02 October 2010

IndianCAs: exposure draft of Revised Schedule XIV -VINOD KOTHARI

Friday, October 1, 2010

ICAI issues exposure draft of Revised Schedule XIV

ICAI issues exposure draft of Revised Schedule XIV

From depreciation rates to depreciable lives,
from statutory rates to indicative rates

Vinod Kothari

The Accounting Standards Board of the Institute of Chartered Accountants of India issued an exposure draft of the proposed replacement of Schedule XIV. When replaced, this revised Schedule XIV will be applicable to such companies as have moved to accounting standards converged with IFRS. That is to say, to such companies as have converged to IFRS, the revised Schedule XIV will apply, and to others, the existing Schedule XIV will continue to apply.

Why is the new schedule needed:

In India, depreciation is governed by the statute, and hence, we commonly use the term "statutory" depreciation. Apparently, sections 205 and 350 of the Act deal with debiting of depreciation for specific purposes – declaration of dividends as for sec 205, and computation of profits for managerial remuneration in case of sec. 350. Hence, at a first glance, one may take the view that these two sections do not pertain to computation of profits for financial reporting, and that it is quite possible for a company to write-off depreciation as per accounting standards for financial reporting, and simply re-compute the same for managerial remuneration or for declaration of dividends. Such an interpretation is also supported by the section heading preceding sections 348 (now redundant), 349 and 350, which do not pertain to financial reporting, but computation of remuneration of managerial personnel.

However, while delinking depreciation as per books of account from those as per tax laws, a historical mistake was made in 1988 – the depreciation debited in the books of account of the company was linked with Schedule XIV. There was no need to do so – that is, Schedule XIV could have anyway been kept of limited relevance to sections 349 and 350 for computation of profits for managerial remuneration.

The situation that arises from a combined reading of sections 205 and 350 is that the Companies Act does lay down "specified rates" at which depreciation has to be provided, as pre Schedule XIV.

Statutory depreciation is surely not IFRS-compliant. Depreciation as per IFRSs is based on the nature of the asset – separate depreciation provisions exist:

  • in case of property plant and equipment, as per IAS 16
  • in case of intangible property, as per IAS 38
  • in case of investment property, as per IAS 40, etc.

In case of these, depreciation is based on depreciable value, that is, the difference between the initially recognized value and the residual value of the asset, and the depreciable value in turn is spread systematically over the useful life of the asset. "Useful life" is the estimated period over which the asset is expected to be available for use. In other words, there is no statutory prescription of the useful life: entities have to estimate the useful life.

Clearly, there are at least 3 points of conflict:

· While Schedule XIV refers to depreciation rates, IAS 16 and other accounting standards relate to useful lives, without laying down either any statutory rate or life;

· Sec 205/350 permit straight-line and WDV systems for depreciation, whereas IAS 16 is flexible and permits any other systematic basis too;

· The write-off required under sec 205/350 is to write off 95% of the asset, if using straight line method, whereas in IAS 16, the require write-off is the cost of the asset, minus residual value.

In order to permit companies converging with IFRS to adopt IAS 16, the amended Schedule XIV is required.

What is being amended?

The proposed replacement of Schedule XIV moves from prescribed rates of depreciation to indicative useful lives of assets. It makes a significant change from the existing scenario:

  • First of all, the revised Schedule XIV prescribes indicative lives only – that is to say, the useful lives of assets as laid down are only indicative and the managements are free to deviate from the same. For sure, there should be no difficulty in choosing a useful life shorter than that laid down (for example, in case of computers, the draft Schedule lays down 6 years – whereas most companies change computers every 3 years). If sufficient justification is available, there should be no difficulty even estimating a period longer than that specified in the draft Schedule;
  • Second, the move from rates to specified lives allows companies the freedom to select methods of spreading depreciation, in addition to commonly used straight-line and WDV options.

Does this resolve conflict between accounting standards and sec 350?

While the intent of the proposed revision of Schedule XIV is evident, the question is, does it at all resolve the conflict between accounting standards and sec 350?

  • First of all, sec 350 empowers the government to prescribe a rate, and not a life. Hence, the revised Schedule is strictly not in accordance with the law.
  • Second, if the law were to lay down an "indicative" schedule, is that the prescriptive schedule that sec 350 envisages?
  • If the schedule was only indicative, and did not require companies to adhere to any prescribed rates or lives, then, does it not make the prescription under sec 350 and 205 purely perfunctory? So, if the idea is to render the prescribed rates under sec 350 purely nugatory, would such idea not be better served by a clarification that sec. 350 of the Act is to be enforced only for the purpose of computation of managerial remuneration, and sec 211 (3A) read with the accounting standards will override sec 350 as far as financial reporting is concerned?

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