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TMI BlogAccounting Standard (AS) 6 on Depreciation Accounting based on general principles of accounting issued by the Council of the Institute of Chartered Accountants of India.X X X X Extracts X X X X X X X X Extracts X X X X ..... ions regarding charge of depreciation for the purpose of payment of dividends and computation of managerial remuneration, respectively, provide the basis for computation of depreciation. The Companies (Amendment) Act, 1988 has amended section 350, as a consequence to which rates of depreciation prescribed in the Income‑tax Act, 1961, and the Rules made thereunder are no more relevant as the aforesaid section now provides that the rates of depreciation applicable would be those prescribed in Schedule XIV, which has been inserted in the Act. This Guidance Note on Accounting for Depreciation in Companies is issued by the Research Committee in the context of the aforesaid sections of the Act as well as the Accounting Standard. 2. The Council of the Institute and its various committees have issued, from time to time, various pronouncements on the subject of accounting for depreciation, in particular reference to the corporate sector, which are listed below : Guidance Note on Provision for Depreciation [published in Compendium of Guidance Notes, Vol. 1, 2nd edn.] Statement on Provision for Depreciation in Respect of Extra or Multiple Shift Allowance [published in Comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ovisions of section 350; 4. Note No. (5)(i) to Schedule XIV requires that depreciation method(s) used by the company shall be disclosed. Part II of Schedule VI requires that if no provision is made for depreciation, the fact that no provision has been made should be stated and the quantum of arrears of depreciation computed in accordance with section 205(2) of the Act shall be disclosed by way of a note. The Committee is of the view that the company should also disclose the method(s) by which the arrears of depreciation have been computed. 5. Adoption of different methods for different types of assets ‑ A company may adopt more than one method of depreciation. Thus, it is permissible to follow different methods for different types of assets provided the same methods are consistently adopted from year to year in accordance with section 205(2). Also, units in different geographical locations can follow different methods of depreciation on machinery purchased in the same year. 6. Change in the method of providing depreciation - The depreciation method selected should be applied from period to period. A change from one method of providing depreciation to another sh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tioned in section 205(2) read with section 350 and Schedule XIV of the Act or whether these bases can be considered as indicating the minimum depreciation which must be provided by the company, insofar as it is required to exhibit a true and fair view of the state of affairs of the company as on a given date and of the profit or loss for the year. 9. The Committee is of the view that 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 Schedule XIV, the company should provide depreciation at such higher rate; but if the rate so arrived at is lower than the rates prescribed in Schedule XIV, then the company should provide depreciation at the rates prescribed in Schedule XIV, 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 based on technological evaluation should be accepted by the auditor unless he has reason to beli ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... orresponding to the WDV rates as per Schedule XIV) can be different than those prescribed under Schedule XIV, provided the company continues to determine the rates as provided under section 205. For instance, against the SLM rate of 11.31 (triple shift rate for general plant and machinery) prescribed under Schedule XIV, a company can charge depreciation at the rate of 10.56 per cent. It may be mentioned that the rate of 11.31 per cent has been determined on the basis of 8 years and 6 months or so of specified period whereas 10.56 per cent is arrived as if 95 per cent of the cost of the asset is divided by 9 years. It is argued that for calculating the SLM rates complete years have to be taken into account whereas the rates under Schedule XIV also take into account fractions of years. 14. The Committee is of the view that a company should provide SLM depreciation at the rates prescribed under Schedule XIV instead of holding the contention that fractions of years can be ignored. This view is supported by Department of Company Affairs, as per its Circular No. 2/89, dated 7th March, 1989 [enclosed as Annexure I]. 15. Applicability of the rates prescribed in Schedule XIV to asse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the basis of rates of depreciation prescribed under Income‑tax Act and in force at the time of acquisition/purchase of the asset . 20. In its Circular No. 2/89, dated 7th March, 1989, the Department has reiterated that the companies which follow Circular No. 1/86 may, therefore, continue to charge depreciation at the old SLM rates in respect of the already acquired assets against which depreciation has been provided in earlier years on SLM basis . 21. The Committee is of the view that where a company is following the straight line method of depreciation in respect of its assets existing on the date of Schedule XIV coming into force, it would be permissible to apply the relevant SLM rates prescribed in the said Schedule on the original cost of the assets from the year of the change of rates. 