1.10  Query:  

Change in accounting policy regarding charge of depreciation.

1. A Government company, within the meaning of section 617 of the Companies Act, 1956, is under the administrative control of Ministry of Defence. The authorised and paid up capital of the company are Rs. 125 crores and Rs. 115 crores respectively as on 1.1.1992. The entire paid up capital of the company is held by the President of India and his nominees.

2. The querist has stated that consequent to the introduction of Schedule XIV to the Companies Act, 1956, the company had changed its accounting policy on depreciation, which reads as below:

“Depreciation on fixed assets is charged on ‘straight line method’. The rate of depreciation is derived by spreading the cost of the asset over its expected life, except in the case of township building where the rate adopted is as per the guidelines issued by the Bureau of Public Enterprises. Depreciation is calculated for the whole year on all additions made during the year in which the  asset is put to use/brought on charge. Rates of depreciation prescribed in Schedule XIV of the Companies Act, 1956 are not adopted. The rates adopted are not less than those prescribed in the said Schedule.”

3. The querist has clarified that every year the company has been disclosing in the notes forming part of accounts, on a consistent basis, the effect on profit due to adoption of depreciation for full year irrespective of the date on which the asset is brought on charge instead on pro-rata basis for number of days calculation as envisaged in Note 4 to Schedule XIV to the Companies Act, 1956. However, the statutory auditors of the company have been qualifying the accounting policy and also the financial note in their audit report disclosing the resultant under-statement of profits for the year and also the under-statement of net fixed assets as at the end of the year.

4. The company now intends to modify the accounting policy on depreciation as below:

“Depreciation on fixed assets is charged on ‘straight line method’. The rate of depreciation is derived by spreading the cost of the asset over its expected life, except in the case of township building where the rate adopted is as per the guidelines issued by the Bureau of Public Enterprises. Depreciation is calculated on and from 1.4.1991 for the full month on all additions, made during the month in which the asset is put to use, brought on charge. Rates of depreciation prescribed in Schedule XIV to the Companies Act, 1956 are not adopted. The rates adopted are not less than those prescribed in the said Schedule.”

5. The querist has further clarified that the company would also like to make adequate disclosure regarding change in the accounting policy on depreciation during the financial year 1991-92 and also the effect on profits of financial year 1991-92, due to such change, in the financial notes forming part of the accounts.

6. In view of the foregoing, the querist seeks the opinion of the Expert Advisory Committee on the following issues:

(i) Whether the company can adopt the proposed modification in the policy with regard to depreciation of assets in respect of additions made on or after 1.4.91.

(ii) If so, whether the company has to make disclosure in the financial notes forming part of the accounts with regard to the under-statement of net fixed assets which were acquired/put to use prior to 1.4.91, since the company followed a different policy of charging depreciation of its assets during such period? If so, for how long?

(iii) Whether the statutory auditors of the company shall be required to qualify their audit report perennially with regard to under-statement of net fixed assets acquired/put to use prior to 1.4.91? If so, for how long? Is it upto the period, the assets acquired/put to use prior to 1.4.91 continue to appear in the books of account of the company or perennially?

                                                                     Opinion                                          March 31, 1992

1. The Committee notes that the querist has sought opinion only with regard to change from the existing practice of charging full year depreciation to the practice of charging pro-rata depreciation in respect of additions made during the year. The Committee also notes that the rates of depreciation adopted by the company are higher than the rates prescribed under Schedule XIV to the Companies Act, 1956. The Committee presumes that the higher rates of deprecation applied by the company are in accordance with the recommendations contained in the Guidance Note on Accounting for Depreciation in Companies, issued by the Research Committee of the Institute of Chartered Accountants of India. The opinion of the Committee given hereafter is, therefore, restricted to the question of charging pro-rata depreciation.

2. The Committee 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., 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.”

3. The Committee presumes that pro-rata depreciation on full month basis has been charged in accordance with paragraph 24 of the said Guidance Note as reproduced above. The Committee, however, notes that the company has not charged pro-rata depreciation in respect of previous accounting periods to which Schedule XIV had become applicable. Since it was not done, the excess depreciation charged in the earlier years should be adjusted in the current accounting year as per paragraph 9 of Accounting Standard (AS) 5 on Prior Period and Extraordinary Items and Changes in Accounting Policies, which reads as follows:

“Prior period items should be separately disclosed in the current statement of profit and loss together with their nature and amount in a manner that their impact on the current profit or loss can be perceived.”

4. On the basis of the above and subject to presumptions made in paras 1 and 3 above, the Committee is of the following opinion in respect of the issues raised by the querist in para 6 of the query:

(i) No. The company should charge pro-rata depreciation with retrospective effect, i.e., from the date Schedule XIV came into force.

(ii) Since the accounting treatment should be as suggested in (i) above, disclosure should be made as per para 9 of AS 5.

(iii) The auditors of the company should not qualify their report with regard to change in accounting policy relating to pro-rata charge of depreciation, if the change is in accordance with (i) and (ii) above.

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