Expert Advisory Committee
ICAI-Expert Advisory Committee
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1.27 Query:    

Pro-rata charge of depreciation as per the requirements

of Schedule XIV to the Companies Act, 1956.

 

1. A trading company is dealing in imports of industrial raw materials, fertilizers and exports of minerals and other non-canalised engineering and agricultural products. The total turnover of the company is to the extent of Rs. 5,000 crores.

 

2. While auditing the accounts of the company for the year 1989-90, the Government Auditors objected to the accounting policy of providing depreciation on the fixed assets which were procured or disposed of during the part of the year.

 

3. Schedule XIV to the Companies Act provides the rates at which the depreciation must be provided to arrive at the profit for the purpose of payment of dividend under section 205 read with section 350 of the Companies Act. However, according to the querist, Schedule XIV provides that a company, at its discretion, may provide depreciation at rates higher than that required under Schedule XIV. The Schedule further provides that in case of assets which have been purchased or disposed of during the year, proportionate depreciation should be provided on such assets. As per the accounting policy of the company, the company is providing full depreciation for the year on assets which have been purchased or disposed of during the year. The Government Auditors’ contention was that this part of the provision of Schedule XIV is mandatory and by not providing depreciation on pro-rata basis, the company has violated the provisions of the Companies Act.

4.The querist has drawn the attention of the Committee to the Guidance Note on Accounting for Depreciation in Companies, issued by the Research Committee of the Institute of Chartered Accountants of India, which, according to the querist, is silent on this issue. However, the Research Committee has recommended that a company may group additions or disposals in appropriate time periods, e.g., 15 days, a month, a 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 (emphasis supplied by the querist). In other words, according to the querist, the Research Committee of the Institute is also of the view that materiality of the amount involved should be considered while taking a decision in respect of depreciation to be provided on the assets which have been procured or disposed of during the year. The company in question is a trading company and the ratio of fixed assets to total current assets is negligible. The provision for depreciation is very nominal in respect of the assets which are disposed of or purchased during the year. In other words, the materiality of the amount, as suggested by the Institute’s Research Committee, is of not much significance in respect of assets mentioned above.

 

5. The reply given by the management on the comments of the Government Auditors is as below:

 

“The Schedule XIV was inserted in place of Appendix A of the Income Tax Rules for the limited purpose of provision of minimum depreciation to enable the companies to pay dividend u/s 205 and compute managerial remuneration u/s 349 of the Companies Act, 1956. Nowhere does the Companies Act provides that Schedule XIV is mandatory. Schedule VI, part II which contains disclosure requirement in respect of profit and loss account does not even refer to it. Disclosure requirements are contained in para 3(iv) of part II of Schedule VI of the Companies Act which is as under:

 

“The amount provided for depreciation, renewals or diminution in value of fixed assets.

 

If such provision is not made by means of depreciation charge, the method adopted for making such provision.

 

If no provision is made for depreciation, 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.”

 

It is, therefore, clear that the provision of Schedule XIV is not mandatory. Govt. Audit Party agrees that so far the provision of depreciation at the rates provided under Schedule XIV are not mandatory and company can opt for higher rate of depreciation, the question of part implementation of Schedule XIV cannot be mandatory.

           

In other words, it is not necessary to provide pro-rata depreciation in respect of assets which have been acquired during the part of the year. We have checked that some of the other Public Sector Companies are also providing depreciation for the whole year even if the assets have been acquired during the fag-end of the year. As such this did not contravene the provisions of the Companies Act. We shall, however, review this during 1990-91.”

 

6. The querist has sought the opinion of the Expert Advisory Committee as to whether the non-provision of pro-rata depreciation is proper keeping in view the facts and circumstances of the query.

 

                                                                                          Opinion                     April 15, 1991

 

1. The Committee notes that paras 8, 9 and 10 of the Guidance Note on Accounting for Depreciation in Companies, issued by the Research Committee of the Institute of Chartered Accountants of India, recommend as below:

 

“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.The Committee further notes that para 24 of the said Guidance Note recommends as follows:

 

“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 the case may be, up to 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., 15days, a month, a 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 is of the view that the recommendation made by the Research Committee in para 24 of the Guidance Note, does not purport to provide exemption to a company from providing pro-rata depreciation; it merely recommends a manner of computation of pro-rata depreciation in appropriate circumstances.

 

 4. On the basis of the above, the Committee is of the opinion that it is necessary, in view of Schedule XIV to the Companies Act, 1956, to provide depreciation on pro-rata basis, where an asset has been acquired, sold, discarded, demolished or destroyed, in a year, as recommended in para 24 of the aforesaid Guidance Note.

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* Circular No. 2/89, dated March 7, 1989.