22. The Committee is accordingly of the view that where a company has been following straight line method of depreciation in respect of its assets existing on the date of Schedule XIV coming into force, the following alternative basis may be adopted for computing the depreciation charge. 1. Where a company follows the manner of charging depreciation recommended by the Depar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the true and fair consideration of preparation of accounts, the rates of depreciation as per Schedule XIV should be applied proportionately taking into consideration the duration of the financial year. 26. Depreciation on low value items ‑ Prior to the enforcement of the Companies (Amendment) Act, 1988, many companies used to follow the practice of writing off low value items in the year of acquisition since such a write off was permitted under the Income‑tax Act. The limit for such a write off was Rs. 5,000. Schedule XIV is, however, silent on this aspect. The Committee is of the view that the concept of materiality should be kept in mind while deciding the amounts to be written off in this regard. For instance, in small companies, the total write off on this basis may be a substantial figure; it may not, therefore, be proper to charge 100 per cent depreciation on low value items. However, in large companies, where the value of assets is very high, it may be proper to charge 100 per cent depreciation on low value items keeping in view the concept of materiality. The Committee recommends that the accounting policy followed by the company in this regard should ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the additional depreciation from the revaluation reserve. Such transfer from Revaluation Reserve should be shown in the Profit and Loss Account separately and an appropriate note by way of disclosure would be desirable. Such a disclosure would appear to be in consonance with the requirement of Part I of Schedule VI to the Companies Act, prescribing disclosure of write up in the value of fixed asset for the first five years after revaluation. 29. If a company has transferred the difference between the revalued figure and the book value of fixed assets to the Revaluation Reserve and has charged the additional depreciation related thereto to its Profit and Loss Account, it is possible to transfer an amount equivalent to accumulated additional depreciation from the revaluation reserve to the Profit and Loss Account or to the General Reserve provided suitable disclosure is made in the accounts as recommended in this Guidance Note. 30. The Revaluation Reserve is not available for payment of dividends. This view is also supported by the Companies (Declaration of Dividend out of Reserves) Rules, 1975. Similarly, accumulated losses or arrears of depreciation should not be set ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tating that specified period once determined may not be recomputed. Accordingly the Department had advised the companies that it was open to them not to recompute the specified period even when there is a change in the rates of depreciation later on (as against the position of the Department s earlier circular of 1985 on the subject). It is argued that as far as the existing assets are concerned, the companies can follow either of the two circulars. An option under the 1986 circular would thus be available to the companies as at present not recomputing the specified period where the Straight Line Method (SLM) is used. In other words, where a company decides to follow the 1986 circular, assets on which SLM depreciation was being charged, can continue to be depreciated at the old SLM rates. In view of this Department s Circular No. 1 of 1986 (No. 1/1/86‑CL-V), dated 21st May, 1986, specified period once determined may not be recomputed. The companies which follow this circular may, therefore, continue to charge depreciation at the old SLM rates in respect of the assets already acquired against which depreciation has been provided in earlier years on SLM basis. (3) Can highe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e assets. As the depreciation provision in the annual account of the companies under section 205/350 of the Companies Act is related to the rates of depreciation as provided in the Income‑tax Act, any change in the rates under the Income‑tax Act affects the provision of depreciation in the annual account of the companies. As a result, this Department has received several queries/ representations from companies enquiring as to what procedure they should adopt for charging depreciation on straight line method on the assets purchased earlier to the change in the rate of depreciation as provided in the Income‑tax Act. 2. This issue has been examined in this Department and it has been decided that under sub‑section (5) of section 205, specified period for providing depreciation on straight line method under clause (b) of sub-section (2) of section 205 has to be recalculated on the basis of the revised rates under the Income‑tax Act. The companies which adopt the straight line method of depreciation should provide for the depreciation in their annual accounts on the following basis : Number of years for which asset has already been depreciated, bef ..... X X X X Extracts X X X X X X X X Extracts X X X X
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