1.7 Query: Charge of pro-rata depreciation.
1. A public sector company is registered under the Companies Act, 1956, and functions under the Ministry of Defence, Government of India. The entire share capital of the company is held by the Government of India. The company maintains its accounts on the basis of mercantile system and the Financial Year is from 1st April to 31st March.
2. The query has arisen in the context of audit of the company under Section 619(4) by the Member, Audit Board, regarding the provision of full depreciation on assets added during the year instead of on pro-rata basis as required in Note 4 of Schedule XIV to the Companies Act, 1956. The method presently being followed by the company is to charge depreciation for the full year even in respect of assets added during the year.
3. The querist has stated that the Companies (Amendment) Act, 1988, has introduced Scheduled XIV to the Companies Act 1956, specifying therein the rates of depreciation for charging depreciation in respect of different categories of assets. The amount of depreciation to be provided is to be calculated in accordance with the provisions of Sections 205 and 350 of the Companies Act, as below:
(a) Section 350 of the Act provides that the amount of depreciation shall be the amount calculated with reference to the written down value of the asset as shown in the books of account of the company at the end of the financial year expiring at the commencement of this Act or immediately thereafter and at the end of each subsequent financial year at the rates specified in Schedule XIV.
(b) Note No. 4 to Schedule XIV makes a mention about the pro-rata depreciation. The said note mentions 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, upto the date on which such asset has been sold, discarded, demolished or destroyed.
4. The querist has stated that the Department of Company Affairs has clarified by way of Circular No. 2/89 that the company can charge depreciation at rates which are higher than those specified in Schedule XIV as long as disclosure is made to that effect in the accounts. The circular has also clarified that the rates contained in Schedule XIV should be viewed as the minimum rates and, therefore, a company shall not be permitted to charge depreciation at rates lower than those specified in Schedule XIV. Thus, on a reading of the circular, according to the querist, it is clear that the spirit of the provisions of the Act is to safeguard the interest of the shareholders by ensuring provision of proper amount of depreciation in the accounts so that the profit distributed as dividend takes care for the future replacement of the assets.
5. The querist is of the view that the provision only mentions about the adequacy of depreciation and so long as the quantum of depreciation charged is higher than that provided in the Companies Act, 1956, the provisions of law are complied with.
6. In the light of the above, the querist has sought the opinion of the Expert Advisory Committee on the following issues:
(a) Whether it is permissible under the Act to charge depreciation for the full year on additions during the year irrespective of the date of addition of the assets.
(b) Whether it is in order for the company to provide for depreciation for the full year on assets sold/discarded/demolished/destroyed during year. Opinion July 6, 1992
1. The Committee notes that para 9 of the Guidance Note on Accounting for Depreciation in Companies, issued by the Research Committee of the Institute of Chartered Accountants of India, recommends as follows:
“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 rate 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.”
2. The Committee also notes para (3) of Circular No. 2/89 of Department of Company Affairs, which deals with the question of higher rates of depreciation, as below:
“It may be clarified that the rates as contained in Schedule XIV should be viewed as the minimum rates, and, therefore, a company shall 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 Schedule. However, if on the basis of a 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” (emphasis supplied by the Committee).
3. The Committee is of the view that in those cases where the difference between the pro-rata depreciation and the full year depreciation is not material in amount, the depreciation for the full year may be charged with appropriate disclosure of the said accounting policy. The concept of materiality has been recognised in para 26 of the said Guidance Note, which recommends charging 100% depreciation on low value items.
4. The Committee, further notes Para 24 of the Guidance Note which states as below:
“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.”
5. On the basis of the above, it is clear that higher depreciation can be provided where it is based on bona-fide technological evaluation. In other words, charge of higher depreciation cannot be a justification for providing depreciation for full year instead of pro-rata basis in respect of additions/disposals of the fixed assets during the year.
6. The Committee is of the following opinion in respect of the issues raised by the querist in para 6 of the query:
(a) No.
(b) No. Pro rata depreciation shall also be provided in respect of assets sold, discarded, demolished or destroyed as per Note no. 4 of Schedule XIV to the Companies Act, 1956, subject to para 3 above. ____________________________ |