1.33 Query
Charging of depreciation on plant and machinery.
1.In a deemed public company manufacturing bulk drugs, depreciation was provided as per Income-tax Rules upto 31.03.88. For the year ending 31.03.89, after introduction of Schedule XIV to the Companies Act, 1956, depreciation was provided as per the rates and provisions of the Schedule with an appropriate note. For the current year ending on 31.03.90, the company intends to change the method of depreciation again and charge depreciation as per the Income-tax Rules. This is because the company had gone in for major expansion investing about Rs. 60 lacs in plant and machinery which was put to use only during January, 1990. Schedule XIV provides that depreciation is to be charged for the proportionate period of usage which is quite disadvantageous to the company in view of the provisions of Section 115J of the Income-tax Act. Thus, to take the benefit of full depreciation for the year in respect of the machinery used only for three months, the company intends to adopt rules of the Income-tax Act for depreciation. The proposed depreciation thus would be much more than envisaged by Schedule XIV and also Section 205 of the Companies Act. The company intends to declare a maiden dividend for the period ending on 31.03.1990.
2. The querist has sought the opinion of the Expert Advisory Committee on the following issues:
(i) Will the company be correct in providing depreciation as per the Income-tax Act instead of Schedule XIV?
(ii) Will the company be able to provide depreciation for entire year instead of depreciation for the proportionate period of use as envisaged in Schedule XIV and charge off higher depreciation to avoid the provisions of 115J of Income-tax Act?
(iii) If the company charges off depreciation as above, does the accounting treatment calls for qualification by the statutory auditor and, if so, the way the qualifications is to be made may be advised.
Opinion August 3, 1990
1.The Committee notes from the facts of the query that the company has been following written down value method of charging depreciation.
2.The Committee notes paragraphs 7, 8, 9, 10, 16 and 24 of the ‘Guidance Note on Accounting for Depreciation in Companies’, issued by the Research Committee of the Institute of Chartered Accountants of India, which recommend, as below:
“7. Section 205 of the Companies Act requires that no dividend shall be declared or paid by a company except out of the profits of the company arrived at after providing for depreciation in accordance with the provisions of sub-section 2 of the Section. This sub-section allows the company to provide for depreciation either in the manner specified in Section 350 of the Act or in the alternative manners specified in that sub-section itself. Part II of Schedule VI further provides that if no provision for depreciation is made, the fact that no provision has been made shall be stated and the quantum of arrears of depreciation computed in accordance with Section 205(2) of the Act shall be disclosed by way of a note.
8. A question may arise as to whether it is obligatory on a company to provide for depreciation only on the basis mentioned in Section 205 (2) read with section 350 and Schedule XIV of the Act or whether these bases can be considered as indicating the minimum depreciation which must be provided by the company, insofar as the accounts of the company are concerned and insofar as it is required to exhibit a true and fair view of the state of affairs of the company as on a given date and of the profit or loss for the year.
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 be 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 bona fide 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”.2.
16. Where a company has been following the written down value method of depreciation in respect of its assets, the WDV rates prescribed 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.
“24. Note No. 4 in Schedule XIV to the Companies Act, 1956, prescribes that “where, during any financial year, any addition has been made to any asset, or where any asset has been sold, discarded, demolished or destroyed, the depreciation on such assets shall be calculated on a pro-rata basis from the date of such addition or, as th case may be, upto the date on which such asset has been sold, discarded, demolished or destroyed.” The Committee is of the view that a company may group additions and disposals in appropriate time period (s), e.g., 15 days, a month, quarter etc. for the purpose of charging pro-rata depreciation in respect of additions and disposals of its assets keeping in view the materiality of the amounts involved.”
3.The Committee also notes sub-section (1A) of section 115J of the Income-tax Act, 1961, which states, inter alia:
“(1A) Every assessee, being a company, shall, for the purposes of this section, prepare its profit and loss account for the relevant previous year in accordance with the provisions of Parts II and III of Schedule VI to the Companies Act, 1956 (1 of 1956)”.
4.The Committee is of the view that the recommendations contained in the aforesaid Guidance Note are applicable for the purpose of preparation of accounts as per Schedule VI to the Companies Act, 1956.
5.The Committee is accordingly of the following opinion in respect of the issues raised in para 2 of the query:
(a) The company should provide depreciation at the rates prescribed in Schedule XIV of the Companies Act. The rates prescribed under the Income-tax Rules, if they are lower than the rates prescribed under Schedule XIV, cannot be adopted since Schedule XIV prescribes the minimum rates of depreciation. The rates prescribed under Income-tax Rules, if they are higher than the rates prescribed in Schedule XIV, can be adopted only if such higher rates are justified on the basis of bona fide technological evaluation and if such higher rates are adopted, proper disclosure must be made in this respect by way of a note forming part of the annual accounts.
(b) The company cannot provide depreciation for the entire year where the assets have been acquired during the year. Depreciation should be calculated on pro rata basis from the date of addition of the asset as per the requirement of Schedule XIV.
(c) If the company charges higher depreciation as per the rates prescribed in Income-tax Rules and the rated are not justified on the basis of bona fide technological evaluation and if the company charges full year depreciation instead of pro-rata depreciation on assets acquired during the year, the auditor should qualify his report stating, inter alia:
(i) Depreciation has been charged as per Income-tax Act and as per the rates prescribed in Schedule XIV to the Companies Act, 1956, and, therefore, it is in contravention to the requirements of that Act. The amount by which the profits and assets have been understated due to the adoption of the Income-tax rates instead of Schedule XIV rates should be quantified.
(ii) Depreciation has been charged for the full period instead of on pro rata basis on assets acquired during the year which is in contravention to the requirements of Schedule XIV to the Companies Act, 1956. The amount by which the profits and assets have been understated due to provision of full year depreciation instead of pro rata depreciation should also be quantified.
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2CircularNo. 2/89, dated March 7, 1989 |