Expert Advisory Committee
ICAI-Expert Advisory Committee
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1.21   Query:  

Accounting for depreciation.

 

1. While closing the accounts of a company, for the financial year ended as on March 31, 1992, an issue was raised, viz., if the original value of any fixed asset of the company undergoes a change due to exchange rate variation or otherwise, whether the depreciation on such change should be provided retrospectively or prospectively over the residual life of the asset.

 

2. The querist has quoted paragraph 26 of Accounting Standard (AS) 6 on ‘Depreciation Accounting’, issued by the Institute of Chartered Accountants of India, 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.”

 

3. The querist has stated that although the status of AS 6 is recommendatory as on this date, the company has deicide to follows, with effect from April 1, 1992, the method of charging depreciation in respect of any change in the value of any asset, prospectively.

 

4. The querist has sought the opinion of the Expert Advisory Committee on the following issues arising from the above:

 

(i)        Whether change in the relevant depreciation policy is to be applied for the earlier years also, i.e., before 1.4.92? The company has decided to follow the prospective method of charging the depreciation with reference to the revision in price, only with effect from 1.4.92.

 

(ii)        In case of devaluation of the foreign currency vis-a-vis Indian currency, the rate of depreciation to be worked out prospectively will be lower than the rate prescribed in Schedule XIV to the Companies Act, 1956. In such a situation, will it be permissible to charge lower rate of depreciation? If not, what should be the modus-operendi of the method?

 

(iii)      Whether it is permissible to charge higher rate of depreciation than the rate prescribed in Schedule XIV to the Companies Act, 1956. If yes, whether a disclosure is required in the annual accounts.

 

 

                                                                                    Opinion                             July 15, 1993

 

1. The Committee notes paragraphs 9 and 10 of Guidance Note on ‘Accounting for Depreciation in Companies’, issued by the Research Committee of the Institute of Chartered Accountants of India, which state 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 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 minimise 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 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. The Committee is accordingly of the view that any favorable fluctuation in the relevant foreign exchange rate would result in reduction of the cost of an asset. This will have the effect of the asset being written off before its stipulated useful life, if the same rate of depreciation is continued to be followed, as was being applied before such change in the cost. However, it does not mean that the rate of depreciation on the asset has increased.

 

4. The Committee notes paragraph 12 of Accounting Standard (AS) 5 on ‘Prior Period and Extraordinary Items and Changes in Accounting Policies’, issued by the Institute of Chartered Accountants of India, which reads as follows:

 

“12.      Any change in an accounting policy which has a material effect should be disclosed. The impact of, and the adjustments resulting from, such change, if material, should be shown in the financial statements of the period in which such change is made to reflect the effect of such change. Where the effect of such change is not ascertainable, wholly or in apart, the fact should be indicated. If a change is made in the accounting policies which has no material effect on the financial statements for the current period but which is reasonably expected to have a material effect in later periods, the fact of such change should be appropriately disclosed in the period in which the change is adopted.”

 

5. The Committee also notes paragraph 26 of Accounting Standard (AS) 6 on ‘Depreciation Accounting’, issued by the Institute of Chartered Accountants of India, as reproduced by the querist at paragraph 2 of the query.

 

6. It appears from the facts of the query that, prior to 1.4.1992, the company was computing depreciation with retrospective effect in case of change in the historical cost of the fixed assets caused by foreign currency fluctuations.

 

7. On the basis of the above, and subject to para 6 above, the Committee is of the following opinion in respect of the issues raised at paragraph 4 of the query:

 

(i)         The policy of charging depreciation, in case of the revision in the cost of an asset, due to exchange fluctuations or otherwise, should be changed with prospective effect only. The fact and the effect on profits, of such change, should be disclosed in the financial statements, as required in paragraph 12 of Accounting Standard (AS) 5, issued by the Institute of Chartered Accountants of India, as reproduced at paragraph 4 above.

 

(ii)     In view of paragraphs 9 and 10 of the Guidance Note on ‘Accounting for Depreciation in Companies’ as reproduced at paragraph 1 above, it is not permissible to charge depreciation at a rate lower than that prescribed under Schedule XIV to the Companies Act, 1956. Therefore, even if the cost of an asset is reduced on account of the exchange rate fluctuations, the company should continue to follow the rate of depreciation as was being applied before such change in the cost of the asset, provided it is not less than the Schedule XIV rate.

 

(iii)       The higher rates of depreciation than that prescribed under Schedule XIV to the Companies Act, 1956, should be applied in the circumstances mentioned in paragraphs 9 and 10 of the abovementioned Guidance Note, subject to disclosure requirements stated therein.

 

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