1.13 - Query

Issues Related to Provision for Depreciation.

A Public Limited Company incorporated in the year 1960 opted for providing depreciation under Section 205 (2) (b) of the Companies Act till the accounting year ended 30th September, 1965. In the year ended 1964, the Company has also paid dividends and created General Reserve out of the Profits.

From the succeeding year, the management desires to change the method of Depreciation to WRITTENDOWN VALUE from the very start of the business. If this method is adopted it results into huge losses every year from the beginning.

Following points are referred for opinion: -

(a) Whether there is any legal bar in changing the method of depreciation from Straight-Line method to Written-Down Value method.
(b) Under the facts and circumstances whether the distribution of dividends in past year (i.e., for the accounting year ended 30th September, 1964) will be treated as dividends out of profit as provided under Section 205 of the Companies Act, 1956.


April 17, 1967

The Company may change over to the method of providing depreciation under the Written-Down value system, from the Straight-Line system of providing depreciation hitherto followed. The change must however be bona fide : the fact of change and its effect on the results in the year of change must be disclosed in the accounts ; and the changed method must be consistently followed in subsequent years. There appears to be no legal bar to such change-over. This is however subject to the remarks in the following paragraphs.

The distribution of dividends for the year ended 30th September, 1964, will not be treated as distribution out of capital merely because there would not have been a distributable profit under Section 205 if the Written-Down value system had been followed from the incorporation of the Company, instead of the Straight-Line system actually followed. For the purposes of distribution of dividends in respect of the financial year for which the method of providing for depreciation is to be altered, (and for subsequent years), however, the following procedure shall have to be adopted.

The difference between the total depreciation that would have been provided for, had the Written-Down value method been adopted since the incorporation of the Company, for all years up to and including the previous financial year, and the depreciation actually provided for under the Straight-Line method up to and including the previous financial year shall have to be ascertained, and this difference shall have to be provided for in the financial year for which the method of providing for depreciation is proposed to be changed. Also, the depreciation for the present financial year on the Written-Down value as at the end of previous financial year, and on additions, if any, shall have to be provided for. After making all these provisions if there is any profit, it may be distributed. If the full depreciation, inclusive of arrears as explained above, cannot be provided for a dividend must not be declared, and the balance of arrears shall have to be provided for in the next financial year and so on before any distribution of dividend is made. It would be contrary to the scheme of the relevant Section of the Act to provide for depreciation only on the difference between the original cost and the depreciation so for provided under the Straight-Line method, without providing for the arrears of depreciation arising out of the change in the method of depreciation provision.

This matter is already dealt with in the publication of the Institute, “Opinion regarding certain provisions of the Companies Act, 1956” (Publication No. 203 (Revised No. H. 7 501 7), issued in 1964). Reader’s attention is drawn to pages 11 to 15 of this Publication.