1.4       Query

Charging depreciation in the books of account on the

basis of the provisions of the Income-tax Act, 1961.

1. A manufacturing company is allowed the following depreciation allowances on additions to plant and machinery for computing its taxable income under the Income-tax Act 1961:

(i) Additional depreciation equal to 50% of the normal depreciation on new additions u/s 32 (i) (ii) (a).

(ii)Extra shift allowance on above additions for full year if the ‘concern’ had worked multiple shift for the full year, although such additions had not worked for full year.

(iii) Extra shift allowance is allowable also on a part of the brought forward machinery installed in a particular section of the factory even if it has not worked multiple shifts but if the concern has worked multiple shift for the full year.

(iv) Depreciation on additions to Plant and Machinery valuing Rs. 750/- at 100%.

(1)Whether the method of charging depreciation as adopted by the company is in accordance with the provisions of the Companies Act; if not, what sections of the Company Law are being infringed?

(2)Has any clarification or opinion been issued by the Institute or its Research Committee on any or on all of the above points?

(3) If the method of providing depreciation adopted by the company is in conflict with the Companies Act, or with the opinion expressed by the Institute, how should the audit report be qualified?

(4) Whether the qualification would contain the quantum of excess depreciation provided in the books?

(5)The mode of charging depreciation in the above manner would affect the written down value for the subsequent year and accordingly the quantum of depreciation to be adjusted in that year would be different. Whether this difference in the amount of depreciation to be adjusted in the subsequent year would have to be quantified and mentioned in the audit report?

(6) If the company describes the above mode of charging depreciation under the head “Statement on Accounting Policies” and annexes the same with its final accounts, would, in that case, the statutory auditor, be required to qualify the audit report, and if so, whether there would be any different qualification of audit report:

a) When such statement on accounting policy is annexed to the final accounts; and

 b) if it is not annexed to the final accounts.

Opinion                                   March 12, 1982

 1. The Committee notes that Part II of Schedule VI to the Companies Act, 1956, requires that the profit and loss account must disclose inter-alia the amount provided for depreciation. Though the basis for calculation depreciation has not been prescribed, it is apparent that since the profit and loss account should disclose a true and fair view of its profit or loss for the financial year, depreciation should be provided in accordance with the sound commercial and accounting practices. Sections 205(2) and 350 of the Companies Act, which prescribe the basis for calculating the amount of depreciation for the purpose of declaration of dividend and for computing managerial remuneration respectively, may be taken as indicative of sound commercial and accounting practices.

2.  One of the bases of providing depreciation under Section 205(2) is as specified under Section 350 of the Companies Act, i.e., in accordance with “the rates specified for the assets by the Indian Income-tax Act, and the rules made thereunder for the time being in force, as normal depreciation including therein extra and multiple shift allowance but not including therein any special, initial or other depreciation or any development rebate, whether allowed by that Act or those rules or otherwise….” It is significant to note that the only provision of the Income-tax Act that is relevant here is the provision specifying the rates of percentage as contained in the Act or Rules; and not all other connected and allied provisions of the Act which prescribe manner of computation of depreciation. It was pointed out by the Sastri Committee (1957) that charging depreciation at the rates specified in the Income-tax Act only “will have the effect of charging against profits each year………….., an amount in respect of depreciation which will be approximately the same as the amount which should properly be written off as depreciation in the company’s profit and loss account for the year, if such account is to show a true and fair view of the profit or loss for the year, as required by section 211(2).”

3. In its ‘Note on Provision for Depreciation’, the Research Committee of the Institute has stated 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 Section 350 or Section 205(2), the company should provide depreciation at such higher rate but if the rate so arrived at is lower than the rates mentioned in [these] sections, then the company should provide depreciation at the rates mentioned in those sections since these represent the minimum rates of depreciation to be provided.” In view of this, depreciation higher than that as per section 350 can be provided only on the consideration that it represents a true commercial charge and not on the basis that the Income-tax Act allows certain special allowances.

4. Thus, it is quite clear that any additional depreciation under section32 (1) (ii) (a) of the Income-tax Act is not a part of the true commercial depreciation for the purpose of disclosing a true and fair view of the profit or loss of a concern.

5. The Committee noted that the prevailing accounting practice in the country is to provide for depreciation in full on assets valuing Rs. 750/- or less [Proviso to Section32 (1) (ii) of the Income-tax Act, 1961] on grounds of materiality. Similarly, according to the prevailing accounting practice, it might not be necessary to provide for depreciation on pro-rata basis in respect of the additions/disposals of the asset made in a year with reference to the actual date of such additions/disposals

6.On the basis of the above, the point-wise opinion of the Committee is as follows:

(1)        (a)  The company has not provided more depreciation than required under

Section 205 (2) and 350 of the Companies Act, and therefore, there is no infringement of these sections except to the extent of the additional depreciation provided under Section 32 (1) (ii) (a) of the Income–tax Act which can not be considered part of the true commercial depreciation.

(b) According to the prevailing accounting practice in the country, depreciation may be provided in full in respect of (i) assets valuing Rs. 750 or less; and (ii) the additions/disposals of assets made in a year, regardless of the actual date of such additions/disposals.

(2)        (i)  Regarding the interpretation of Section 350 of the Companies Act 1956,

the Institute obtained the opinion of Mr. F.S. Nariman, a senior counsel.

The opinion was reproduced in the September 1980 issue of “The Chartered Accountant.”

(ii) The Research Committee of the Institute in its “Compendium of Notes” (1980) has given a note on “Provision for depreciation.”

(3)        (a) If the auditor is of the opinion that the amount of additional depreciation

charged on the basis of the provisions of  Section 32 (1) (ii) (a) is material, he may qualify his report as follows:

“The Company has provided for additional depreciation amounting to Rs……………….on the basis of the provisions of Section 32 (1) (ii) (a) of the Indian Income-tax Act, 1961 which in our opinion is in excess of the amount of depreciation according to the sound commercial and accounting practices by Rs……

Subject to the above…………………..”.

(b) In respect of depreciation provided on the basis discussed in (1) (b) above, the auditor need not qualify his report.

(4) Please see (3) above.

(5)  The provision of additional depreciation u/s 32 (1) (ii) (a) of the Income-tax Act, would also affect the depreciation charge to be made in the profit and loss account of the subsequent years (because depreciation is calculated with respect to the written down value) and such difference if not adjusted, and if material, may be reported by the auditor as indicated in (3) above. The auditor need not qualify his report in the subsequent years in respect of the basis adopted in (1) (b) above.

(6)        (a) Where a  ‘Statement  on  Accounting  Policies’  is  annexed  to the Annual

Accounts, much will depend upon the manner in which the mode of calculation of depreciation is disclosed. If it discloses the amounts indicated in (3) (a) above, the auditor may qualify his report by making a brief reference to the relevant part in the Statement on Accounting Policies.

(b) If such statement is not annexed to the Annual Accounts, the auditor may qualify his report as in (3) (a)

“Compendium of Notes” (1980), issued by the Research Committee of the Institute of Chartered Accountants of India, p.1.