CHANGING OF DEPRECIATION METHODS

Compliance with an accounting standard or if it is considered that the change

would result in a more appropriate preparation or presentation of the financial
statements of the enterprise. When such a change in the method of depreciation
is made, depreciation is recalculated in accordance with the new method from
the date of the asset coming into use. The deficiency or surplus arising from
retrospective recomputation of depreciation in accordance with the new method
is adjusted in the accounts in the year in which the method of depreciation is
changed. In case the change in the method results in deficiency in depreciation
in respect of past years, the deficiency is charged in the statement of profit and
loss. In case the change in the method results in surplus, the surplus is credited
to the statement of profit and loss. Such a change is treated as a change in
accounting policy and its effect is quantified and disclosed.

DEPRECAITION PROVIDED ON FIXED ASSETS ADDITION/

DELETION DURING THE YEAR

Schedule XIV to the Companies Act 1956, prescribed that “where during the
year, any addition has been made to any assets, or 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”.

Depreciation should be provided when the asset is installed even though not in
use (but ready to use) for the whole or part of any financial year, due to reasons
like strike, lock-out, shortage of raw materials etc. However, if the asset is not
installed and is thus not ready for being put to use, depreciation should not be
provided on them. If the company has purchased certain equipments which are

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in capital WIP, since civil work has been delayed for along period, the company
should not provide depreciation on the equipments.

PROVISIONS FOR THE DEPRECIATION ON FIXED ASSETS ITEMS

BELOW Rs. 5000

As per the Schedule XIV of the Companies Act, individual items below rupees
five thousands (Rs. 5000) should be depreciated 100 %. An item of furniture
such as chair or table is capable of being used independently, therefore each
chair or table will have to be provided 100 % depreciation if its individual value
does not exceed Rs. 5000. The 100 % depreciation provision cannot be avoided
by arguing that the furniture can be used only as a set, for example, asset of
chairs, which cost Rs. 5000 (unless they are attached and fixed to each other
and one chair cannot be moved without simultaneously moving the other).
When these items are purchased during the year, the 100 % depreciation should
be pro- rated based on date of addition. In the case of plant and machinery
where the aggregated actual cost of individual items of plant and machinery
costing Rs. 5000 constituents more than 10 % of the total actual cost of plant
and machinery, normal Schedule XIV rates should be used.

INCOME TAX BASIS OF DETERMINING DEPRECIATION

ACCEPTABLE IN THE FINANCIAL ACCOUNTS UNDER
COMPANIES ACT 1956

After Schedule XIV coming into the force, rates higher than those under that
schedule can also be adopted on the basis of bona fide determination of the
commercial life of an asset in accordance with AS-6, 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.

AS-6 and schedule XIV require pro-rata depreciation to be charged in respect of

addition/ deletion to fixed assets. Therefore for purposes of Companies Act
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financial accounts, it is not appropriate to determine depreciation, after crediting
profit on sale of assets against the concerned block of assets, like it is done for
income-tax purpose. Infact profit on sale of assets needs separate recognition
and disclosure in the Companies Act financial statements.

CONTINUOUS AND NON-CONTINUOUS PRCOCESS PLANT’s

DEPRCIATION DISTINGUISH

The distinction between a continuous process and non continuous process plant
is important because the continuous plant carries a depreciation rate of 5.28 %
SLM (15.33 % WDV) without any requirement to provide extra shift
depreciation as the plant has to be continuously in operation. Non continuous
process plant carries depreciation rate of 4.75 % SLM (13.91 % WDV), plus
extra-shift depreciation. Therefore treating the plant as non continuous would
result in high depreciation where a plant has worked extra-shift. Schedule XIV,
note 7 defines continuous process plant which is required and designed to
operate 24 hours a day. Guidance note on schedule XIV issued by ICAI further
clarifies that the technical design of a continuous process plant is such that there
is a requirement to run it continuously for 24 hours a day, if it is not so run,
there are significant energy loss. It is however possible that due to various
reasons, for example, lack of demand, maintenance; etc such a plant may be
shut down for some time. The shut down does not change the inherent technical
nature of the plant , for instance a blast furnace which is required and designed
to operate 24 hours a day may be shut down due to various reasons; it would
still be considered as a continuous process plant. In contrast a textile unit may
be operated for 24 hours a day, yet they are not continuous process plant
because their technical design is not such that they have to be operated for 24
hours.

