Depreciation, as an allocation of cost of depreciable assets over their useful life and hence a Charge to the Profit and Loss Account has, for a long time now been, an issue engaging the attention of Corporate world and all the Professionals connected with it, as it forms a very significant element of cost in arriving at the Profit/Loss of an enterprise which is computed for the purpose of Dividend to Shareholders, Remuneration to Managerial Personnel, Bonus to Employees, Tax to Government, etc.
Earlier, the Companies Act, 1956 in Sections 205, 349, 350 and Schedule XIV had dealt with this Issue elaborately. Besides these, various clarifications issued by the Government of India, supplemented/ complimented/elaborated more by the Guidance Notes and Accounting Standards, Expert Committee Advisory Opinions of the Institute of Chartered Accountants of India have also added to the plethora of literature available on this Issue.
Though the Companies Act, 2013 has not yet become fully operational in respect of all 470 Sections and 7 Schedules contained in it, majority of the sections are effective from 01‐04‐2014 and the Section 123 dealing
with Depreciation figures in this. That means the new Companies Act, 2013 will become operational on a piecemeal basis. Notwithstanding, having gone through the Schedule‐II (presumably drafted in consultation with Institute of Chartered Accountants of India, because it is more accounting oriented and not Company law oriented), read with Sec. 123 of the Companies Act, 2013
I have tried to comprehend them for a few significant contents/changes and put forth my reflections in this small write‐up.
Significant contents or changes in Schedule II:
1) The Companies Act, 1956 had dealt with only depreciation of tangible assets. Now, the new Act provides specifically for depreciation of intangible assets which are to be governed as per Accounting Standards. In fact, intangible assets are amortised and not depreciated, though these words and their actions have same effect on the P & L Account.
2) Instead of method and rates of Depreciation (whether WDV method or Straight line Method and Single shift or double shift or triple shift) useful Lives of Assets have been prescribed. These Useful Lives based on single shift working appear minimum, but, they can, in practice, be different from what is given in the Schedule.
3) If a Company, being a class of company specifically prescribed by MCA, can adopt a different useful life
longer than what is prescribed in Schedule II, however the same shall be disclosed, (I suppose, probably, by way of a Note on Accounts) together with justification. For other companies, useful life cannot be longer than what is prescribed in Schedule II.
4) Residual value is prescribed at 5% of the original cost as the maximum quantum. Earlier, there was no fixed Residual Value, but, while prescribing the rates, it had factored‐in only 95% of the cost of the assets, thereby leaving only 5% as Residual Value.
5) List of Assets has become more exhaustive and specific.
6) The concept of actual number of days working as a percentage to prescribed number of days of working
(seasonal/non‐seasonal factory) for double shift or triple shift has been deleted and if the asset is used FOR ANY TIME during the year in double shift or triple shift, the quantum of depreciation would go up by 50% or 100% more than the single shift working respectively.
7) There is no specific mention about useful life of assets whose cost does not exceed Rs. 5000/‐ as it provided earlier for depreciation at 100% for such assets.
8) New words like Residual Value, Retained Earnings etc., find place in the Schedule‐II remaining undefined which were not in earlier Schedule – XIV or Sections 205, 349 or 350 and have to be understood and interpreted based on literature available on Accounting .
9) Issues relating to computation of depreciation prorata are more Accounting oriented as contained in Accounting Standards AS‐6 and AS‐10 and not company‐law oriented.
10) The new Act provides for the concept of componentisation of assets. Where cost of a part of the asset is significant to total cost of the asset and useful life of that part is different from the useful life of the remaining asset, useful life of that significant part shall be determined separately.
PRACTICAL IMPLEMENTATION ISSUES:
The heart and soul of the Schedule–II lies in Notes No. 5, 6 and 7. Now that the Schedule II and Sec. 123 have become operational from 01‐ 04‐2014, actions on how to implement them effectively for Notes No. 7(a) and 7(b) specifically should engage the attention of all the concerned. I have made a humble attempt towards this in the following paragraphs:
Note No. 7 (a) : From 01‐04‐2014, the carrying amount of the Asset on that date shall be depreciated over the remaining useful Life of the Asset as per this Schedule:
Example: General purpose Plant & Machinery under earlier Straight Line Method was @ depreciation of 4.75% per annum.
What is the Issue here?
Since the words “Carrying amount” have not been defined in the Schedule, the question is whether Sl No. 8 is correct or Sl No. 9 is correct? I personally feel that Sl. No. 8 should be correct, because of the definition for the words “Carrying amount” contained in AS‐28 which says that Carrying amount means the amount at which an asset is recognised in the Balance Sheet after deducting any accumulated Depreciation (amortization) and accumulated impairment losses thereon”. There is no mention about Residual Value there.
