates prescribed in Schedule XIV to existing assets would depend upon whether the company has been charging depreciation on its assets as per the written down value method or the straight line method.
16. Where a company has been following the written down value method of depreciation in respect of its assets, the WDV rates described in Schedule XIV should be applied to the written down value as at the end of the previous financial year as per the books of the company.
22. The Committee is accordingly of the view that where a company has been following straight line method of depreciation in respect of its assets existing on the date of Schedule XIV coming into force, the following alternative bases may be adopted for computing the depreciation charge:
(a) Where a company follows the manner of charging depreciation recommended by the Department of Company Affairs in its Circular No. 1/85, it has to change its depreciation rates as follows:
(i) The specified period should be recomputed by applying to the original cost, the revised rate as prescribed in Schedule XIV;
(ii) Depreciation charge should be calculated by allocating the unamortized value as per the books of account over the remaining part of the recomputed specified period.
(b) A company which follows the Circular No. 1/86, can continue to charge depreciation on straight line basis at old rates in respect of assets existing on the date on which the new provisions relating to depreciation came into force.
(c) SLM rates prescribed Schedule XIV can be straightaway applied to the original cost of all the assets including the existing assets from the year of change of the rates.
23. A company which changes the rates of depreciation should make an appropriate disclosure in its accounts pertaining to the year in which the change is made.
27. The Department of Company Affairs, as per its circular no. 3/19/88-CL V, dated April 13, 1989, has stated that “For the purpose of determining net profits of any financial year the amount of depreciation required to be deducted in pursuance of clause (k) of sub-section (4) of Section 349 read with Section 350 shall be the amount calculated as per the written down value method at the rate specified in Schedule XIV, on the assets as shown by the books of the Company at the end of the relevant financial year”. The Committee is of the opinion that the language of Section 350 as it stands at present, does not permit the use of the Straight Line Method. The aforesaid section makes reference to ‘written-down value of the assets’ indicating thereby that for the purposes of computation of managerial remuneration, only the WDV method can be used as the SLM rates, by definition, are applicable only to the original cost of the assets and not to the WDV of the assets.”
2. On the basis of above, the Committee is of the following opinion, in respect of the issues raised by the querist in para 3 of the query:
(a) SLM rates specified in Schedule XIV cannot be applied on the depreciated value of the assets on which depreciation has already been charged on straight line method, but can be applied only on the original cost of the assets as prescribed in paragraph 22(a) and 22(c) of the ‘Guidance Note on Accounting for Depreciation in Companies’ reproduced above. The issues at 3(a) (i) and (ii) need not be answered as the aforesaid reply is not in the affirmative.
(b) The following treatment should be given to the assets in respect of which depreciation at rates other than the rates prescribed in Schedule XIV has already been provided prior to the introduction of the said Schedule:
Where the company is following WDV method of depreciation
Where a company has been following WDV method of depreciation in respect of its assets existing on the date of Schedule XIV coming into force, WDV rates specified in Schedule XIV should be applied to the written down value as at the end of the previous financial year as per the books of the company.
Where the company is following SLM Method of depreciation
Where a company has been following SLM method of depreciation in respect of its assets existing on the date of Schedule XIV coming into force, either of the following alternative basis may be adopted for computing the depreciation charge:
(1) Where a company follows the manner of charging depreciation recommended by the Department of Company Affairs in its Circular No. 1/85 dated 10.1.1985, it has to change its depreciation rates as follows:
(A) The specified period should be recomputed by applying to the original cost, the revised rate as prescribed in Schedule XIV.
(B) Depreciation charge should be calculated by allocating the unamortized value as per the books of account over the remaining part of the recomputed specified period.
(2) Where a company follows the manner of charging depreciation recommended by the Department of Company Affairs in its Circular No. 1/86 dated 21.5.1986, it can continue to charge depreciation at the old rates.
(3) SLM rates prescribed in Schedule XIV can be straightway applied to the original cost of the asset from the year of change of the rates.
(c) Where the company is following WDV method of depreciation
(i) WDV rates of depreciation prescribed in Schedule XIV are applicable to additions to fixed assets subsequent to the date of amendment as well as the fixed assets existing on the date of amendment.
(ii) Since the rates prescribed in Schedule XIV are also applicable to the assets existing on the date of amendment, the issue raised in para 3 (c)(ii) of the query need not be answered.
(iii) Depreciation at rates higher than the rates prescribed in Schedule XIV can be charged only if such higher rates are justified on the basis of bona fide technological evaluation and where such higher rates are adopted, a proper disclosure should be made by way of a note forming part of the annual accounts.
Where the company is following SLM method of depreciation
(i) SLM rates of depreciation prescribed in Schedule XIV are not only restricted to the additions to the fixed assets subsequent to the date of amendment, but can also be applied to the assets existing at the date of amendment in the manner prescribed in paragraph 22(a) and 22(c) of the ‘Guidance Note on Accounting for Depreciation in Companies’ reproduced above.
(ii) Where a company charges depreciation in accordance with either paragraph 22(a) or 22(b) of the ‘Guidance Note on Accounting for Depreciation in Companies’, the rates arrived at may be different from the rates specified in Schedule XIV.
(iii) In respect of the assets acquired after the date of amendment, depreciation at rates higher than the rates prescribed in Schedule XIV can be charged only if such higher rates are justified on the basis of bona fide technological evaluation and where such higher rates are adopted, a proper disclosure should be made by way of a note forming part of the annual accounts.
(d) It is permissible as per Circular No. 1/85, to recompute the specified life of an asset by applying the rates prescribed under Schedule XIV to the original cost of the asset. The unamortized value of asset as per the books of account should be allocated over the remaining part of the recomputed specified period and as such there will not arise any need to recompute and adjust the depreciation.
_____________________________ 1 Circular No. 2/89, dated March 7, 1989. |