In integrated steel plants, coke ovens, blast furnace, steel melting shops and
rolling mills are main plants of a steel mill. In coke ovens, blast furnaces, and
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steel melting shops there is a technological compulsion to operate 24 hours a
day, i.e., if such plants are shut down costs also. But there is no such
technological compulsion in case of rolling mills. When this matter was referred
to the EAC for opinion, it gave the following opinion: “the committee is of the
view that whether a particular rolling mill is a continuous prices plant should be
determined on the basis of the facts and technical evaluation that whether it is
both designed and required to operate 24 hours a day. The committee notes that
the argument advanced by the querist primarily emphasize the “technical
compulsion” to operate certain mills 24 hours a day. However apart from
fulfilling the aforesaid condition the plant should also be designed to operate 24
hours a day. Whether a plant is designed to operate 24 hours a day is also a
question of fact of a technical nature.

In case of a cement plant the process are lime stone mining, lime stone crusher,
raw mill/coal mill, klin and cement mill. The lime and stone are heated in the
klin, and the output generated is klinker (small particles). The klin is designed
to operate for 24 hours a day, as it operates under high temperature. Any closure
of the klin results in high power loss and thermal shock. The klinker is
processed in the cement mill too generate cement. The clinker and the cement
mill can be operated separately (non continuous) though since output of one is
input of the other, there capacities and operation have to be balanced. However,
such balancing can be done also by purchasing/selling clinker from/to third
parties the klin is designed to operate for 24 hours a day but not the other plants
in the cement factory, for example, the lime stone crusher, cement mill, coal
mill etc are not designed to operate 24 hours a day, though from capacity
balancing point of view it may be beneficial to operate them for 24 hours a day.

Therefore whereas the kiln plant may satisfy the definition of a continuous
process plant the other plants in the cement fulfill ICAI’s definition of a
continuous process plant.
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DISCLOSURE REQUIRED UNDER AS-6

The following information should be disclosed in the financial statements:

(i) The historical cost or other amount substituted for historical cost of each
class of depreciable assets;
(ii) Total depreciation for the period for each class of assets; and
(iii) The related accumulated depreciation.

The following information should also be disclosed in the financial statements

along with the disclosure of other accounting policies:

(i) depreciation methods used; and

(ii) depreciation rates or the useful lives of the assets, if they are different from
the principal rates specified in the statute governing the enterprise.

In case the depreciable assets are revalued, the provision for depreciation is
based on the revalued amount on the estimate of the remaining useful life of
such assets. In case the revaluation has a material effect on the amount of
depreciation, the same is disclosed separately in the year in which revaluation is
carried out.

A change in the method of depreciation is treated as a change in an accounting

policy and is disclosed accordingly.

Where depreciable assets are disposed of, discarded, demolished or destroyed,

the net surplus or deficiency, if material, is disclosed separately.

AS-10: ACCOUNTING FOR FIXED ASSETS

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OBJECTIVE AND SCOPE OF AS-10

Fixed Assets often comprise a significant portion of the total assets of an

enterprise, and therefore are important in the presentation of financial position.
Furthermore, the determination of whether expenditure represents an assets or
an expense can have a material effect on an enterprise’s reported results of
operations. This standard is mandatory in nature. The provisions relating to
borrowing costs, intangible assets and leases that were originally contained in
this standard were withdrawn once new accounting standards were developed in
these areas. This statement does not deal with accounting for the following
items to which special consideration apply;
 Forests, plantations and similar regenerative natural resources;
 Wasting assets including mineral rights, expenditure on exploration for
and extraction of minerals, oil, natural gas and similar non-regenerative
resources;
 Expenditure on real estate development; and
 Livestock

Expenditure on individual items of fixed assets used to develop or maintain the

activities covered in (i) to (iv) above, but separable from those activities, are to
be accounted for in accordance with this statement.

WHAT ARE FIXED ASSETS?

Fixed asset is an asset held with the intention of being used for the purpose of
producing or providing goods or services and is not held for sale in the normal
course of business. This statement deals with accounting for fixed assets such as
land, buildings, plant and machinery, vehicles, furniture and fittings, goodwill,
patens, trademarks and designs. This statement however does not deal with
specialised aspects of accounting for fixed assets that arise under a

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comprehensive system reflecting the effects of changing prices but applies to
financial statements prepared on historical cost bases. It may be appropriate to
aggregate individually insignificant items, such as moulds, tools and dies, and to
apply the criteria to the aggregate value.

