1.19 Query: Accounting for depreciation 1. A company has certain plant and machinery, acquired out of foreign currency loans. These plant and machinery items were commissioned in 1986-87. In respect of fixed assets covered by foreign currency loans, the company has been consistently following the practices of providing depreciation as given below:
(a) At the end of each financial year, the foreign currency liabilities are restated at the closing market rates/forward rates, as the case may be.
(b) The foreign currency fluctuations are added to the fixed assets value at the end of each year as an addition.
(c) The respective assets are depreciated as per the method prescribed under section 205(2)(a) of the Companies Act, 1956, i.e., to the extent specified in section 350, which says that depreciation be provided at the rate specified in Schedule XIV. The company has chosen straight-line method rate and has been following the same consistently.
(d) Depreciation is provided on the total exchange fluctuations during the year at the prescribed rate for the entire year. For example, if the restatement as on 31st March comes to Rs. 400 lakhs, depreciation at the prescribed rate of 11.31% is provided on the entire amount of Rs. 400 lakhs for the full year.
(e) It may be noted here that the company has chosen one of the four methods provided under section 205(2) and that method provides for “rate prescribed in Schedule XIV” and there is no reference to any ‘specific period’ or ‘useful life’ in this particular method.
2. The company has been consistently following the aforesaid method, prescribed under section 205(2)(a) of the Companies Act, and it wants to continue the same practice.
3. The querist has quoted para 27 of Accounting Standard (AS) 11 on ‘Accounting for the Effects of Changes in Foreign Exchange Rates’, issued by the Institute of Chartered Accountants of India, as follows:
“Where the historical cost of depreciable asset has undergone a change due to increase or decrease in liability on account of exchange fluctuations, the depreciation on the revised unamortised depreciable asset should be provided prospectively over the residual useful life of the asset.” [emphasis supplied by the querist.]
4. The querist has further stated that:
(a) The company has been consistently following the method of depreciation provided under section 205(2)(a), by providing for depreciation at the rate specified in the provisions of the Companies Act. The present method appears to be in conformity with the first choice out the four choices given in section 205(2) of the Act.
(b) The plants in question are estimated to have a ‘useful life’ of about 20 years (as similar plant set up in 1971 is still being used to manufacture its rated output). Therefore, even if the company has to go by Accounting Standard (AS) 11, all the foreign currency fluctuations would be provided for by the year 2004 whereas the plants will have a useful life at least upto the year 2007. It is presumed by the querist that the phrase ‘useful life’ mentioned in the Institute’s standard refers to the normal useful physical life of the plant and machinery depending on the conditions of the particular industry and that it does not refer to any particular ‘specified period’.
(c) The method of depreciation followed by the company in terms of section 205(2)(a) appears to be in conformity with the requirements of the Companies Act, as this particular choice under section 205(2)(a) does not refer to any ‘specified period’ but it prescribes a specific rate, viz., 11.31% which is being followed.
(d) The method prescribed under the Companies Act, and followed by the company, has the effect of providing depreciation at a faster rate than what one would get by the ‘useful life’ concept. Thus, this method meets with both the requirements of the Companies Act as also Accounting Standard (AS) 11 inasmuch as it talks of ‘useful life’ of the asset only.
5. The querist has sought the opinion of the Expert Advisory Committee as to whether the present method of providing depreciation on foreign currency fluctuations can be continued by the company without requiring any further disclosure.
Opinion May 4, 1993
1. The Committee notes paragraph 26 of Accounting Standard (AS) 6 on ‘Depreciation Accounting’, issued by the Institute of Chartered Accountants of India, which reads as follows:
“26. Where the historical cost of a depreciable asset has undergone a change due to increase or decrease in long term liability on account of exchange fluctuations, price adjustments, changes in duties or similar factors, the depreciation on the revised unamortised depreciable amount should be provided prospectively over the residual useful life of the asset.”
2. The Committee notes the instruction inserted in Schedule VI to the Companies Act, 1956, vide Notification No. G.S.R.129, dated January 1, 1968, which states, inter alia, as follows:
“… any fixed asset which has been acquired from a country outside India and in consequence of a change in the rate of exchange at any time after the acquisition of such asset there has been an increase or reduction in the liability of the company, as expressed in Indian currency, for making payment towards the whole or a part of the cost of the asset or for repayment of the whole or a part of monies borrowed by the company from any person, directly or indirectly in any foreign currency specifically for the purpose of acquiring the asset (being in either case the liability existing immediately before date on which the change in the rate of exchange takes effect), the amount by which the liability is so increased or reduced during the year, shall be added to, or as the case may be, deducted from the cost, and the amount arrived at after such addition or deduction shall be taken to be the cost of the fixed asset.”
3. On the basis of the above, the Committee is of the opinion that the depreciation policy being followed by the company is not correct. The revised unamortised depreciable amount (i.e., unamortised depreciable amount after adding the increase in long term liability on account of exchange fluctuations) should be provided over the remaining life of the asset as per Schedule XIV to the Companies Act, 1956. Since the new rate worked out would be higher than the rate prescribed in the said Schedule, disclosure thereof has to be made as required under clause 5 (ii) of the Schedule. The policy followed by the company in this regard should also be appropriately disclosed. ___________________________ |