(1) Particulars of depreciation to be shown in fixed assets records under the MAOCARO 1975.

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1 1. QURIES ON AS 6 (1) Particulars of depreciation to be shown in fixed assets records under the MAOCARO In the context of the Manufacturing and Other Companies (Auditor s Report) Order 1975, [u/s 227(4A) (i) of the Companies Act 1956], the auditor is required to include a statement in his report as to whether the company is maintaining proper records to show full particulars, including quantitative details and situation of fixed assets. The querist has sought the opinion of the Committee on the following matters pertaining to the particulars of depreciation to be shown in fixed assets records: -- (i) (ii) In order to report that the Company has maintained proper records showing full particulars, is it necessary that the records should also show the amount of depreciation provided on the fixed assets? If the depreciation provided on the fixed assets is not shown in the fixed assets register but only the rate of depreciation is shown therein then could it be said that the company has maintained proper records showing full particulars including quantitative details and situation of its fixed assets? (iii) If the depreciation provided in the books of accounts is not shown in the fixed assets register either individually or as group of assets then is it necessary for the statutory auditors to qualify their report by mentioning that the company has maintained proper records showing full particulars (other than depreciation) including quantitative details and situation of its fixed assets? 2. The querist has drawn the attention of the Committee to Para 22(a) of the Institute s publication Statement on the Manufacturing and Other Companies (Auditor s report) Order 1975 which states as below: (a) What are proper records have not been specified but it would appear that normally the records should show the following particulars: -- (1) Sufficient description of the asset to make identification possible.

2 (2) Classification, that is, the head under which it is shown in the accounts, e.g., plant and machinery, office equipment etc. (3) Location. (4) Quantity, i.e., number of units. (5) Original Cost. (6) Adjustment for revaluation or for increase or decrease in cost consequent on revaluation of foreign currency liabilities, if any. (7) Particulars regarding retirement. It would be desirable if the records also show (i) the year of purchase and (ii) the rate of depreciation or the accumulated depreciation to date. 3. The querist has drawn the attention of the Committee specifically to the fact that whereas the word should has been used for the above-mentioned 7 particulars to be shown on the fixed assets records, the Statement uses the word desirable for depreciation. (2). 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 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 (3) Special depreciation on assets leased out. Query 1. A company, which is a Government of India Undertaking, carries on, inter alia, the business of leasing out the EPABX systems. This business was taken up by the company from 1987 onward. In 1987, the Institute had issued an exposure draft (Proposed Guidance Note on Accounting for Leases) and the company adopted these guidelines in toto. 2. Accordingly, out of the rental received, finance income was being taken at the pre-determined rate (say 14%) on net investment outstanding during the period and the balance annual capital recovery charge was spilt in two parts, i.e., normal depreciation and special lease depreciation. For instance, in , the net investment in lease was Rs. 18,500/- and the rental received was Rs. 10,000/-. The net investment during the period as such works out to Rs. 8,500/- (Rs. 18,500 - Rs.10,000 = Rs. 8,500). The finance income works out to Rs. 1,190/-. The annual capital recovery charge (Rs. 10,000 Rs. 1,190 = Rs. 8,810) is being spilt in two parts, normal depreciation on the asset, (say 25%) Rs. 4,625/- and the balance amount Rs. 4,185/- is being treated as the special lease depreciation. The auditors have expressed their reservations on the special lease depreciation. They have stated that due to charging of special leased depreciation, profits of the company are being understated. According to them, only the normal depreciation as per the accounting policy of the company should be charged.

4 3. In the accounting policy of the company, the above treatment has been fully disclosed in the accounts as under LEASE ACCOUNTING Income is recognized as a constant periodic rate of return on the Company s net investment outstanding in the lease. Normal depreciation is charged in the accounts on the straight line method. In case, the rental income is in excess of finance income, special lease depreciation is charged. 4. As the above lease accounting was being followed consistently by the company, the auditors did not give any comment on the above in the accounting year but advised that the company should seek expert opinion on the matter. The querist has sought the opinion of the Expert Advisory Committee as to whether in view of the above policy, the special lease depreciation, if the rental income is in excess of finance income, should be charged or not. (4) Change in accounting policy regarding charge of depreciation. Query: 1. A Government company, within the meaning of section 617 of the Companies Act, 1956, is under the administrative control of Ministry of Defence. The authorised and paid up capital of the company are Rs. 125 crores and Rs. 115 crores respectively as on The entire paid up capital of the company is held by the President of India and his nominees. 2. The querist has stated that consequent to the introduction of Schedule XIV to the Companies Act, 1956, the company had changed its accounting policy on depreciation, which reads as below:

