TECHNICAL SESSION 3 DEPRECIATION, INTERNAL AUDIT, VOLUNTARY REVISION OF FINANCIAL STATEMENTS ,ICFR & CONSOLIDAT

1. TECHNICAL SESSION 3DEPRECIATION, INTERNAL AUDIT, VOLUNTARY REVISION OF FINANCIAL STATEMENTS ,ICFR & CONSOLIDATION UNDER THE COMPANIES ACT, 2013 CA (DR.) SANJEEV SINGHAL HEAD: CENTRE OF EXCELLENCE FOR ACCOUNTING AND MANAGEMENT ASSURANCE JUBILANT LIFE SCIENCES LTD.

2. DEPRECIATION APPLICABLE PROVISIONS • Section 123 of the Companies Act, 2013 • Schedule II of the Companies Act, 2013 • (Note: Above provisions are effective from 1st April, 2014 as per notification by MCA dated 26th March, 2014) • Amendment to Schedule II of the Companies Act, 2013

3. DEPRECIATION RELATED PROVISIONS-KEY HIGHLIGHTS(Useful Life vis-a-vis rates of depreciation) • Schedule II of the Companies Act, 2013 provides the useful life as against the minimum rates of depreciation which were there in the Schedule XIV of the Companies Act, 1956. • In case of Plant and Machinery, Schedule II of the Companies Act, 2013 gives the industry specific useful life. • Schedule XIV of the Companies Act, 1956 contained the minimum rates of depreciation. No Company was allowed to charge depreciation at the rates lower than the rates prescribed in Schedule XIV. • However, the Companies Act, 2013 does not have any such restriction. This is a significant change in the approach of the regulator and will bring the Indian companies at par with international practice.

4. Classification of companies as per the Companies Act, 2013 to decide the application of depreciation rates • All Companies: • Useful life should not generally be longer than the useful life specified in Part ‘C’ and the residual value shouldnot be more than 5% of the original cost of the asset. • However, where a company uses a useful life or residual value of the asset which is different from the above limits, justification for the difference shouldbe disclosed in its financial statement. • (Replaced by amendment to Schedule II) • IMPACT: Now, instead of only prescribed companies, all the companies are required to comply with the above provision.

5. II. Class of companies or class of assets where useful lives or residual value are prescribed by a regulatory authority constituted under an act of the Parliament or by the Central Government: • The useful life or residual value of any specific asset, as notified for accounting purposes by a Regulatory Authority constituted under an Act of Parliament or by the Central Government should be applied in calculating the depreciation to be provided for such asset irrespective of the requirements of Schedule II.

6. Useful Life & Residual Value: *Residual value was inbuilt in depreciation rates prescribed under Schedule XIV

7. Rates applicable to Intangible Assets • For Intangible assets, there is no specific provision in the Schedule XIV of the Companies Act, 1956 except that in the case of toll road, amortization was done using the amortization rate arrived at by dividing actual revenue for the year with total estimated revenue. • Now, no separate depreciation rate is prescribed for intangible assets in the Schedule II of the Companies Act, 2013. Rather, the same will be governed by the notified AS (i.e., AS 26). • In practice, we do not expect a change for Intangible assets.

8. Change brought in by the amendment • For intangible assets, the provisions of the accounting standards applicable for the time being in force will apply, except in case of intangible assets (Toll Roads) created under ‘Build, Operate and Transfer’, ‘Build, Own, Operate and Transfer’ or any other form of public private partnership route in case of road projects. • Where a company arrives at the amortisation amount in respect of the Intangible Assets in accordance with any method as per the applicable Accounting Standards, the same should be disclosed. • Where a company arrives at the amortisation amount in respect of the said Intangible Assets in accordance with any method as per the applicable Accounting Standards, it shall disclose the same. • IMPACT: Revenue based amortization permitted for intangible assets (toll roads) under service concession

9. Example: • Cost of creation of Intangible Assets Rs. 500 crores • Total period of Agreement 20 Years • Time use for creation of Intangible Assets 2 Years • Intangible Assets to be amortized in 18 Years • Assuming that the Total revenue to be generated out of Intangible Assets over the Period would be Rs. 600 Crores, in the following manner:

10. BasedonthisthechargeforfirstyearwouldbeRs. 4.16Crore(approximately)(i.e.,Rs. 5/Rs. 600XRs.500Crores)whichwouldbechargedtoprofitandlossand0.83%(i.e., Rs. 4.16 crore /500 crore *100) is the amortisation rate for the first year. ‘*’will be actual at the end of financial year

11. Useful life of Continuous process plant • Useful life of Continuous process plant for which no special rate has been prescribed [NESD] is increased from 8 to 25 years by the amendment.

12. Extra Shift Depreciation • Earlier, the extra shift depreciation rates were given for the categories of assets for which extra shift depreciation was allowed. Now, no separate rates are prescribed for extra shift depreciation. A blanket statement is provided that the period of time an asset is used in double shift, depreciation will increase by 50% and by 100% in case of triple shift working.

