Case: Bengal Aluminum

Reporting of Fixed Assets & Depreciation Policy& Impact

Mohini Sharma is an investment analyst in Esbeeye Securities, a medium-

sized stock brokers firm. She specializes in the stocks of non-ferrous metal
companies. As a part of her job, she provides reviews on theses stocks in
the firm’s newsletter. The newsletter is a monthly publication and is sent to
Esheeye’s clients who are mostly private, non-institutional shareholders.

In early July 2009, Sharma is preparing an analysis of aluminum companies

based on their annual reports for the year ended March 31, 2009. She has
come across the following footnote appearing in the financial statements of
Bengal Aluminum Company:

“During the year, the company has changed the method of

depreciation for the smelter from the written-down-value method
to the straight-line-method. If the company had not made this
change, the depreciation expense for the current year would have
been higher by Rs. 14,15,86,327.”

No other reference to the deprecation method change was available in the

company’s report, except an item in the profit and loss account, “Excess
provision for depreciation written back, Rs. 78,23,12,370”, shown ‘above
the line.’ Until last year, aluminum companies have followed similar
accounting policies. The main smelter of Bengal Aluminum was purchased
on April 1, 2006, for Rs. 300 crore with an estimated useful life of ten years
and was expected to fetch Rs. 15 crore at the end of that time. Sales and
profits after tax, in crores, in recent years are as follows:

Year ended Bengal Aluminum

March 31 Sales Profit after
Tax
2006 1215 129
2007 1324 138
2008 1589 163
2009 2066 257

Sharma’s immediately problem is how to evaluate Bengal Aluminum’s 2009

results in the light of the company’s past performance. Her other concern is
to find out the management’s motives for the depreciation policy switch.
Required:
1. What would have been Bengal Aluminum’s profit after tax for the
year ended March 31, 2009, but for the change in depreciation
method?
2. What could have been the motives for Bengal Aluminum’s
depreciation policy switch?
3. Do you consider the company’s disclosure of the accounting change
adequate?
4. Draft a short paragraph on the accounting change which Sharma
should consider including in her report on aluminum stocks.

Problems
1. Z Company bought the following assets:
Asset Cost (Rs.) Residual Value Useful Life Depreciation Method
Machinery 500,000 25,000 5 years Written-Down-Value
Building 700,000 100,000 25 years Straight-Line

After using these assets for three years, the company decided to change its
depreciation policy as follows:
a) Change the method of depreciation for machinery to the straight-line
method;
b) Revise the remaining useful life of building to 30 years, keeping its
residual value at Rs. 100,000
These changes are to be implemented in the financial statements for Year 4.

Required:
1. Compute the depreciation expense for Year 4 without giving effect
to the change in depreciation policy. What is the effect of the
change on the profit before tax for Year 4?
2. What disclosures concerning the change should the company
make in its financial statements for Year 4?

2. HU Company bought machinery on April 1, 20X1 for 600,000. The

machinery a method. In 20X6, the company engaged a firm of
professional valuers to determine the current expected to have a useful
life of ten years. The company followed the straight-line depreciation
value of the machinery. The valuers reported that on April 1, 20X6
similar machinery with an estimated useful life of 10 years would cost
1,000,000. The company's year-end is March 31. How will the asset
appear in the financial statements for the year ending on March 20X7 on
the basis of IFRS?
3. BU Corporation provides air transport services for short distances. It
acquired an aircraft costing Rs. 1000 lakhs. The aircraft was expected to
last 50,000 flying-hours with an estimated residual value of Rs.
40,00,000. At the beginning of Year 4, the company carried out a
modification to the aircraft engine at a cost of Rs. 8,00,000. At the time,
the aircraft had completed 30,000 flying-hour. After the modification,
the aircraft will have a remaining estimated useful life of 30,000 flying-
hours and an estimated residual value of Rs.75,00,000. In Year 4, the
aircraft flew 8,000 hours. How will the firm record the modification in
financial statements?

4. MY Industries started business with equity capital of Rs. 2,500,000 in

cash. Soon after, it bought machinery costing Rs. 20,00,000 for cash. The
machinery had an estimated useful life of 10 years and an estimated
residual value of Rs. 1,00,000. In the first year, the company’s revenues
(in cash) were Rs. 70,00,000 and cash operating expenses were Rs.
45,00,000. The machinery was depreciated on the straight-line basis.
For tax purposes, the machinery was eligible for depreciation at the rate
of 25 per cent. Income tax rate is 35 per cent.

Required
1. Prepare the statement of profit and loss and the cash flow statement
for Year 1. Using a reconciliation statement, explain the difference
between the profit after tax and the cash flow from operations.
2. Repeat Requirement 1, assuming that the machinery has an
estimated useful life of eight years and an estimated residual value of
100,000. Does the cash flow from operations differ from that in
Requirement 1? Explain.
3. Repeat Requirement 1, assuming that the company uses the income
tax depreciation for accounting purposes as well. How do the results
differ from your answer to Requirement 1?