1.27     Query 

Provision for depreciation

1. A government warehousing corporation provides depreciation on its assets by charging off 100% value of the assets on straight line basis. The rates of depreciation have been arrived at on the basis of technical report regarding the expected life of assets. The rates worked out are neither as per Income-tax Rules nor as per the Companies Act. Further, the rates are also not reviewed even though, large number of assets continue to be in use, even after 100% depreciation has been provided e.g. in respect of typewriters depreciation @ 30% is provided for the first three years and in the fourth year 10% is charged.

 2.The querist is of the view the straight line method cannot be followed arbitrarily, more so when the basis is unscientific. In case straight line method of depreciation is adopted, the asset must have a residual value of 5% till such time such asset is discarded.

3.The querist has sought the opinion of the Expert Advisory Committee on the following matters arising from the above.

 (i)Will it not be inappropriate to charge the depreciation at a specified rate and while reaching near 100%, the balance is provided in a lumpsum, e.g., in case depreciation is provided @ 30% for three years, charge will be @ 30% and for the fourth year only 10%.

(ii) Whether it is in order if the asset is completely written off, even though the same is in use.

(iii) Whether the straight line method of depreciation should be based as per Income-tax Rules read with Companies Act, 1956 or it can be just what an entity wants.

(iv) Will it not be necessary to quantify the difference and also give a qualifying note regarding 100%charge-off even though the asset is in use.

                                                                Opinion                                                      October 14,1986

1.The Committee notes that para 13 of Accounting Standard 6, Depreciation Accounting, issued by the Institute of Chartered Accountants of India, states that “The statute governing an enterprise may provide the basis for computation of the depreciation.”

 2.The Committee notes that the statute governing the corporation viz., The Warehousing Corporation Act, 1962, provides in section 30(1) that “Every Warehousing Corporation shall established a reserve fund out of its annual profits.

    (2)  After making provision for bad and doubtful debts, depreciation on assets and all other matters which are usually provided by companies registered and incorporated under the Companies Act, 1956, Warehousing Corporation may, out of its net annual profits declare a dividend…………”

 3.On the basis of the above, the Committee is of the view that the corporation should provide for depreciation as prescribed under sections 205 and 350 of the Companies Act, 1956, the relevant extracts of which are reproduced below:

 Section 205 (2)  “For the purpose of sub-section (1), depreciation shall be provided either-

  (a)   to the extent specified in section 350; or

(b)        in respect of each item of depreciable asset, for such an amount as is arrived at by dividing ninety-five percent of the original cost thereof to the company by the specified period in respect of such asset; or

(c)        on any other basis approved by the Central Government which has the effect of writing off by way of depreciation ninety-five per cent of the original cost to the company of each such depreciable asset on the expiry of the specified period; or

(d)        as regard any other depreciable asset for which no rate of depreciation has been laid down by the Indian Income-tax Act, 1922, or the rules made thereunder, on such basis as may be approved by the Central Government by any general order published in the official Gazette or by any special order in any particular case:

provided that where depreciation is provided for in the manner laid down in clause (b) or clause (b) or clause(c), then, in the event of the depreciable asset being sold, discarded, demolished or destroyed the written down value thereof at the end of the financial year in which the asset is sold, discarded, demolished or destroyed, shall be written off in accordance with the proviso to section 350.”

Section 205 (5):      “For the purpose of this section-

(a) “specified period” in respect of any depreciable asset shall mean the number of years at the end of which at least ninety-five per cent of the original cost of that asset to the company will have been provided for by way of depreciation if depreciation were to be calculated in accordance with the provisions of section 350.”

 Section 350  “The amount of depreciation to be deducted in pursuance of clause (k) sub-section (4) of section 349 shall be the amount calculated with reference to the written-down value of the assets as shown by the books of the company at the end of the financial year expiring at the commencement of this Act or immediately thereafter and at the end of each subsequent financial year, 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.”

4.The Committee also notes that the note on ‘Provision for Depreciation’* issued by the Research Committee of the Institute of Chartered Accountants of India, recommends 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 striaghtline 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 those sections since these represent the minimum rates of depreciation to be provided.

Since the determination of commercial life of an asset is a technical matter, the decision of the Board of Directors should be accepted by the auditor unless he has reason to believe that such decision is grossly incorrect. 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.

 5. On the basis of the above, the opinion of the Expert Advisory Committee, on the issues raised by the querist in para 3 of the query is as below:

 (i)         Depreciation on straight-line basis should be calculated by dividing at least 95 per cent of the original cost of the asset, with the specified period calculated as per section 205 (5) (a) of the Companies Act, 1956. Depreciation rate calculated in this manner will be uniform including the last year, except 5 per cent will be left as the residual value where 95 per cent cost is written-off. In the latter case, the asset is carried over at that value until it is discarded or revalued.

(ii)        An asset may be completely written-off at the end of the specified period even though it may still be in use. In such a situation, the asset should be shown at gross value less accumulated depreciation. Normally, the net book value of the asset is shown at a nominal value, say Re. 1.

(iii)       The minimum charge of depreciation should be worked out as per sections 205 and 350 of the Companies Act, 1956, which require rates prescribed as per Income-tax Rules 1962 to be adopted for such computation. However, rates higher than those prescribed under the said Rules will be acceptable in case the specified period (commercial life of the asset) is lower on technical considerations compared to the one worked out on the basis of Income-tax rates as per section 205 (5) (a) of the Companies Act, 1956, if it is so approved by the Board of Directors.

(iv)       In case depreciation is not charged in accordance with the above recommendations, the auditor should qualify his report, quantifying the difference between the depreciation that has been charged and that should have been charged and the impact thereof on profit/loss and assets of the corporation. Where an asset has been completely written-off in accordance with (iii) above and the asset is still in use, the auditor should not qualify his report where the asset is shown on the balance sheet at gross value less accumulated depreciation.

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