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Query No. 2
Subject:
Valuation of fixed assets from incomplete records.1
A. Facts of the Case
1. A State Government company in which the State Government
is holding 99.99% shares is engaged in mining and selling of rock
phosphate, gypsum, limestone and lignite and its mines are located
at different places in the State. The company also has wind power
mills installed in one of the districts of the State.
2. In the year 2002-03, vide gazette notification dated 19.12.2003
issued by the Department of Company Affairs (now known as the
Ministry of Corporate Affairs), Government of India, the company
and XYZ Ltd., another State Government mining corporation, were
amalgamated under section 396 of the Companies Act, 1956 with
effect from 20.02.2003. Accordingly, the annual accounts of both
the companies were consolidated from 1.4.2001 and common
accounting policies were adopted for the year 2002-03 and onwards.
3. As per the querist, prior to amalgamation, the company was
following written down value (WDV) method for charging
depreciation on its fixed assets whereas XYZ Ltd. was charging
depreciation on straight line method (SLM). After amalgamation, a
common policy of charging depreciation on WDV method, was
adopted by the amalgamated company and accordingly, impact
on the profits of the amalgamated company due to change in
accounting policy, was to be shown in the accounts of the
amalgamated company by recalculating depreciation retrospectively
on the assets of XYZ Ltd. as per WDV method in compliance with
the provisions of Accounting Standard (AS) 6, ‘Depreciation
Accounting’.
4. The querist has further stated that the depreciation on WDV
method could not, however, be calculated as the gross purchase
prices (opening balances) of most of the assets of XYZ Ltd. were
not available. As per the querist, there were a number of small
units of XYZ Ltd. in which fixed assets were purchased from time
to time, but complete records of such assets indicating purchase value of individual asset, depreciation charged on each asset,
location, etc., were not maintained by such small units and records
of only gross block of assets were being maintained.
5. The querist has also stated that since the original cost of
individual assets of XYZ Ltd. was not available, the company could
not calculate and charge depreciation on WDV method for such
assets retrospectively and to that extent, the provisions of AS 6
could not be complied with and is also not possible to do so. Since
then, the statutory auditors are qualifying the balance sheet of the
company stating that on account of amalgamation of XYZ Ltd.
with the company, the effect of change of accounting policy of
charging depreciation from SLM to WDV is not given retrospectively
for the assets of XYZ Ltd. as per the requirements of AS 6. The
querist has also mentioned that the value of the assets of XYZ
Ltd. is very negligible compared to the assets of the company.
B. Query
6. The querist has sought the opinion of the Expert Advisory
Committee as to what action should be taken by the company to
comply with the provisions of AS 6.
C. Points considered by the Committee
7. The Committee notes that the basic issue raised in the query
relates to the determination of gross purchase price of individual
assets of XYZ Ltd., for the purposes of calculating depreciation
thereon as per the WDV method. The Committee has, therefore,
considered only this issue and has not touched upon any other
issue arising from the Facts of the Case, such as, accounting for
amalgamation, etc.
8. The Committee notes that AS 6 does not exempt recalculating
depreciation from retrospective effect on account of difficulty in the
estimation of original cost/gross purchase price of various assets.
The Committee further notes that the querist has stated in
paragraph 3 above that XYZ Ltd. was following straight line method
of depreciation before amalgamation. In the view of the Committee,
if the gross block of assets is known (as mentioned by the querist
in paragraph 4 above) and straight line method is being followed,
the amount of depreciation for individual assets can be determined based on the yearly amount of depreciation and the life of the
asset. Accordingly, in such circumstances, the original cost of a
fixed asset can be determined by adding in the balance of fixed
asset as on the date of change in the method of depreciation, the
total depreciation charged as per the annual accounts for the
number of years of operation of the asset and making adjustments
for the assets purchased or sold during a year. However, as stated
by the querist in paragraph 4 above, in case of small units, where
complete records of such assets are not available, and it is not
possible to determine the depreciation for individual assets due to
any reason, the management should make an appropriate
assessment keeping in view the facts and circumstances of the
case, to determine the purchase price of individual fixed asset and
to determine depreciation in accordance with WDV method. In this
regard, factors, such as, book values of similar fixed assets in the
books of the company/similar companies in the industry, of the
same specifications as to brand, year of make, year of purchase,
model, capacity, method(s) employed for the use of the asset, etc.
may be taken into account.
9. As regards the contention of the querist that the value of the
assets of XYZ Ltd. is ‘very negligible’, it is not clear as to which
value is being contemplated here – the balances as appearing in
the books of XYZ Ltd. at the date of amalgamation or the estimated
gross purchase price. Moreover, the Committee notes that the
term ‘very negligible’ is nowhere used in the pronouncements of
the Institute of Chartered Accountants of India. The term used in
various pronouncements is “material”. With regard to the materiality
aspect, the Committee notes that paragraph 4.3 of the Preface to
the Statements of Accounting Standards, issued by Institute of
Chartered Accountants of India, states, inter alia, that “The
Accounting Standards are intended to apply only to items which
are material”. The Committee further notes that paragraph 17(c)
of Accounting Standard (AS) 1, ‘Disclosure of Accounting Policies’,
explains ‘materiality’ as below:
“C. Materiality
Financial statements should disclose all “material” items, i.e.
items the knowledge of which might influence the decisions of
the user of the financial statements.”
10. The Committee also notes that paragraph 3 of Standard on
Auditing (SA) 320 (AAS 13), ‘Audit Materiality’, issued by the
Institute of Chartered Accountants of India, explains, inter alia,
that, “Materiality depends on the size and nature of the item,
judged in the particular circumstances of its misstatement. Thus,
materiality provides a threshold or cut-off point rather than being a
primary qualitative characteristic which the information must have
if it is to be useful”. It further states, inter alia, in paragraphs 4 and
5, respectively that “the assessment of what is material is a matter
of professional judgement” and “the concept of materiality
recognises that some matters, either individually or in the aggregate,
are relatively important for true and fair presentation of financial
information in conformity with recognised accounting policies and
practices”.
11. From the above, the Committee is of the view that threshold
of materiality is applicable to all items of financial statements. If an
information is not material, on the consideration of materiality as
mentioned in the paragraphs above, its accounting would not have
any effect on the decisions of the users of the financial statements.
Accordingly, it needs to be determined under the specific facts
and circumstances of the company concerned as to whether the
value of fixed assets of XYZ Ltd., if not determined as per the
revised method of depreciation, can influence the decisions of the
users of the financial statements. For this purpose, various factors,
such as the revised estimated value of such assets of XYZ Ltd. as
compared to the value of the fixed assets of the company as on
the date of amalgamation, nature of the items, impact on profit/
loss etc., should be considered.
12. On the basis of the above, the Committee is of the view that if
keeping into consideration the factors mentioned in the aforesaid
paragraphs, the aggregate revised estimated value of the fixed
assets of XYZ Ltd. is not material, i.e., their disclosure at unrevised
value would not influence the decisions of the users of the financial
statements, these could be disclosed at the unrevised value.
D. Opinion
13. On the basis of the above, the Committee is of the opinion
that the company should provide for the depreciation as per the revised method of depreciation, i.e., WDV method by determining
the gross purchase prices of the various assets of XYZ Ltd. by
adding back the total depreciation provided on SLM basis to the
balance of fixed assets on the date of amalgamation or on some
other basis as discussed in paragraph 8 above. However, if the
value is not material, the assets of XYZ Ltd. could be shown at
unrevised value as mentioned in paragraphs 11 and 12 above.
1Opinion finalised by the Committee on 17.3.2008
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