Expert Advisory Committee
ICAI-Expert Advisory Committee
Options:

1.36   Query:  

Change in the method of charging depreciation.

 

1. A government company in the petroleum sector has been charging depreciation on its assets up to the year ending as on 31.3.1988 at the rates prescribed under the Income-tax Rules, 1962, on written down value (WDV) method.

 

2. The company decided to adopt rates prescribed in Schedule XIV to the Companies Act, 1956, from the financial year ending as on 31.3.1989, for charging depreciation as per written down value method and disclosed the same in the accounts for the year 1988-89. The company continued to charge depreciation according to this method up to the financial year ending as on 31.3.1991.

 

3. Before closing the accounts for the financial year 1991-92, the board of directors of the company decided to change the method of charging depreciation from written down value method to straight line method w.e.f. 1.4.1990. Accordingly, while preparing the accounts for the financial year ending as on 31.3.1992, the company recalculated the depreciation at the rates prescribed for straight line method in Schedule XIV on the written down value of the assets as on 1.4.1990 and on the cost of assets acquired during the years 1990-91 and 1991-92 without making any adjustment for the life of the assets.

 

4. The following disclosure was made in the statement of significant accounting policies, in the accounts for 1991-92:

 

“Depreciation is provided in accordance with Schedule XIV to the Companies Act on the straight line method w.e.f. 1.4.1990”

 

5. The following was disclosed in the notes to accounts, forming part of the annual accounts:

 

“The company has changed the method of depreciation from WDV method to the straight line method w.e.f. 1.4.1990, as a result of which a sum of Rs. 2795.58 lacs has been written back to the Profit and Loss Account as an extraordinary item for 1990-91. Had this change not been made, the profit for the year would have been lower by Rs. 2707.56 lacs on account of current depreciation and the value of the net fixed assets would have been lower by Rs. 5503.14 lacs.”

 

6. The querist has sought the opinion of the Expert Advisory Committee in respect of the following issues:

 

(a) Whether changing the method of depreciation from written down value method to straight line method by straightaway charging the straight line rates on the written down value of the assets as on 1.4.1990, without making any adjustment for the life of the assets and on the cost of the assets acquired thereafter, would amount to distortion of the true and fair view of the accounts of the company?

 

(b) Whether the policy adopted by the company is in accordance with the  guidance issued by the Institute of Chartered Accountants of India on accounting for depreciation in companies?

 

(c) Whether the company can continue to charge depreciation as per the aforesaid method, i.e., straight line rate on written down value of the assets as on 1.4.1990 and on the cost of the assets acquired thereafter, while finalising the accounts for the financial year ending as on 31.3.1993?

 

(d) If the above method of charging depreciation is not proper, what method the company should adopt for finalising the accounts for the financial year 1992-93, both in respect of charging depreciation as well as for making adjustment in respect of the accounts of the financial year 1991-92, already adopted and approved at the annual general meeting of the company.

 

                                                             Opinion                              January 20, 1993

 

1. The Committee notes para 6 of the ‘Guidance Note on Accounting for Depreciation in Companies’, issued by the Institute of Chartered Accountants of India, which states as follows:

 

“The depreciation method selected should be applied consistently from period to period. A change from one method of providing depreciation to another should be made only if the adoption of the new method is required by statute or for compliance with an accounting standard or if it is considered that the change would result in a more appropriate preparation or presentation of the financial statements of the enterprise. When a change in the method of depreciation is made, depreciation should be recalculated in accordance with the new method from the date of the asset coming into use*. The deficiency or surplus arising from retrospective recomputation of depreciation in accordance with the new method would be adjusted in the accounts in the year in which the method of depreciation is changed. In case the change in the method results in deficiency in depreciation in respect of past years, the deficiency should be charged to the profit and loss account. In case the change in the method results in surplus, it is recommended that the surplus be initially transferred to the ‘Appropriations’ part of the profit and loss account and thence to General Reserve through the same part of the profit and loss account. Such a change should be treated as a change in accounting policy and its effects should be quantified and disclosed.”

 

2. The Committee is of the view that normally a company should not make a change in the method of charging depreciation unless required by any law or is necessary for compliance with an accounting standard, or when it is reasonably necessary and would be most appropriate in the circumstances. The Committee presumes that the change in the method of depreciation made by the company is in accordance with these considerations, viz., more appropriate presentation of financial statements. Moreover, if a company decides to effect a change in the method of depreciation, the change should be with retrospective effect, i.e., from the date the relevant assets were first put to use. Thus, depreciation as per straight line method should be charged on the original cost of the assets whether acquired before or after 1.4.1990.

 

 3. On the basis of the above, the Committee is of the following opinion in respect of the issues raised in para 6 of the query:

 

                        (a) Yes.

 

(b) No. The accounting policy of the company is inconsistent with the recommendations made in Guidance Note on ‘Accounting for Depreciation in Companies’, issued by the Institute of Chartered Accountants of India.

 

(c) No. In respect of the assets acquired before 1.4.90, the depreciation should be charged in the financial year 1992-93 and onwards in accordance with the recommendations made in para 6 of the said guidance note, as reproduced at para 1 above. On the assets acquired thereafter, depreciation should also be charged as per straight line method on the original cost of the assets.

 

(d) The company may continue to follow straight line method of depreciation on the relevant assets in future years, provided necessary adjustments as per para 1 above are made in the accounts for the year 1992-93, since the accounts for the earlier years are not allowed to be re-opened after adoption thereof in the annual general meeting of the company. The effect of said adjustments on the profits of the current year, if any, should be quantified and appropriately disclosed.

___________________________

* It is hereby clarified that the relevant portion of Accounting Standard (AS) 6 on ‘Depreciation Accounting’, issued by the Institute of Chartered Accountants of India, is being revised to bring it in line with this recommendation of the Guidance Note.