1.11     Query:

Accounting for depreciation on additions

to a fixed asset.

1. A company had made some additions to one of its factory buildings. The building was initially a two-storeyed structure and its book value at the time of making the additions was nil as depreciation had already been completely charged-off over its estimated useful life. The additions included construction of (new) third floor along with provision of facilities like water and sanitary fittings, glazed partition doors, PVC flooring, water and electricity connections and installation of cables for power supply to air-conditioners. According to the querist, the construction of these additional structures was undertaken on the strength of the assurance from engineers that the new structure would have a life equivalent to that of a new building. The addition involved creation of additional space in the building as it was a new construction.

2. The querist has drawn the attention of the Committee to para 24 of Accounting Standard (AS) 6 (Revised) on “Depreciation Accounting” issued by the Institute of Chartered Accountants of India, which provides as under:

“Any addition or extension which becomes an integral part of the existing asset should be depreciated over the remaining useful life of that asset. The depreciation on such addition or extension may also be provided at the rate applied to the existing asset. Where an addition or extension retains a separate identity and is capable of being used after the existing asset is disposed of, depreciation should be provided independently on the basis of an estimate of its own useful life.”

3. In the above context, the querist has sought the opinion of the Expert Advisory Committee on the following issues:

(i)   Should the above addition be considered as part and parcel of the existing building? In such a case, as the book value of the existing asset is nil, should the entire addition/extension be charged off as depreciation in the year of construction itself?

(ii)  Alternatively, as the addition is specifically identifiable and is likely to have a useful life equal to that of a new building as per technical evaluation, should the addition be considered as a new asset for the purpose of depreciation? That is, should depreciation on the addition be spread over its estimated useful life inspite of the fact that it is a construction not independent of the existing building although usable independently?

                                                      Opinion                                                            July 14, 1995

1.The Committee notes para 24 of Accounting Standard (AS) 6 (Revised) on “Depreciation Accounting”, issued by the Institute of Chartered Accountants of India, as reproduced at para 2 of the query.

2. The Committee also notes para 23 of the abovementioned Accounting Standard (AS) 6, which is reproduced below:

“23. The useful lives of major depreciable assets or classes of depreciable assets may be reviewed periodically. Where there is a revision of the estimated useful life of an asset, the unamortised depreciable amount should be charged over the revised remaining useful life.”

3. Based on the above, the Committee is of the view that whether an addition or extension of the existing asset retains a separate identity and is capable of being used after the existing asset is disposed of are questions of fact, which have to be determined on the basis of facts and circumstances of each case. In case the addition or extension can be classified as having a separate identity and is capable of being used after the existing asset is disposed of, the depreciation on each addition or extension should be provided independently on the basis of an estimate of its own useful life. In case the addition or extension is classified as an integral part of the existing asset, the relevant rate of depreciation on the revised cost of the asset (i.e. the cost of additions plus the book value of the existing asset, if any) would be the rate which was being applied to the asset in the past. However, it is possible that the useful life of the entire asset, consisting of the existing asset and the addition/extension, may be reviewed and accordingly a depreciation rate may be worked out. In any case the rate to be applied should not be lower than the corresponding rate prescribed in Schedule XIV to the Companies Act, 1956.

4. Based on the above, the Committee is of the following opinion on the issues raised by the querist at para 3 of the query:

                        (i)         See para 3 above.

                        (ii)        See para 3 above.

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