Query No. 17
Subject: Change in accounting policy regarding depreciation.[1] A. Facts of the Case
1. A government company is engaged in mining activities. The product of the company is compulsorily procured by the government at a rate fixed by it (i.e., the government).
2. Till the year 1996-97, the company had been charging depreciation at the rates determined on the basis of technical assessment of the life of each asset. The accounting policy of the company in this regard was as below:
“Depreciation is charged on straight line method on opening balance as on 16.10.1967 based on the life of the assets determined on technical assessment. In the case of assets acquired before 1.4.1987 depreciation is continued to be provided based upon the life adopted earlier. On the assets acquired on or after 2.4.1987 depreciation is calculated on the life of each asset taking into consideration the technical assessment of life of the asset concerned”.
3. During the year 1997-98, the administrative ministry of the company constituted a committee for recommending a formula for fixation of compensation for the product of the company. One of the recommendations of the committee was as below:
“It has been found from the past annual reports of the company that amount of depreciation provided by the company for various assets is more than the norms prescribed under Schedule XIV of the Companies Act, 1956. It is proposed that in order to measure the true cost of production, the actual cost under the head depreciation will be restricted to the amount prescribed under Schedule XIV of the Companies Act.”
4. On the basis of the above recommendation, the company changed its accounting policy (without making any fresh technical assessment of the life of the assets) with effect from April 1, 1997 as below:
“Depreciation is charged on straight line method on the basis of rates prescribed in Schedule XIV of the Companies Act, 1956. For assets acquired prior to 1.4.1997, depreciation is charged on straight line method on opening net book value of assets as on 1.4.1997 at rates derived on the basis of the remaining period of life of assets as indicated in Schedule XIV of the Companies Act, 1956.”
5. The querist has explained that upon change in the accounting policy w.e.f. April 1, 1997, depreciation on assets capitalised on or before March 31, 1997, was charged at the new rates prospectively. In respect of assets capitalised on or after April 1, 1997, depreciation was charged on straight-line rates prescribed in Schedule XIV from the respective dates of their capitalisation. For assets which were inadvertently omitted to be capitalised earlier and were capitalised on or after April 1, 1997, depreciation was provided on straight line rates prescribed in Schedule XIV from the date those assets ought to have been capitalised.
6. According to the querist, in the accounts for the year 1997-98, the company has made adequate disclosure with respect to the above change.
7. The government auditors made the following observation on the above change:
“Accounting policy of the company is contrary to the provisions of the Accounting Standard 6 ‘Depreciation Accounting’, which inter-alia states that when a change in the method of depreciation is made, depreciation should be recalculated retrospectively in accordance with the new method from the date of the asset coming into use.”
B. Queries
8. The querist has sought the opinion of the Expert Advisory Committee on the following issues:
C. Points Considered by the Committee
9. Paragraph 20 of Accounting Standard (AS) 6, ‘Depreciation Accounting’, states the following: “20. The depreciable amount of a depreciable asset should be allocated on a systematic basis to each accounting period during the useful life of the asset.”
Thus, AS 6 requires a depreciable asset to be depreciated over its useful life.
10. Paragraph 8 of AS 6 recognises that the determination of the useful life of a depreciable asset is a matter of estimation and is normally based on various factors. Paragraph 13 of the Standard deals with situations where the statute governing an enterprise provides the basis for computation of depreciation. These paragraphs state as below:
“8. Determination of the useful life of a depreciable asset is a matter of estimation and is normally based on various factors including experience with similar types of assets. Such estimation is more difficult for an asset using new technology or used in the production of a new product or in the provision of a new service but is nevertheless required on some reasonable basis.”
“13. The statute governing an enterprise may provide the basis for computation of the depreciation. For example, the Companies Act, 1956 lays down the rates of depreciation in respect of various assets. Where the management’s estimate of the useful life of an asset of the enterprise is shorter than that envisaged under the provisions of the relevant statute, the depreciation provision is appropriately computed by applying a higher rate. If the management’s estimate of the useful life of the asset is longer than that envisaged under the statute, depreciation rate lower than that envisaged by the statute can be applied only in accordance with requirements of the statute.”
11. It can be seen that paragraph 13 of AS 6 requires that where the useful life of an asset as estimated by the management is shorter than that envisaged under the provisions of the relevant statute, depreciation should be provided on the basis of the management’s estimate of the useful life and not on the basis of the useful life envisaged under the statute. Paragraphs 8 and 9 of the Guidance Note on ‘Accounting for Depreciation in Companies’ issued by the Institute of Chartered Accountants of India reaffirm the above position and state as below:
“8. A question may arise as to whether it is obligatory on a company to provide for depreciation only on the basis mentioned in Section 205(2) read with section 350 and Schedule XIV of the Act or whether these bases can be considered as indicating the minimum depreciation which must be provided by the company, insofar as the accounts of the company are concerned and insofar as it is required to exhibit a true and fair view of the state of affairs of the company as on a given date and of the profit or loss for the year.”
“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 minimum rates of depreciation to be provided ...”
12. From the facts of the query, the Committee notes that the change in depreciation rates has been effected by the company merely on the basis of the recommendation of the committee constituted by the administrative ministry. No technical assessment of the remaining useful lives of the assets was carried out before changing the depreciation rates. The Committee also notes that the management’s earlier estimate of the useful lives of the assets was shorter than that implicit in the relevant rates specified in Schedule XIV to the Companies Act, 1956. It seems quite possible, therefore, that the actual remaining useful lives of the assets are shorter than those implicit in the application of the depreciation rates specified in the said Schedule. In the opinion of the Committee, it is necessary for the company to carry out a fresh technical assessment of the remaining useful lives of the assets concerned to determine whether or not the adoption of the rates specified in Schedule XIV would be in accordance with AS 6. Thus, if the remaining useful life of an asset as estimated on the basis of the technical assessment is shorter than that implicit in the application of the depreciation rate specified for the asset in Schedule XIV, depreciation should be provided on the basis of the remaining useful life as per the technical assessment. If, on the other hand, the remaining useful life as per the technical assessment is longer than that implicit in the application of the depreciation rate specified for the asset in Schedule XIV, depreciation should be provided on the basis of the rate specified in Schedule XIV.
13. As regards the manner of providing depreciation in case of a revision in the estimate of the useful life of a depreciable asset, paragraph 23 of AS 6 provides the following:
“23 ....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.”
Thus, irrespective of whether the revised depreciation rates are determined on the basis of the technical assessment of the remaining useful lives or whether the rates specified in Schedule XIV are adopted (in accordance with paragraph 12 above), depreciation at the revised rates should be provided prospectively (and not retrospectively). The Committee notes that the accounting treatment followed by the company in this behalf, as described in paragraph 5 above, gives prospective effect to the change in depreciation rates and is, therefore, in consonance with paragraph 23 of AS 6.
14. The Committee is of the view that the company has merely revised the depreciation rates; there is no change in the method of depreciation. The Committee, therefore, does not agree with the observation made by the government auditors as given in paragraph 7 above.
D. Opinion
15. Based on the above, the Committee is of the following opinion on the issues raised in paragraph 8 above:
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[1] Opinion
finalised by the Committee on 28.5.1999.
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