5 Depreciation on fixed assets is charged on straight line method. The rate of depreciation is derived by spreading the cost of the asset over its expected life, except in the case of township building where the rate adopted is as per the guidelines issued by the Bureau of Public Enterprises. Depreciation is calculated for the whole year on all additions made during the year in which the asset is put to use/brought on charge. Rates of depreciation prescribed in Schedule XIV of the Companies Act, 1956 are not adopted. The rates adopted are not less than those prescribed in the said Schedule. 3. The querist has clarified that every year the company has been disclosing in the notes forming part of accounts, on a consistent basis, the effect on profit due to adoption of depreciation for full year irrespective of the date on which the asset is brought on charge instead on pro-rata basis for number of days calculation as envisaged in Note 4 to Schedule XIV to the Companies Act, However, the statutory auditors of the company have been qualifying the accounting policy and also the financial note in their audit report disclosing the resultant under-statement of profits for the year and also the understatement of net fixed assets as at the end of the year. 4. The company now intends to modify the accounting policy on depreciation as below: Depreciation on fixed assets is charged on straight line method. The rate of depreciation is derived by spreading the cost of the asset over its expected life, except in the case of township building where the rate adopted is as per the guidelines issued by the Bureau of Public Enterprises. Depreciation is calculated on and from for

6 the full month on all additions, made during the month in which the asset is put to use, brought on charge. Rates of depreciation prescribed in Schedule XIV to the Companies Act, 1956 are not adopted. The rates adopted are not less than those prescribed in the said Schedule. 5. The querist has further clarified that the company would also like to make adequate disclosure regarding change in the accounting policy on depreciation during the financial year and also the effect on profits of financial year , due to such change, in the financial notes forming part of the accounts. 6. In view of the foregoing, the querist seeks the opinion of the Expert Advisory Committee on the following issues: (i) Whether the company can adopt the proposed modification in the policy with regard to depreciation of assets in respect of additions made on or after (ii) If so, whether the company has to make disclosure in the financial notes forming part of the accounts with regard to the under-statement of net fixed assets which were acquired/put to use prior to , since the company followed a different policy of charging depreciation of its assets during such period? If so, for how long?

7 (iii) Whether the statutory auditors of the company shall be required to qualify their audit report perennially with regard to under-statement of net fixed assets acquired/put to use prior to ? If so, for how long? Is it upto the period, the assets acquired/put to use prior to continue to appear in the books of account of the company or perennially? (5) Different methods of providing depreciation.1 A. Facts of the Case 1. The relevant portion of the notes forming part of the financial statements of a company for the year ended 31st March, 2001, is reproduced below: Depreciation has been charged under the written down value (WDV) method at the rates prescribed in Schedule XIV to the Companies Act, 1956, in respect of fixed assets existing as on 31st March,1994, and under the straight line method (SLM) on assets acquired thereafter and depreciation has been calculated at the applicable rates instead of 100% in respect of the additions during the year on the specified category of assets costing less than Rs. 5,000 per unit. 2. The above has resulted in providing depreciation under two different methods for the same type/category of fixed assets, i.e., on written down value (WDV) basis for assets acquired on or before 31st March, 1994,and on straight line method (SLM) for assets acquired after 31 March,1994. This policy has been consistently followed upto the last financial year ending on 31st March, As per the querist, the above accounting policy was the result of a conscious decision taken by the company as it did not want to write back depreciation provided on the existing assets which would have the effect of inflating the book profit for the financial year The querist has stated that the intention of the company was to charge the depreciation on straight line method for the assets acquired for expansion project (in existing premises) as well as on any other assets acquired thereafter. 4. The auditors of the company have pointed out that there cannot be two methods of depreciation within the same category of assets located in the premises. They have mentioned that if the company chooses to provide depreciation under a particular method, it has to adopt the same method to depreciate all assets falling under that category. The auditors suggested to the company to switch entirely to either the straight line method of depreciation or to the written down value method.

