1.18 Query
Proper method of charging depreciation 1.A wholly owned subsidiary of a State Industrial Development Corporation is engaged in the manufacture of white crystal sugar and industrial alcohol having two units at different places and the head office at third place. The units are maintaining independent books of account and the final accounts are prepared at the head office. The accounting year of the company closes on 30th June. In respect of one of the units, the commercial production started in 1980-81. All pre-operative expenses in respect of that unit upto 14/11/80 have been capitalised to plant and machinery and buildings in the ratio of their value.
2. The querist has raised the following issues for the opinion of the Expert Advisory Committee with regard to calculation of depreciation:
(i) Should depreciation be charged on straight line method or on written down value method taking into consideration that fixed assets of the company have been depreciated on written down value in the earlier years.
(ii) Is it possible that plant and machinery and buildings be depreciated on straight line method and all other assets on written down method?
(iii) Is there any circular/directive either from the Company Law Board or from the Comptroller & Auditor General of India regarding charging of depreciation on straight line method?
(iv) Can the company claim 100 per cent depreciation on a boiler and if not the specified rate of depreciation which can be charged.
(v) In the absence of assessable income, is it possible that the investment allowance and initial depreciation allowance not be charged to profit and loss account and disclosing the same by way of a not to accounts?
Opinion September 5, 1985
1.The Committee notes that Accounting Standard (AS-6) on ‘Depreciation Accounting’, issued by the Institute of Chartered Accountants of India, states in paras 12 and 22 as below:
“12. There are several methods of allocating depreciation over the useful life of the assets. Those most commonly employed in industrial and commercial enterprises are the straight line method and reducing balance method. 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. A combination of more than one method is sometimes used. In respect of depreciable assets which do not have material value depreciation is often allocated fully in the accounting period in which they are acquired.”
“22. The depreciation method selected should be applied consistently from period to period. A change from one method of providing depreciation to another should be made only if the adoption of the new method is required by statute or for compliance with an accounting standard or if it is considered that the change would result in a more appropriate preparation or presentation of the financial statements of the enterprise. When a change in the method of depreciation is made the unamortised depreciable amount of the asset should be charged to revenue over the remaining useful life by applying the new method. Such a change should be treated as a change in accounting policy and its effect should be quantified and disclosed.”
2. The Committee also notes that the Research Committee of the Institute of Chartered Accountants of India, has recommended in its note on ‘Provision for Depreciation’* as below:
“The Research Committee is of the opinion that it is open to a company to provide for depreciation either on the written down value method or on the straightline basis. It is recommended that the method adopted for providing the depreciation should be disclosed in the accounts. 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 rate mentioned in the above quoted sections, then the company should provide depreciation at the rates mentioned in these sections since these represent the minimum rates of depreciation to be provided.
The Research Committee is also of the view 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.”
3.The opinion of the Committee on the issues raised by the querist in para 2 of the query is as below:
(i) Depreciation can be charged on either straight-line method or written down method on the basis of the factors specified in para 12 of AS-6 (reproduced in para 1 above). The company can decide to change over to straight line method, in case the conditions laid down in para 22 of AS—6 are fulfilled (reproduced in para 1 above) and disclosure is made as suggested therein. In respect of charging depreciation on the assets of the new unit, the company can follow straight line method even though written down value method is being followed in the rest of the company.
(ii) It is possible that plant and machinery and buildings be depreciated on straight line method and all other assets on written down value method.
(iii) A number of circulars have been issued by the Department of Company Affairs regarding straight-line method on different matters. Querist may refer to “Circulars and clarifications on Company Law” by Bhargava & Bhargava, published by ‘Taxman’.
The Committee is not aware whether C & A. G. has issued any circular on the matter since they are not published normally.
(iv) The company can claim 100 per cent depreciation on the boiler, in case the Income-tax Rules prescribe that rate in respect of that asset or category of assets.
(v) Investment allowance and initial depreciation do not form part of the normal depreciation charge in the profit and loss account under Schedule VI. However their admissibility under Income-tax Act is a separate issue on which a number of court decisions are available. _____________________________________
_________________________________ * Compendium of Notes 1980 P, 1----2.
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