HOW TO  CALCULATE DEPRECIATION FOR ARRIVING AT NET PROFITS FOR PURPOSES OF MANAGERIAL REMUNERATION

1.                 Not that depreciation has to be calculated strictly in accordance with the provisions of section 350 of the Act of arriving at net profits for purposes of managerial remuneration.

2.                 Note that the requirement of section 350 is to calculate depreciation “with reference to the written down value of the assets”  at the end of each financial year at the rates specified in Schedule XIV.  Depreciation cannot be calculated with reference to the original cost of the asset which is relevant for purpose of deriving the straight line method rate of depreciation.  Therefore, you have to calculate depreciation at the WDV rate laid down in Schedule XIV.

3.                 Note that you can recalculate depreciation at the WDV rate laid down in Schedule XIV even in respect of a financial year closing before 15^th June, 1988, provided at least the financial year had endked on a date subsequent to 2^nd April, 1987.  So long as the actual recalculation is done after 15^th June, 1988, the mere fact that the WDV rate laid down in Schedule XIV if adopted for such previous financial year will not make section 350 retrospective, Schedule XIV having already come into existence on 2^nd April, 1987.

4.                 See also topic VIIIC1 for calculation of depreciation.

    ANNEXURE:

    Sections 205, 350 and Schedule XVI : Departmental Circular: The following Departmental Circular in regard to the amendment made by the Companies (Amendment) Act, 1988 may be notjed:--

Clarifications on the provisions relating to depreciation under the Companies Act, 1956, as amended by the Companies (Amendment) Act, 1988.

This Department has been receiving queries from different quarters on the subject mentioned above, from time to time, and, accordingly the following clarifications are issued:--

(1)   Date on which the new provisions relating to depreciation become effective:

The Companies (Amendment) Act, 1988, specifically provides that Schedule XIV shall be deemed to have come into force on 2^nd April, 1987.  The amended provisions of sections 205 and 350 of the Act have come into force on 15^th June, 1988, by virtue of the notification issued by this Department.  A question arises, therefore, whether depreciation can be charged on assets on the basis of the rates provided in Schedule XIV for accounting years ending between 2^nd April, 1987 and 14^th June, 1988.

In view of the intention of the Legislature behind the amendments in sections 205 and 350 of the Act, the amended provisions have come into force with effect from 2^nd April, 1987.

(2)   Recomputation of specified period:

It is stated that in 1986, the Department had issued a circular stating that specified period once determined may not be recomputed.  Accordingly, the Department had advised the companies that it was open to them not to recomputed 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-CLV), dated 21^st 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 higher rates of depreciation be charged?

It is stated that Schedule XIV clearly states that a company should disclose depreciation rates if they are different from the principal rates specified in the Schedule.  On this basis, it is suggested that a company can charge depreciation at rates which are lower or higher than those specified in Schedule XIV.

It may be clarified that the rates as contained in Schedule XIV should be viewed as the minimum rates, and, therefore, a company shall 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.  However, if on the basis of a 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 account.

(4)   Can SLM rates be different than those specified under Schedule XIV?

It is stated that SLM rates (corresponding to the Written Down Value (WDV) rates, as per Schedule XIV)  can be different than those prescribed under Schedule XIV provided a company continues to determine the rates as provided under section 205.  thus, against SLM rates prescribed under Schedule XIV of 11.31 per cent (triple shift rate for general plant and machinery), 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 eight years and six months or so of specified period whereas if 95 per cent is divided by nine years, the corresponding SLM rate comes to 10.56 per cent.  The argument is 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.

It is clarified that a company must necessarily provide SLM depreciation at the rates prescribed under Schedule XIV and the interpretation that fractions of years cannot be taken into account is not correct. [Circular No.2 of 1989 dated 7^th March, 1989 issued by the Company Law Board (1989) 65 Comp Cas 628 (St.)]