ACCOUNTING FOR MACHINERY SPARES

The accounting of machinery spares is done in accordance with this statement

and not in accordance with AS-2 on ‘Inventories”. Stand-by equipment and
servicing equipment are normally capitalized. Machinery spares are usually
charged to the profit and loss statement as and when consumed. However, if
such spares can be used only in connection with an item of fixed asset and their
use is expected to be irregular, it may be appropriate to allocate the total cost on
a systematic basis over a period not exceeding the useful life of the principal
item.
In certain circumstances, the accounting for an item of fixed asset may be
improved if the total expenditure thereon is allocated to its component parts,
provided they are in practice separable, and estimates are made of the useful
lives of these components. For example, rather than treat an aircraft and its
engines as one unit, it may be better to treat the engines as a separate unit if it is
likely that their useful life is shorter than that of the aircraft as a whole

COMPONENTS OF COSTS OF FIXED ASSETS

The cost of an item of fixed asset comprise its purchase price, including import
duties and other non-refundable taxes or levies and any directly attributable cost
of bringing the asset to its working condition for its intended use; any trade
discounts and rebates are deducted in arriving at the purchase price. MODVAT
credit can be considered to be of the nature of a refundable tax. Therefore,
MODVAT credit should be reduced from the purchase cost of capital goods
concerned. Examples of directly attributable cost are

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  Sites preparation;
 Initial delivery and handling costs;
 Installation costs, such as special foundation for plant; and
 Professional fees, for example fees of architects and engineers.
 The cost of a fixed asset may undergo changes subsequent to its
acquisition or construction on account of exchange fluctuations, price
adjustments, change in duties of similar factors.

Administration and other general overhead expenses are usually excluded from
the cost of fixed assets because they do not relate to a specific fixed asset.
However, in some circumstances, such expenses as are specifically attributable
to construction of a project or to the acquisition of a fixed asset or bringing it to
its working condition, may be included as part of the cost of the construction
project or as a part of the cost of the fixed asset.
The expenditure incurred on start-up and commissioning of the project,
including the expenditure incurred on test runs and experimental production is
usually capitalized as an indirect element of the construction cost. However, the
expenditure incurred after the plant has begun commercial production, i.e.
production intended for sale or captive consumptions, is not capitalised and is
treated as revenue expenditure even though the contract may stipulate that the
plant will not be finally taken over until after the satisfactory completion of the
guarantee period.
Amount paid for know-how for the plans, layout and designs of buildings
and/or design of the machinery should be capitalised under the relevant asset
heads such as buildings, plants and machinery, etc. Depreciation should be
calculated on the total cost of those assets, including the cost of the know-how
capitalised. Know-how related to the manufacturing process is usually expensed
in the year in which it is incurred. Where the amount paid for know-how is a
composite sum in respect of both the manufacturing process as well as plans,

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drawings and designs for buildings, plant and machinery, etc., the management
should apportion such consideration into two parts on a reasonable bases. If the
said costs are not directly attributable to bringing the assets concerned to their
working condition for their intended use, it should not be capitalised as part of
the cost the asset.

SELF-CONSTRUCTED FIXED ASSETS

In arriving at the gross book value of self-constructed fixed assets, the above
principles apply. Included in the gross book value are costs of construction that
relate directly to the specific asset and costs that are attributable to the
construction activity in general and can be allocated to the specific asset. Any
internal profits are eliminated in arriving at such costs.

ACCOUNTING OF COST INCURRED DURING PROJECT DELAYS

AND WASTAGES

If the interval between the date a project is ready to commence commercial

production and the date at which commercial production actually begins is
prolonged, all expenses (other than borrowing costs) incurred during this period
are charged to the profit and loss statement. However, the expenditure incurred
during this period is also sometimes treated as deferred revenue expenditure to
be amortised over a period not exceeding to 3 to 5 years after the
commencement of commercial production.
Normal wastages are capitalised. Abnormal wastages are not capitalised but
charged to the profit and loss account.

