Query No. 46

Subject:   

Revaluation of fixed assets.[1]

A. Facts of the Case

1. A public limited company has three divisions, namely, yarn, suitings and petrofils divisions.  The company closes its accounts every year on 31^st March.

2. Accounts for the financial year ended 31^st March, 2000, were approved by the board of directors at their meeting held on 2^nd December, 2000, and were later adopted by the shareholders in the annual general meeting held on 29^th December, 2000.  While considering the accounts for the year ended 31^st March, 2000, the board of directors had approved diminution in the value of fixed assets in yarn and suitings divisions and abandonment of expansion scheme in suitings division, and charged the same to the profit and loss account as per details given below:

(a)  Diminution in the value of fixed assets of       (Rs. in crore)
yarn division :

 

                 Written down value as per books                               34.66

 

                 Less: Market value of the assets as per

                 valuation report                                                        13.18

 

                 Total diminution in the value of assets                        21.48

 

                 Less: Adjustment on account of Revaluation Reserve 11.72

 

                 Balance charged to profit and loss account                   9.76

 

(b) Diminution in the value of fixed assets of       (Rs. in crore)
suitings division :

 

                 Written down value as per books                               44.10

 

                 Less: Market value of the assets as per

                 valuation report                                                        15.24

 

                 Balance charged to profit and loss account                 28.86

 

 (c)  Abandonment of expansion scheme in suitings division

 

The company has also decided to abandon the expansion scheme for installation of 27 looms and expenses incurred on this scheme amounting to Rs.7.23 crore were debited to profit and loss account.

3. Reasons for diminution in the value of fixed assets of yarn and suitings divisions and abandonment of expansion scheme in suitings division by the company are that the yarn division of the company is inoperative for the last more than 3 years due to labour problem and its value has substantially diminished.  The plant is old and since its establishment innovations have also taken place.  The company was forced to discontinue operations of its process-house due to unfavourable excise duty structure for composite mills, which had substantially eroded the margins.  The unhealthy competition from power loom sector has also made the working of the suitings division unviable and, therefore, the company has decided to dispose off the assets of the yarn division and suitings division.

4. In order to bring the values of the fixed assets of these divisions in consonance with the present day estimated realisable value, the company appointed a government approved valuer to ascertain the present realisable values of fixed assets of these divisions.  One of the financial institutions which had provided finance to the company had also appointed a chartered accountants firm to ascertain estimated fair market value of the assets of these divisions independently, who have also estimated the realisable values of fixed assets of these divisions.  As per the querist, it is important to note that the values estimated by both the valuers are almost similar, as would be seen from the following table:

The company adopted the valuation of the government approved valuers.

5. According to the querist, a proper disclosure of the fact that the diminution in the value of the fixed assets and value of abandoned expansion scheme have been charged to the profit and loss account was made in the directors’ report of the company.

6.  The company made the following disclosure in the notes on accounts:

“14.(a)     Yarn division of the company is not in manufacturing operations for last few years due to labour problem and is not a going concern.  The efforts to resume the operations could not succeed.  Suitings division of the company has also become unviable in past few years, due to change in excise duty structure and unhealthy competition from power loom sector.  In view of the above the company intends to dispose off the aforesaid divisions and therefore has obtained valuation report from the approved valuer to ascertain the realisable value of fixed assets as at 31.3.2000.  From the valuation report it was noticed that the value of fixed assets of the above divisions has been substantially diminished.  As per the prudent accounting principles and in accordance with relevant accounting standard issued by the Institute of Chartered Accountants of India, the diminution in value of fixed assets amounting to Rs.3,862.09 lac has been charged to profit and loss account.

 

(b)   Further, the revaluation reserve created in 1985 and 1992 (except for land) in respect of the yarn division, has been reversed.  It has resulted in reduction of Gross Block by Rs.2,147.14 lac and Net Block by Rs.1,172.08 lac.

 

(c)  The management has also decided to abandon the expansion scheme in Suitings Division at Alwar.  Amount spent including advances for the said scheme Rs.723.33 lac (including interest and pre-operative expenses Rs.213.92 lac) has been charged to profit and loss account.”

B.  Queries

7.  The querist has sought the opinion of the Expert Advisory Committee on the following issues:

(a)  Whether in the facts and circumstances stated above, amounts charged to the profit and loss account of the company towards (i) diminution in the value of fixed assets of yarn division and suitings division, and (ii) abandonment of expansion scheme of suitings division, is in consonance with guidelines issued by the Institute of Chartered Accountants of India.

 

(b)  In case the guidelines are yet to be framed, whether the same is generally in consonance with the guidelines issued by the Institutes of other well-known countries and/or international accounting practice.

 

C. Points Considered by the Committee

8. The Committee restricts itself to the particular issues raised by the querist and has not touched upon any other issue such as the appropriateness of the adoption of values determined by the government approved valuers or the chartered accountants firm.

9. The Committee notes paragraph 13.7 of Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’, which states as below:

“13.7  An increase in net book value arising on revaluation of fixed assets is normally credited directly to owner’s interests under the heading of revaluation reserves and is regarded as not available for distribution. A decrease in net book value arising on revaluation of fixed assets is charged to profit and loss statement except that, to the extent that such a decrease is considered to be related to a previous increase on revaluation that is included in revaluation reserve, it is sometimes charged against that earlier increase. It sometimes happens that an increase to be recorded is a reversal of a previous decrease arising on revaluation which has been charged to profit and loss statement in which case the increase is credited to profit and loss statement to the extent that it offsets the previously recorded decrease.”

10. The Committee also notes the disclosure requirements stated in paragraph 39 of AS 10, which provides, inter alia, as below:

“39. The following information should be disclosed in the financial statements:

……

(iii)  revalued amounts substituted for historical costs of fixed assets, the method adopted to compute the revalued amounts, the nature of indices used, the year of any appraisal made, and whether an external valuer was involved, in case where fixed assets are stated at revalued amounts.”

 

11. From the above, the Committee is of the view that though the accounting treatment for diminution followed by the company was appropriate, the disclosures made by the company were not appropriate.  The revaluation resulting in diminution in the value of fixed assets should be disclosed in the manner described in paragraph 39 of AS 10 reproduced above.

12. The Committee is also of the view that upon abandonment of any project, the net realisable value of the various items of assets, if any, should be assessed and shown in the books till their disposal and the resultant loss should be charged to the profit and loss account immediately upon abandonment.

D. Opinion

13. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 7:

(a)  (i)  Though the accounting treatment of diminution in the value of fixed assets of yarn division and suitings division followed by the company is appropriate, the disclosure in respect thereof is not appropriate.  The disclosure in respect of the revaluation resulting in diminution should be made in accordance with paragraph 39 of AS 10.

 

     (ii)  The accounting treatment of loss on the abandonment of the expansion scheme would be appropriate only if assets, if any, created under the expansion scheme, did not have any net realisable value.  If the said assets had any net realisable value, then the amount of loss to be written off on abandonment would be the expenditure incurred on expansion so far minus the net realisable value of the assets.

 

(b)  This question does not arise in view of (a) above.

[1]Opinion finalised by the Committee on 17.1.2001.