Expert Advisory Committee

1.22 Query

Provision for depreciation.

1.A company has been consistently charging depreciation in accordance with the provisions of Section 205(a) of the Companies Act which required, prior to the Companies (Amendment) Act, 1988, depreciation to be provided as per the Section 350 of the said Act, i.e., at the rates specified in the Income-tax Act and the rules made thereunder for the time being in force. The company finalised its accounts before the passing of the Companies (Amendment) Act, 1988, and due to the introduction of higher depreciation rates on block of assets as provided in the Income-tax Rules, the company charged depreciation on block of assets, thereby crediting the full sale value of assets sold during the year to the concerned block of assets and showing the net written down value of each block in the balance sheet.

2. The querists have sought the opinion of the Committee on the following issues:

(a) Whether adoption of block concept of charging depreciation in accounts, as per the Income-tax Act, is justified? If so, whether the concept of true and fair view of accounts is affected when the profit on sale of assets is not credited to profit and loss account but to the concerned block of assets.

(b) Whether the company may follow the method of charging depreciation as per the Income-tax method in its accounts even after the introduction of Schedule XIV to the Companies Act, 1956, since Note No. 5 of the Schedule XIV requires only disclosure of the method of depreciation in accounts and depreciation rates or the useful lives of the assets, if they are different from the principal rates specified in the schedule.

(c) If depreciation is to be charged as per Schedule XIV to the Companies Act, 1956, whether charging depreciation on pro-rata basis is mandatory?

Opinion March 21, 1989

1.The Committee notes that section 350 of the Companies Act, 1956, prior to the amendment in that section by virtue of Companies (Amendment) Act, 1988, appeared as below:

“The amount of depreciation to be deducted in pursuance of clause (k) of 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.

Provided that if any asset is sold, discarded, demolished or destroyed for any reason before depreciation of such asset has been provided for in full, the excess, if any, of the written-down value of such asset over its sale proceeds or as the case may be, its scrap value, shall be written off in the financial year in which the asset is sold, discarded, demolished or destroyed.”

2.The Committee notes that after amendment, section 350, prescribes as below:

3.The Committee also notes that the Research Committee has issued a guidance note on ‘Provision for Depreciation’, which, inter alia, 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 straight line 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.”

4.The Committee is of the view that, on the basis of the language of section 350 of the Companies Act (prior to amendment), the said section stipulated adoption of only the rates as given in the Income-tax Act, and the Rules thereunder. In other words, the entire scheme or depreciation as per that Act/Rules could not be adopted for the purposes of the Companies Act. The Committee also notes that clause 3 (xii) (b) of Part II of Schedule VI to the Companies Act, 1956, requires that “profits or losses in respect of transactions of a kind, not usually undertaken by the company or undertaken in circumstances of an exceptional or non-recurring nature, if material in amount shall be disclosed”. Thus, in the view of the Committee, prior to the Companies (Amendment) Act, 1988 coming into force, the company could adopt the rates applicable to the block of assets, but crediting the full sale value of assets sold during the year to the concerned block of assets, thereby showing the net written down value of each block in the balance sheet, would not be correct.

5.The Committee also notes that Note No. 4 to Schedule XIV to the Companies Act, 1956, requires “where, during any financial year, any addition has been made to any asset, or where any asset has been sold, discarded, demolished or destroyed, the depreciation on such assets shall be calculated on a pro-rata basis from that date of such addition or, as the case may be, up to the date on which such asset has been sold, discarded, demolished or destroyed.”

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

(a) Prior to the amendment in section 350 of the Companies Act, 1956, by virtue of the Companies (Amendment) Act, 1988, coming into force, the block concept of charging depreciation could be adopted only so far as the applicable rates of depreciation were concerned. The concept of true and fair view of accounts would be affected if the profit on sale of assets was credited to the concerned block of assets and was not credited to profit and loss account as required in clause 3 (xii) (b) of Part II of Schedule VI to the Companies Act, 1956 and by Accounting Standard 5 (AS-5) on ‘Prior Period and Extraordinary Items and Changes in Accounting Polices’, issued by the Institute of Chartered Accountants of India.

(b) After the Schedule XIV coming into force, rates higher than those under that schedule can only be adopted on the basis of a bona fide determination of the commercial life of an asset, which is a technical matter. Also, in such a case, proper disclosure has to be made. Therefore, a company can follow rates prescribed under the Income-tax Act/Rules only if these rates represent bona fide commercial depreciation.

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