13. Example-1 • From the following information, compute the depreciation as per the provisions of Schedule XIV of the Companies Act, 1956 and Schedule II of the Companies Act, 2013 and show the difference in both. • Purchase cost of the Reactors Rs.40,00,000 • Cost of installation Rs.1,50,000 • Residual Value Nil • Estimated Useful Life 25 Years • Useful Life prescribed in Schedule II 20 years

14. Statement showing computation of depreciation

15. Notes: • Prescribed rates have been used for computation of depreciation under Schedule XIV of the Companies Act, 1956. • b) The rates prescribed in the Schedule XIV of the Companies Act, 1956 have the inbuilt effect of residual value, i.e., the rates are prescribed such that 5% of residual value remains after depreciating 95% of the cost. Accordingly, the residual value is not deducted in the example in computing the depreciation under Schedule XIV. But it is deducted for depreciation computed under the Schedule II of the Companies Act, 2013. • c) Useful life considered for computation of depreciation under Schedule II of the Companies Act, 2013 is the one that is prescribed in Part C of the Schedule. • d) According to the Schedule XIV of the Companies Act, 1956, lower rate of depreciation (based on higher estimated useful life of 25 years) than prescribed cannot be used

16. e) According to the Schedule II of the Companies Act, 2013, entities may charge a lower depreciation than the rate envisaged in Schedule II on disclosing justified reasons of the differences. In case the entity goes with the option of charging depreciation at the rates lower than the prescribed rates, the rates will be as follows: • In case the entity goes with the option of rates lower than the prescribed rates, the rates will be as follows: • Single shift: (1*100/25= 4%) • In this case, the difference would be as follows:

18. Example-2 • A ltd. is using Roll Grinder (falling in category of Plant and Machinery used in manufacture of non-ferrous metals in schedule II) in its operation process. Details are as follows: • Capitalised value of the Roll Grinder Rs. 5,00,000/- • Useful Life 40 Years • Residual Value Rs. 25,000/- • Useful Life prescribed in Schedule II 40 years • Required: • Calculate depreciation as per the provisions of schedule XIV of the Companies Act, 1956 and Schedule II of the Companies Act, 2013, if the machine is used for: • a)Single shift • b)Double shift • c)Triple shift

19. Statement showing computation of depreciation

20. Notes • a)Prescribed rates have been used for computation of depreciation under Schedule XIV of the Companies Act, 1956. • b)The rates prescribed in the Schedule XIV of the Companies Act, 1956 have the inbuilt effect of residual value, i.e., the rates are prescribed such that 5% of residual value remains after depreciating 95% of the cost. Accordingly, the residual value is not deducted in the example in computing the depreciation under Schedule XIV. But it is deducted for depreciation computed under the Schedule II of the Companies Act, 2013. • c)According to the Schedule XIV of the Companies Act, 1956, lower rate (based on higher estimated useful life of 40 years) of depreciation than prescribed cannot be used.

21. Major Impact on Depreciation relevant items: Single Shift

23. Increased to ‘25 years’ by the amendment

28. Note: “Buildings" include roads, bridges, culverts, wells & tube-wells and "factory buildings" does not include offices, godowns, officers & employees' quarters, roads, bridges, culverts, wells & tube-wells according to the Schedule XIV of the Companies Act, 1956. Hence, the corresponding schedule XIV rates considered for comparison are those of ‘buildings (other than factory buildings) NESD’ specified in Schedule XIV.

29. Component Accounting made mandatory: • Useful life specified in Part C of the Schedule is for whole of the asset. Where cost of a part of the asset is significant to total cost of the asset and useful life of that part is different from the useful life of the remaining asset, useful life of that significant part should be determined separately.

30. Example • X Ltd., a steel company is in the process of enhancing its production capacity. The company has got another furnace commissioned. Based on its historical experience, the company determines the life of furnace to be 30 years. The cost of the furnace is Rs. 90 crores. The break-down of the cost is as below: Give the impact of component accounting on replacement of components after introduction of the Companies Act, 2013 and compare with the earlier situation under the Companies Act, 1956. Residual value may be assumed to be nil.

31. Treatment under the Companies Act, 1956 • The component accounting was not mandatory under the Companies Act, 1956. The replacement cost was charged to the Statement of Profit and loss in the year in which it was incurred. • Annual depreciation of the furnance =Rs. 90 crore/30 • = Rs. 3 crores • Replacement cost of various components will be charged to the statement of Profit and loss.

32. Treatment under Companies Act, 2013: Statement showing component wise annual depreciation

33. When at the end of the respective useful lives of the components, the components will be replaced, the replacement cost should be capitalised because by that time, they are fully depreciated and the carrying value at the end of their respective useful lives is nil. • Thus, although the overall amount that will be charged to the statement of Profit and loss will be same during the entire life of the furnance, the annual charge to the statement of profit and loss will differ significantly.

34. There is no specific requirement of 100% depreciation on assets whose actual cost does not exceed Rs. 5,000 in the Companies Act, 2013. However, under the Companies Act, 1956, assets whose actual cost does not exceed Rs. 5 thousand are depreciated @ 100%. • There is no significant change in pro-rata basis of providing depreciation and in the concept of residual value.