8 5. The company is of the view that the present policy of providing for the depreciation, i.e., written down value method for assets acquired on or before 31st March, 1994, and straight line method for assets purchased on or after 1st April, 1994, is consistently followed and, therefore, the same is in conformity with the accepted accounting principles. 6. The querist has stated that there are instances of companies, including a public sector company, which provide depreciation on written down value method for assets acquired upto a particular date and on straight line method for assets acquired after such date. The querist has reproduced the relevant extracts from a schedule to the financial statements of a public sector company for the reference of the Committee as below: (ii) On the assets purchased/acquired during the period from 1st April, 1986 to 31st March, 1994, depreciation has been provided for on written down value method at the rates specified from time to time in Schedule XIV to the Companies Act, (iii) On assets purchased/acquired after 31st March, 1994, depreciation has been provided for on straight line method at the rates prescribed in Schedule XIV to the Companies Act,1956. B. Query 7. The querist has sought the opinion of the Expert Advisory Committee as to whether the accounting policy followed by the company for providing depreciation is in accordance with the accepted accounting principles. C. Points considered by the Committee 8. The Committee notes that paragraph 12 of Accounting Standard (AS) 6, Depreciation Accounting, issued by the Institute of Chartered Accountants of India, provides that the management of a business selects the most appropriate method(s) based on various important factors e.g., (i) type of asset, (ii) the nature of the use of such asset and (iii) circumstances prevailing in the business. The Standard also provides that a combination of more than one method is sometimes used. However, the Committee notes that, in the case under consideration, the selection of the method for charging depreciation on assets acquired after 31st March, 1994, is not based on any such factors. 9. The Committee also notes paragraph 5 of the Guidance Note on Accounting for Depreciation in Companies which is reproduced below: Adoption of different methods for different types of assets 5. 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

9 different geographical locations can follow different methods of depreciation provided the same are consistently followed. 10. The Committee further notes the Circular Letter No.10 (1)-CL VI dated issued by the Department of Companies Affairs, reproduced below: It is permissible to adopt different methods for different types of assets provided the same basis is consistently adopted from year to year in accordance with the provisions of section 205(2). 11. From the above, the Committee is of the view that a company may follow different methods of depreciation for different types of assets such as providing depreciation on building and plant and machinery under straight line method and adopting reducing balance method for motor vehicles, furniture, fittings, etc., provided the same methods are consistently followed from year to year. The Committee is of the view that the company should follow the same method of depreciation for same type of assets irrespective of the year of acquisition. The Committee is of the view that adopting different methods of providing depreciation for the same type of fixed assets is not in accordance with generally accepted accounting principles. 12. The Committee notes that note no. 8 of Schedule XIV to the Companies Act, 1956, requires as below: 8. Notwithstanding anything mentioned in this Schedule, depreciation on assets, whose actual cost does not exceed five thousand rupees, shall be provided depreciation at the rate of hundred per cent: Provided that where the aggregate actual cost of individual items of plant and machinery costing Rs. 5,000 or less constitutes more than 10 per cent of the total actual cost of plant and machinery, rates of depreciation applicable to such items shall be the rates as specified in Item II of the Schedule. Accordingly, the Committee is of the view that the company should provide depreciation at the rate of hundred per cent on assets costing less than Rs. 5,000, subject to the proviso to note 8 of Schedule XIV to the Companies Act, 1956.

10 OPINION GIVEN BY ICAI EAC ON THE QUIRES ON AS-6 (1) 1. The Committee considered the implications of para 22 (a) of the Statement and noted that the particulars mentioned therein refer to an individual item of fixed assets. It follows that if depreciation had been included along with the 7 items mentioned in the Statement, it would have amounted to showing depreciation for each individual item. A detailed and meticulous calculation of depreciation for each item of fixed assets would, in many cases, be very laborious and time consuming and in some cases may not be possible at all. 2. In view of the above, the Committee s opinion on the queries is as under: -- (i) (ii) In order to report that a company has maintained proper records showing full particulars, it is not necessary to show on such records the amount of depreciation provided on each individual fixed asset where it is very laborious or time consuming to do so. However if such information is available, it would be desirable to do so. Even if the fixed assets register does not show depreciation on individual items, it could be stated that the company has maintained proper records showing full particulars including quantitative details and situation of its fixed assets provided information on depreciation is available for the various categories of fixed assets as a whole. (iii) In view of the (i) & (ii) above, the auditor should not, in the circumstances mentioned above, state in his report that the company has not maintained proper records. (2) 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

11 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 ignored 4. 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.

