EAC opinion

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Facts:

A company is a joint venture company of three public sector enterprises and is engaged in transportation of petroleum through underground pipeline. The company is following depreciation policy of its fixed assets on Straight Line Method (SLM) at applicable rates as prescribed in Schedule XIV to the Companies Act, 1956. The company is charging average rate of depreciation on plant & machinery and main pipeline considering single shift @ 4.75% double shift @ 7.42% and triple shift @ 10.34% as per the rates specified in Schedule XIV to the Companies Act, 1956. Zero depreciation was considered for shutdown period as no rate has been specified for shutdown period in Schedule XIV to the Companies Act, 1956. The methodology has been followed consistently since commissioning from the financial year 2003-04 onwards.

During the supplementary audit conducted by the Comptroller and Audit General of India (C&AG) for the financial year 2009-10, it commented that extra shift depreciation was worked out on 365 days instead of actual number of 329 working days and applied the average rate of depreciation of 7.381% against required 8.547%. The above have resulted in understatement of depreciation for the year and overstatement of net block of fixed assets by Rs.6 crores.

Query:

The company has sought the opinion of the Expert Advisory Committee on the adoption of the method of depreciation on extra shift working to comply with the minimum depreciation as per Schedule XIV to the Companies Act, 1956.

Opinion:

The committee after considering definition of the term ‘Depreciation’ as provided in paragraph 3.1 of Accounting Standard (AS) 6, ‘Depreciation Accounting’ noted that depreciation arises due to several factors including efflux of time and wear and tear due to use. Accordingly, depreciation occurs with the passage of time, even if concerned assets is not in use. The Committee noted that Schedule XIV to the Companies Act specifies separate rates of depreciation in respect of single shift, double shift and triple shift.

As regards depreciation to be charged in respect of extra shift working, the Committee, after considering clauses 4 and 6 to Notes to Schedule XIV of the Companies Act, is of the view that physical wear and tear of a depreciable asset, which is operated for more than a shift, is generally higher than the one, which is used on a single-shift basis. Accordingly, Schedule XIV to the Companies Act prescribes higher rates of depreciation for the assets operating for extra shifts. Further, it prescribes methodology to compute ‘extra depreciation’ for the assets operating for extra shifts. The Committee is further of the view that the rates of depreciation specified in respect of single shift have been determined based on two factors — effluxion of time and wear and tear. However, in case of double shift and triple shift, the factor of effluxion of time remains constant. Therefore, rates for extra shifts include only the incremental/extra depreciation due to extra wear and tear. Thus, the Committee is of the view that single shift depreciation rate should be applied for the time period when the asset is held by the company irrespective of the fact whether such asset is in use or not. As regards ‘extra depreciation’ to be computed for items of plant and machinery operating for extra shifts, the incremental depreciation should be determined by applying the differential rate of depreciation, i.e., depreciation rate as specified for the relevant shift less the rate specified for the single shift in the proportion which the company worked for the double/triple shift bears to the number the number of days on which the factory or ‘concern’ actually worked during the year. The formula for arriving at the ‘depreciation’ shall be as under:

Depreciation for single shift working + (Depreciation for double/triple shift working — Depreciation for single shift working) x (Number of days worked double or triple shift/Normal working days during the year).

The Committee further noted that clause 6 of Schedule XIV to the Companies Act requires that for ‘extra depreciation’, normal number of working days would be the number of working days on which the factory or ‘concern’ actually worked during the year. Thus, it is not the working days of individual plant and machinery item, which should be considered for the purpose of computing extra shift depreciation rather it is the working days of the factory or ‘concern’. In this regard, it may be mentioned that various units/departments/mills/factories should be taken as separate concerns. Accordingly, the Committee is of the view that ‘normal number of working days’ should be calculated after deducting shut down period of the factory or ‘concern’.