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NON MONETARY CONSIDERATION FOR FIXED ASSETS:

When a fixed asset is acquired in exchange for another asset, its cost is usually
determined by reference to the fair market value of the consideration given. Fair
market value is the price that would be agreed to in an open and unrestricted
market between knowledgeable and willing parties dealing at arm’s length who
are fully informed and are not under any compulsion to transact. It may be
appropriate to consider also the fair market value of the asset acquired if this is
more clearly evident. An alternative accounting treatment that is sometimes
used for an exchange of assets, particularly when the assets exchanges are
similar, is to record the asset acquired at eh net book value of the asset given up
in each case; an adjustment is made for any balancing receipt or payment of
cash or other consideration. When a fixed asset is acquired in exchange for
share or other securities in the enterprise, it is usually recorded at its fair market
value, or the fair market value of the securities issued, whichever is more
clearly evident.

SUBSEQUENT EXPENDITURE INCURRED ON FIXED ASSETS

AFTER INITIAL CAPITALISATION ACCOUNTED

Frequently, it is difficult to determine whether subsequent expenditure related to

fixed asset represents improvements that ought to be added to the gross book
value or repair that ought to be charged to the profit and loss statement. Only
expenditure that increases the future benefits from the existing asset beyond its
previously assessed standard of performance is included in the gross book
value, e.g., an increase in capacity or structural alteration to a building that
increases the strength of the building beyond its original strength. Examples of
improvements which result in increased future economic benefits include:
 Modification of an item of plant to extend its useful life, including an
increase in its capacity;

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  Upgrading machine parts to achieve a substantial improvement in the
quality of output; and
 Adoption of new production processes enabling a substantial
reduction in previously assessed operating costs

While deciding whether subsequent expenditure resulted in an increase in the

future benefits from the asset or not, recognition should be given both to the
increase in the benefits ‘per annum’ as well as increase in benefits through
extension of the life of the asset. Thus, even if there was no increase in the
annual capacity, but the life of the asset was substantially increased, it would be
taken as an increase in the future benefits from the concerned asset beyond its
previously assessed standard of performance. The expenditure on regular
overhauling only results in maintaining the previously estimated standard of
performance and it does not have the effect of improving the previously
assessed of performance. Lets consider an example, where a land right is in
dispute when it was acquired by an enterprise. The enterprise subsequently
incurred legal expenses and got all the land rights transferred in its favour. This
expenditure should be capitalised because it increases the value of the land
beyond its original assessed standard of performance. Lets consider another
example. An enterprise purchases a land on which there is not dispute.
Subsequent to the acquisition there is encroachment of land. The enterprise
incurs legal expenses to vacate the encroachers. This expenditure cannot be
capitalised because it does not increase the value of the land beyond its original
assessed standard of performance.
The cost of an addition or extension to an existing asset which is of a capital
nature and which becomes an integral part of the existing asset is usually added
to its gross books value.
Expenditure on repairs or maintenance of property, plant and equipment is made
to restore or maintain the future economic benefits that an enterprise can expect

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from the originally assessed standard of performance of the asset. As such, it is
usually recognised as an expense when incurred. For example, the cost of
servicing or overhauling plant and equipment is usually an expense since it
restores, rather than increase, the originally assessed standard performance.

BASIS FOR REVALUATION OF FIXED ASSETS AND USE OF

REVALUATION RESERVE FOR DECLARING DIVIDENDS OR
ISSUING BONUS SHARES

Sometimes financial statements that are otherwise prepared on a historical cost

basis include part or all of the fixed assets at a valuation in substitution for
historical costs and depreciation is calculated accordingly. A commonly
accepted and preferred method of restating assets is by appraisal, normally
undertaken by competent valuer’s. Other methods are used are indexation and
reference o the current prices which when applied across checked periodically
by appraisal method. According to Schedule VI of Companies Act, every
balance sheet susbsequent to revaluation shall disclose the increased figure with
the date of increase in place of original cost for all the first 5 years. The fact of
revaluation will be disclosed in all the future balance sheets till such time the
revalued assets appear in the company’s balance sheet.
Revaluation reserve is a reserve that represents the excess of the estimated
replacement cost or estimated market values over the book values thereof. As
the revaluation reserve is a not a realized gain, it is not available for distribution
of dividends or issue of bonus shares , or writing off accumulated losses or
profit and loss debit balance or clearing backlog of depreciation of arrears etc.
SEBI also prohibits use of revaluation reserve for purpose of declaring bonus
shares.

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