12 (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. (3) 1. The Committee notes that, as per the querist, the accounting treatment explained in para 2 of the query is in accordance with the Exposure Draft on the proposed Guidance Note on Accounting for Leases, issued by the Research Committee of the Institute of Chartered Accountants of India. The Committee, however, notes that the Exposure Draft was subsequently revised in the light of the comments received from the public and issued finally as the Guidance Note on Accounting for Leases, in December, Thus, a company which has started following the recommendations contained in the exposure draft is expected to change its treatment for accounting for leases in accordance with the recommendations contained in the Guidance Note. 2. The Committee presumes that the company is leasing out the assets under finance lease. 3. The Committee notes paragraphs 11 and 12 of the Guidance Note on Accounting for Leases, issued by the Research Committee of the Institute of Chartered Accountants of India, which are reproduced below: 11. It is appropriate that against the lease rental, a matching annual charge is made to the profit and loss account. This annual lease charge should represent recovery of the net

13 investment/ fair value of the leased asset over the lease term. The said charge should be calculated by deducting the finance income for the period (as per para 12 below) from the lease rental for that period. This annual lease charge would comprise (i) minimum statutory depreciation (e.g., as per the Companies Act, 1956) and (ii) lease equalisation charge, where the annual lease charge is more than the minimum statutory depreciation. However, where annual lease charge is less than minimum statutory depreciation, a lease equalisation credit would arise. In this regard, the following accounting entries/disclosures should be made: (a) A separate Lease Equalisation Account should be opened with a corresponding debit or credit to Lease Terminal Adjustment Account, as the case may be. (b) Lease Equalisation Account should be transferred every year to the Profit and Loss Account and disclosed separately as a deduction from/addition to gross value of lease rentals shown under the head Gross Income. (c) Statutory depreciation should be shown separately in the profit and loss account. (d) Credit balance standing in Lease Terminal Adjustment Account at the end of the year should be shown under the head Current Liabilities. Similarly, debit balance standing in Lease Terminal Adjustment Account at the end of the year, should be shown under the head Current Assets, since it is of the nature of an expenditure the value of which is to

14 be received in future. At the end of the lease term, the balance standing in Lease Terminal Adjustment Account should be transferred to leased asset account, and should be disclosed as recommended in (e) below. (e) Accumulated statutory depreciation should be deducted from the original cost of the leased asset in the balance sheet of the lessor. However, in the last year of the lease term, the balance in the lease Terminal Adjustment Account should be shown as a deduction from the book value of the asset arrived at as stated earlier. The method of income measurement suggested in this paragraph, is in consonance with the inherent nature of a finance lease. The above method is illustrated in the Appendix to this Guidance Note. 12. The finance income for the period should be calculated by applying the interest rate implicit in the lease to the net investment in the lease during the relevant period. This method would ensure recognition of net income in respect of a finance lease at a constant periodic rate of return on the lessor s net investment outstanding in the lease. However, some lessors use a simpler method for calculating the finance income for each of the periods comprising the lease term by apportioning the total finance income from the lease in the ratio of minimum lease payments outstanding during each of the respective periods comprising the lease term. (The total finance income from the lease is the difference between the aggregate minimum lease payments receivable over the lease term and the fair value of the leased asset at the inception of the lease.) This