On the other hand, in case of Sl No. 9, since the rate of 4.75% and Rs. 47.50 have already been factored‐ in for the residual value of 5% and only the 95% value of the asset is divided by its useful life. As such, Sl No. 9 does not appear correct. My this view is supported by:
a) the views of a luminary in the field of Accounting‐ Sri. Kamal Gupta in his celebrated Book “Kamal Gupta on Depreciation”‐ 1993 Edn, P.36 and
b) Circular No. 1/85 dated 10‐1‐1985 issued by the Government of India in the Ministry of Industry & Corporate Affairs,, Department of Company Affairs.
c) As such, if we take Sl No.9, it may tantamount to considering the Residual Value twice, once in arriving at the rate of 4.75% and again by deducting the Residual Value for computing Depreciation for the unexpired period.
Note No. 7(b): From 01‐04‐2014, the carrying amount of the Asset on that date, after retaining the Residual value, shall be recognized in the Opening balance of Retaining Earnings, where the remaining useful life of the Asset is NIL as per this Schedule :
Example: General purpose Plant & Machinery under Straight Line Method was depreciated @ 4.75% per annum.
What is the Issue here?
Now that the Schedule‐ II‐ 7(b) is made effective for Financial Years commencing on or after 01‐04‐2014, the Journal Entry on 01‐04‐2014 should be as below:
- Retained Earnings Account Dr 23.75
- To Provision for Depreciation/Accumulated Depreciation 23.75
(Being the short‐fall of Depreciation consequent upon change in the useful Life of Asset provided for after retaining Residual of 5%Value and charged against the Opening balance Retained Earnings)
It is the carrying amount at Sl. No. 8 and not 7 that should be considered, because of the following reasons:
1. though the definition contained in AS‐28 states that ‐ “Carrying amount is the amount at which an asset is
recognised in the Balance Sheet after deducting any accumulated Depreciation (amortization) and accumulated impairment losses thereon, it does retain the Residual Value as required by Note No. 7(b) and
2. on a strict interpretation, the amount in Sl No.7 does not consider the Residual value, notwithstanding the fact that it has already factored‐in 5%. Retained Earnings: Since “Retained Earnings” is not a single ledger Account finding place as such in the Balance Sheets of Indian Corporates, it becomes necessary to know what exactly this means. Similarly, the ‘Accumulated Depreciation’. Accumulated Depreciation is the amount
shown in the “Depreciation Block” of Schedule of Fixed Assets as Total Depreciation. Here also there is no single ledger Account called Accumulated Depreciation. As such, “Accumulated Depreciation” means the total of Provisions for Depreciation.
“Retained Earnings” have neither been defined in the Schedule‐II nor in the Guidance Note on Terms used in Financial Statements issued by the Institute of Chartered Accountants of India. I may say that Retained Earnings connote “Surplus” grouped under “Reserves & Surplus” in the Balance Sheet.
Looking into other reliable sources becoming necessary to understand the exact meaning of the words” Retained Earnings”, reliance is placed, inter‐alia numerous literature, on the following to ascertain the exact meaning of the word “ Surplus”:
a) “Accumulated Net Income less distributions to stockholders and transfer to paid in capital Accounts; also known by older title Earned surplus” (Eric L Kohler‐ A Dictionary for Accountants, ‐ 5th Edn ‐P. 409)
b) “Accumulated amount of Profits and earnings of the business which has not been capitalised, offset by losses or given out to stockholders as property dividends. (D.S.Pasion‐ Introductory Accounting, P. 195)
c) “After all dividends are paid to investors, the earned surplus/undistributed earnings comprise the net earnings that will become the companies’ equity. AKA earned surplus and undistributed earnings “ (Black’s law Dictionary)
d) “It is a credit balance or series of credit balances denoting the existence with the Undertaking of profits which have not been distributed to its proprietors”‐ (Principles of Accounting” ‐Stanley W Rowland‐ 3rd Edn, P. 272.)
I may add that the amounts transferred to “Reserves” though appear to be the cumulative sum of unappropriated surpluses of the past years, its utilisation is governed by a different provisions of Company Law whether for issue of Bonus Shares or payment Dividends, etc. As such, I feel it cannot fall within the meaning of the word “Retained Earnings” used in the Schedule‐II.
Inviting scintillating reactions from my coprofessionals, I wish to be enlightened and corrected for any errors that may have crept in unwittingly.
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