1.35 Query
Use of different methods of depreciation for the same class of fixed assets.
1. A public limited company is following two alternative methods for providing depreciation in the books of account. The company has four manufacturing plants. For the first three plants, the written down value method as per the Income-tax Rules for providing depreciation is followed for different class of assets such as buildings, furniture & fixtures and plant & machinery. For the same class of assets installed in the fourth plant, the straight line method of depreciation is followed.
2. The querist has mentioned that during the audit of accounts by the C & A.G. it was observed that as per the provisions of the Companies Act, for the same class of assets used in different plants of the same company, two methods of depreciation cannot be applied. Further, they also observed that the provision for extra shift allowance has to be made even in respect of assets for which straight line method of depreciation is followed.
3. The querist has sought the opinion of the Expert Advisory Committee on the following issues with regard to provision for depreciation:
(i) whether the application of different methods of depreciation for the same class of assets used in different plants of the company is permitted under the Companies Act; and
(ii) whether it is necessary to provide for extra shift allowance in the case of assets used in the fourth plant even though depreciation has been provided by the company under the straight line method at equivalent income-tax rates, with effect from 1.4.1987. Opinion November 15, 1988
1. Regarding the application of different rates for the same class of assets used in different plants of the company, the Committee notes that para 12 of Accounting Standard 6 (AS-6) on ‘Depreciation Accounting’, issued by the Institute of Chartered Accountants of India, provides as follows:
“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 select the most appropriate method(s) based on various important factors, e.g., (i) type of assets, (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.”
Accordingly, the Committee is of the view that the management could select a combination of more than one method if that was the most appropriate thing to do considering factors such as the type of asset, nature of the use of such asset and circumstances prevailing in the business.
2. Regarding the provision for extra-shift allowance under the straight line method, the Committee notes that a ‘Statement on Provision for Depreciation in respect of Extra or Multiple Shift Allowance’, has been issued by the Council of Institute of Chartered Accountants of India. The Council in that Statement has reiterated the recommendation of the Research Committee of the Institute, 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 ignored4. The Council further stated that “depreciation includes extra or multiple shift allowance depending on use of the machinery. Provision of full depreciation in essential for the disclosure of a true and fair view of financial statements”.
Accordingly, the Committee is of the view that the company should charge extra shift allowance even when it is using the straight line method of depreciation.
3. On the basis of the above considerations, the opinion of the Expert Advisory Committee, on the issues raised by the querist in para 3 of the query, is as follows:
(i) Different methods of depreciation for the same class of assets used in different plants of the company can be applied if the management considers it appropriate to do so after taking into account important factors such as the type of asset, the nature of the use of such asset and circumstances prevailing in the business.
(ii) If a company has provided depreciation on straight line basis at rates derived from the corresponding WDV rates as prescribed under the Income-tax Act, in respect of the periods prior to the enforcement of the amended provisions of the Companies Act, it is necessary to provide for extra shift allowance.
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4 ‘Provision for Depreciation’, Compendium of Guidance Notes, Vol. I (2nd Edition) (Pp. 2.1). |