15 method may be used where the finance income in respect of all individual periods as per this method approximates the finance income for the corresponding periods determined according to the former method. It is however clarified that where this method is used, overdue lease rentals, i.e., lease rentals fallen due but not collected should not be taken into account for determining the amount of minimum lease payments outstanding during each of the respective periods comprising the lease term. 4. The Committee, therefore, advises the company to adopt the accounting treatment as suggested in the Guidance Note on Accounting for Leases. (4) 1. The Committee notes that the querist has sought opinion only with regard to change from the existing practice of charging full year depreciation to the practice of charging pro-rata depreciation in respect of additions made during the year. The Committee also notes that the rates of depreciation adopted by the company are higher than the rates prescribed under Schedule XIV to the Companies Act, The Committee presumes that the higher rates of deprecation applied by the company are in accordance with the recommendations contained in the Guidance Note on Accounting for Depreciation in Companies, issued by the Research Committee of the Institute of Chartered Accountants of India. The opinion of the Committee given hereafter is, therefore, restricted to the question of charging pro-rata depreciation. 2. The Committee notes that para 24 of the said Guidance Note recommends as follows:

16 24. Note no. 4 in Schedule XIV to the Companies Act, 1956, prescribes that 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 the 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. The Committee is of the view that a company may group additions and disposals in appropriate time period(s), e.g., 15 days, a month, a quarter etc., for the purpose of charging pro rata depreciation in respect of additions and disposals of its assets keeping in view the materiality of the amounts involved. 3. The Committee presumes that pro-rata depreciation on full month basis has been charged in accordance with paragraph 24 of the said Guidance Note as reproduced above. The Committee, however, notes that the company has not charged pro-rata depreciation in respect of previous accounting periods to which Schedule XIV had become applicable. Since it was not done, the excess depreciation charged in the earlier years should be adjusted in the current accounting year as per paragraph 9 of Accounting Standard (AS) 5 on Prior Period and Extraordinary Items and Changes in Accounting Policies, which reads as follows: Prior period items should be separately disclosed in the current statement of profit and loss together with their nature and amount in a manner that their impact on the current profit or loss can be perceived.

17 4. On the basis of the above and subject to presumptions made in paras 1 and 3 above, the Committee is of the following opinion in respect of the issues raised by the querist in para 6 of the query: (i) No. The company should charge pro-rata depreciation with retrospective effect, i.e., from the date Schedule XIV came into force. (ii) Since the accounting treatment should be as suggested in (i) above, disclosure should be made as per para 9 of AS 5. (iii) The auditors of the company should not qualify their report with regard to change in accounting policy relating to pro-rata charge of depreciation, if the change is in accordance with (i) and (ii) above. 1. The Committee notes that Accounting Standard (AS) 6 on Depreciation Accounting, issued by the Institute of Chartered Accountants of India, defines useful life of a depreciable asset as follows: useful life is either (i) the period over which a depreciable asset is expected to be used by the enterprise; or (ii) the number of production or similar units expected to be obtained from the use of the asset by the enterprise.

18 2. The Committee also notes paras 9 and 10 of the Guidance Note on Accounting for Depreciation in Companies, issued by the Institute of Chartered Accountants of India, which recommend as below: 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 rate 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 believe that such decision results in a charge which does not represent true commercial depreciation. In case a company adopts the higher rates of depreciation as recommended above, the higher depreciation rates/lower lives of the assets must be disclosed as required in Note no. 5 of Schedule XIV to the Companies Act, The view is supported by the Department of Company Affairs and it has clarified that the rates as contained in Schedule XIV should be viewed as the minimum rates, and, therefore, a company will not be permitted to charge depreciation at rates lower than those specified in the Schedule in relation to assets purchased after the date of applicability of the Schedule. If, however, on the basis of bona fide technological evaluation, higher rates of depreciation are justified, they may be provided with proper disclosure by way of a note forming part of annual accounts.

19 3. On the basis of the above, the Committee is of the following opinion in respect of the issue raised in para 6 of the query: (i) Minimum depreciation for a year as worked out on the basis of Schedule XIV to the Companies Act, 1956, is required to be charged, even if the computation on the basis of number of hours is lower. (ii) Depreciation higher than that arrived as per (i) above, should be charged on the basis of actual hours flown by each helicopter every year, multiplied by the hourly rate (computed by dividing 95% of the original cost by the estimated number of total flying hours being the useful life of the asset, provided it is based on bona fide technological evaluation). (5) Opinion 13. On the basis of the above, the Committee is of the opinion that the accounting policy adopted by the company is not in accordance with the accepted accounting principles.