1.10 Query
Provision for depreciation under Section 350 and 205(2) of the Companies Act
1.A public limited manufacturing company provides for depreciation on straight line basis. The company decided to change its current accounting year so that the ‘previous year’ for the purposes of Income-tax Act, is of 18 months. The income tax officer, while giving approval to the change in the previous year, imposed a condition that the company shall claim depreciation for 12 months only and not for 18 months. The company agreed to this condition in order to obtain approval, as it felt that there was no provision for contesting such decision of the ITO in appeal under the Act.
2.The company proposes to provide depreciation in the accounts on straight line basis for 12 months, without any extra shift allowance, although the company has worked triple shift throughout the period. The company also proposes to pay dividend. However, for the purpose of income-tax, the company proposes to claim full depreciation for 18 months, including triple shift allowance, inspite of the condition imposed by ITO, since under Rule 5 of the Income-tax Rules, the company is entitled to claim depreciation at higher proportion based on number of months in the previous year.
3. For the purpose of computation of managerial remuneration as per the requirements of Sections 349 and 350 of the Companies Act, 1956, the company proposes to consider only 12 months depreciation out of the accounting year of 18 months. The company has contended that since the Income-tax department has imposed a condition for allowing depreciation for 12 months only, it is justified in deducting depreciation for 12 months for the purpose of Section 350 also, as it refers to depreciation under the Income-tax Act. In this context, the company does not consider Rule 5 of the Income- tax Rules, relevant.
4.The querists have raised the following issues for the opinion of the Expert Advisory Committee:
(i) Whether the company has correctly interpreted Section 350 of the companies act in proposing to change depreciation for 12 months out of the 18th months accounting year?
(ii) Whether the depreciation proposed to be provided in accounts by the company for 12 months on straight-line basis without computing extra-shift allowance is in accordance with law? Whether the depreciation is adequately provided for the purpose of computing available profits for dividend under Section 205(2) of the Companies Act?
(iii) If the company insists on providing depreciation on aforesaid basis and paying dividend, what should the auditor do in giving his report (a) on quantum of depreciation, (b) on payment of managerial remuneration, and (c) on payment of dividend, in the light of the answers given on (i) and (ii) above.
Opinion August 24,1984
1.The Committee notes that Section 350 of the Companies Act, prescribes that the amount of depreciation to be deducted “in pursuance of Section 349 shall be the amount calculated…….. at the rate specified for the assets by the Indian Income-tax Act (1961), and the rules made thereunder for the time being in force, as normal depreciation including therein extra and multiple shift allowances but not including therein any special, initial or other depreciation or any development rebate whether allowed by that Act or those rules or otherwise ………………..”
2.The Committee is of the view that having regard to the specific provisions contained in the proviso to Rule 5(1) of the Income-tax Rules, the depreciation has to be provided for 18 months for the purpose of Section 350 of the Companies Act also.
3.Regarding the company’s proposal not to provide depreciation for extra shift allowance although the company has worked triple shift throughout, the Committee notes that the Research Committee of the Institute of Chartered Accountants of India, in its note on ‘Provision for Depreciation’, which is included in its publication ‘Compendium of Notes’ (1982) (p-2), has recommended that “…… where for the purposes of Section 350 or Section 205(2), income-tax rates are adopted, the rates to be considered are the normal rates together with the allowance for extra-shift working but initial depreciation and development rebate have to be ignored.” The Council of the Institute has recently reiterated this view and has recommended that “in cases where depreciation has not been provided in respect of extra or multiple shift allowance, it will be necessary for the auditor to qualify his report accordingly.” The said view of the Council is published at page 831 of the June, 1984 issue of ‘The Chartered Accountant’.
4.On the basis of the above considerations, the opinion of the Expert Advisory Committee, on the issues raised by the querists, is as below: -
(i) The Company’s interpretation of Section 350 of the Companies Act, in proposing to charge depreciation for 12 months out of the 18 months accounting year, is not correct.
(ii) The Company’s proposal to charge depreciation on straight line basis, without computing extra-shift allowance, is not in accordance with the law. Also, the depreciation so provided would not be adequate for the purpose of computing available profits for dividend under Section 205(2) of the Companies Act.
(iii) In case the company insists on providing depreciation as it proposes, the auditor should qualify his report stating therein (a) the extent to which the depreciation has not been provided due to non-provision in respect of the part of the accounting year i.e., for 6 months, and non-provision of extra-shift allowance being contrary to the accounting practice recommended by the Institute of Chartered Accountants of India, (b) the extent to which the managerial remuneration has been over-paid (c) the dividends paid or proposed to be paid from the excess profits arising from lower depreciation provision as a consequence to (a), if any. The auditor should also quantify, wherever possible, the effect of the qualifications on the financial statements in clear and unambiguous manner as per the recent recommendation of the Council in this regard which has been published in the September, 1983 and March, 1984 issues of ‘The Chartered Accountant’ under Revised Chapter 3 of the Statement on Qualifications in Auditor’s Report’.
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