3.2       Query

Creation of Investment Allowance Reserve out of profits arrived at after writing back depreciation

arising because of change in accounting policy regarding depreciation

1. Some of the companies have changed accounting policy, with respect to depreciation method, on the following lines:

            (a) Method of depreciation changed from WDV to SLM.

(b) In the year of addition of fixed assets, they are providing depreciation under SLM on a pro-data basis, i.e., depreciation from the month in which addition is made to the last date of the accounting year.

(c) Above changes are being made from retrospective effect.

2. The querist has sought the opinion of the Expert Advisory Committee as to whether the company can create Investment Allowance Reserve under section 32A of the Income-tax Act out of profits arrived at after writing back depreciation by changing accounting policy as stated in para 1 above.

                                                              Opinion                                            September 28, 1987

1.  At the outset, the Committee wishes to state that it is expressing its opinion on the limited question of creation of Investment Allowance Reserve after writing back depreciation by changing its relevant accounting policy with retrospective effect and not on the propriety or otherwise of charging pro-rata depreciation under straight line method.

2. The Committee notes that section 32A (4)(ii) merely requires creation of Investment Allowance Reserve by debiting the profit and loss account.

3.The Committee further notes that the Institute of Chartered Accountants of India has issued Accounting Standard  (AS-6) on ‘Depreciation Accounting’. Para 22 of the Standard recommends as below:

“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.”

4.The Committee is therefore of the opinion that Investment Allowance Reserve u/s 32A of the Income-tax Act, can be created out of profits arrived at after writing-back the depreciation by changing the policy regarding method of depreciation with retrospective effect if such a change is in accordance with the recommendations contained in para 22 of AS-6.

___________________________