Query No. 50

Subject:          

  Different methods of providing depreciation.1

A. Facts of the Case

1. The  relevant  portion  of  the  notes  forming  part  of  the  financial statements  of  a  company  for  the  year  ended  31st  March,  2001,  is reproduced below:

“Depreciation has been charged under the written down value (WDV) method at the rates prescribed in Schedule XIV to the Companies Act,  1956,  in  respect  of  fixed  assets  existing  as  on  31st  March,1994, and under the straight line method (SLM) on assets acquired thereafter  and  depreciation  has  been  calculated  at  the  applicable rates instead of 100% in respect of the additions during the year on the  specified  category  of  assets  costing  less  than  Rs.  5,000  per unit.”

2. The above has resulted in providing depreciation under two different methods for the same type/category of fixed assets, i.e., on written down value (WDV) basis for assets acquired on or before 31st March, 1994,and on straight line method (SLM) for assets acquired after 31 March,1994. This policy has been consistently followed upto the last financial year ending on 31st March, 2001.

3. As per the querist, the above accounting policy was the result of a conscious decision taken by the company as it did not want to write back depreciation provided on the existing assets which would have the effect of  inflating the  book profit for  the financial  year  1993-94. The  querist has stated that the intention of the company was to charge the depreciation on straight line method for the assets acquired for expansion project (in existing premises) as well as on any other assets acquired thereafter.

4. The auditors of the company have pointed out that there cannot be two methods of depreciation within the same category of assets located in  the  premises.  They  have  mentioned  that  if  the  company  chooses  to provide depreciation under a particular method, it has to adopt the same method to depreciate all assets falling under that category. The auditors suggested  to  the  company  to  switch  entirely  to  either  the  straight  line method of depreciation or to the written down value method.

5. The company is of the view that the present policy of providing for the depreciation, i.e., written down value method for assets acquired on or before 31st March, 1994, and straight line method for assets purchased on or after 1st April, 1994, is consistently followed and, therefore, the same is in conformity with the accepted accounting principles.

6. The querist has stated that there are instances of companies, including a  public  sector  company,  which  provide  depreciation  on  written  down value method for assets acquired upto a particular date and on straight line method for assets acquired after such date. The querist has reproduced the  relevant  extracts  from  a  schedule  to  the  financial  statements  of  a public sector company for the reference of the Committee as below:

“(ii)  On the assets purchased/acquired during the period from 1st April, 1986 to 31st March, 1994, depreciation has been provided for on written down value method at the rates specified from time to time in Schedule XIV to the Companies Act, 1956.

(iii)   On  assets  purchased/acquired  after  31st  March,  1994, depreciation has been provided for on straight line method at the rates prescribed in Schedule XIV  to the Companies Act,1956.”

B. Query

7. The querist has sought the opinion of the Expert Advisory Committee as to whether the accounting policy followed by the company for providing depreciation is in accordance with the accepted accounting principles.

C. Points considered by the Committee     

8. The  Committee  notes  that  paragraph  12  of  Accounting  Standard (AS) 6, ‘Depreciation Accounting’, issued by the Institute of Chartered Accountants of India, provides that “the management of a business selects the most appropriate method(s) based on various important factors e.g., (i)  type  of  asset,  (ii)  the  nature  of  the  use  of  such  asset  and  (iii) circumstances  prevailing  in  the  business”.  The  Standard  also  provides that  “a  combination  of  more  than  one  method  is  sometimes  used”. However, the Committee notes that, in the case under consideration, the selection of the method for charging depreciation on assets acquired after 31st  March, 1994, is not based on any such factors.

9. The  Committee  also  notes  paragraph  5  of  the  ‘Guidance  Note  on Accounting for Depreciation in Companies’ which is reproduced below:

“ Adoption of different methods for different types of assets

5. A company may adopt more than one method of depreciation. Thus,  it  is  permissible  to  follow  different  methods  for  different types of assets provided the same methods are consistently adopted from year to year in accordance with section 205(2). Also, units in different  geographical  locations  can  follow  different  methods  of depreciation provided the same are consistently followed.”

10. The Committee further notes the Circular Letter No.10 (1)-CL VI dated  27-9-1961  issued  by  the  Department  of  Companies  Affairs, reproduced below:

“It is permissible to adopt different methods for different types of assets provided the same basis is consistently adopted from year to year in accordance with the provisions of section 205(2).”

11. From the above, the Committee is of the view that a company may follow  different  methods  of  depreciation  for  different  types  of  assets such  as  providing  depreciation  on  building  and  plant  and  machinery under  straight  line  method  and  adopting  reducing  balance  method  for motor  vehicles,  furniture,  fittings,  etc.,  provided  the  same  methods  are consistently followed from year to year. The Committee is of the view that  the  company  should  follow  the  same  method  of  depreciation  for same type of assets irrespective of the year of acquisition. The Committee is of the view that adopting different methods of providing depreciation for  the  same  type  of  fixed  assets  is  not  in  accordance  with  generally accepted accounting principles.

12. The  Committee  notes  that  note  no.  8  of  Schedule  XIV  to  the Companies Act, 1956, requires as below:

“8. Notwithstanding  anything  mentioned  in  this  Schedule, depreciation  on  assets,  whose  actual  cost  does  not  exceed  five thousand rupees, shall be provided depreciation at the rate of hundred per cent:

Provided that where the aggregate actual cost of individual items of plant and machinery costing Rs. 5,000 or less constitutes more than 10 per cent of the total actual cost of plant and machinery, rates of depreciation applicable to such items shall be the rates as specified in Item II of the Schedule.”

Accordingly,  the  Committee  is  of  the  view  that  the  company  should provide depreciation at the rate of hundred per cent on assets costing less than Rs. 5,000, subject to the proviso to note 8 of Schedule XIV to the Companies Act, 1956.

  D. Opinion

13. On the basis of the above, the Committee is of the opinion that the accounting policy adopted by the company is not in accordance with the accepted accounting principles.

1Opinion finalised by the Committee on 30.1.2002.