35. Transitional Provisions • From the date the Schedule II comes into effect, the carrying amount of the asset as on that date: • (a) Should be depreciated over the remaining useful life of the asset as per Schedule II; • (b) after retaining the residual value, should be recognised in the opening balance of retained earnings where the remaining useful life of an asset is nil.

36. Example-1 • A company acquired a building (other than factory building and RCC Frame Structure) at a cost of Rs. 10 crores. The company was depreciating the building according to Schedule XIV SLM rate, i.e., 1.63% (rate computed assuming useful life to be approximately 60 years). Now, in April, 2014, Schedule II of the Companies Act, 2013 became effective, useful life specified in which is 30 years. • Explain how the transitional provision effect will be accounted for: • A. If the building is acquired on 1st April, 2000 • B. If the building is acquired on 1st April, 1980

37. A. Transition effect in case the building is acquired on 1st April, 2000 • Depreciation charged till FY 2013-14, i.e., depreciation on SLM for 14 years • Rs. 10 crores*1.63%*14 yrs •  Rs. 2,28,20,000 • Carrying Value as on 1st April, 2014 • Cost less accumulated depreciation till FY 2013-14 • Rs. 10,00,00,000 – Rs. 2,28,20,000 •  Rs. 7,71,80,000 • The carrying value as on 1st April, 2014 will be depreciated over the remaining useful life of the asset as per Schedule II of the Companies Act, 2013. The remaining useful life as per new Schedule is (30-14) 16 years. Accordingly, depreciable amount of Rs. 7,71,80,000 will be depreciated over 16 years. So, annual depreciation to be charged to Profit and loss account from FY 2014-15 onwards would be Rs. 7,71,80,000/16 yrs , i.e., Rs. 48,23,750.

38. Impact • After 16 years from FY 2014-15, i.e., from FY 2030-31 onwards no depreciation would be charged • For 16 years, i.e., from FY 2014-15 to FY 2029-30, higher depreciation would be charged. If Schedule II would not have been introduced, depreciation charged annually would have been Rs. 10 cr. * 1.63% = Rs. 16,30,000. After the introduction of Schedule II of the Companies Act, 2013, depreciation charged for these 16 years would be Rs. 48,23,750 which is higher by Rs. 31,93,750.

39. B. Transition effect in case the building is acquired on 1st April, 1980 • If the building would have been purchased on 1st April, 1980, then as on 1st April, 2014, useful life of 30 years as per new Schedule has already expired. In such case, the carrying value as on 1st April, 2014 would be recognised in the opening balance of retained earnings. • Depreciation charged till FY 2013-14, i.e., depreciation on SLM for 34 years • Rs. 10 crores*1.63%*34 yrs •  Rs. 5,54,20,000 • Carrying Value as on 1st April, 2014 • Cost less accumulated depreciation till FY 2013-14 • Rs. 10,00,00,000 – Rs. 5,54,20,000 •  Rs. 4,45,80,000

40. Carrying value as on 1st April, 2014 of Rs. 4,45,80,000 would be recognised in the opening balance of retained earnings. (assuming residual value to be nil) • Impact • Opening balance of retained earnings would reduce by the carrying amount. • No depreciation from FY 2014-15 onwards shall be charged to the profit and loss account, which otherwise would have been charged if Schedule II would not have come into force. • Note: In case, there is a residual value, say, Rs. 10,00,000 then Rs. 4,35,80,000 would be recognized in the opening balance of retained earnings and Rs. 10,00,000 will remain in the carrying amount of asset.

41. Example-2 • A company acquired a reactor used in the manufacture of pharmaceuticals and chemicals at a cost of Rs. 40 lakhs on 1st April, 2005. The reactor worked for triple shift. The company was depreciating the reactor according to Schedule XIV triple shift SLM rate, i.e., 10.34%. Now, in April, 2014 Schedule II of the Companies Act, 2013 became effective, useful life specified in which is 20 years. • Explain how the transitional provision effect will be accounted for: • A. If the reactor is acquired on 1st April, 2005 • B. If the reactor is acquired on 1st April, 1993

42. Notes: • Reactor was not specifically covered under the Schedule XIV of the Companies Act, 1956, so rate is taken to be the rate applicable to ‘general plant and machinery (not being a ship) other than a continuous process plant for which no specific rate has been prescribed’. • Reactor is specified as NESD under the Schedule II of the Companies Act, 2013, i.e., under new schedule, no extra shift depreciation would be applicable. However, under old schedule extra shift depreciation was applicable as earlier it was covered under the category of ‘general plant and machinery (not being a ship) other than a continuous process plant for which no specific rate has been prescribed’ and it was not specified in the items of general plant and machinery (for which no specific rate has been prescribed) to which extra shift depreciation is not applicable.

43. A. If the reactor is acquired on 1st April, 2005 • Depreciation charged till FY 2013-14, i.e., depreciation on SLM for 9 years • Rs. 40 lakhs*10.34%*9 yrs •  Rs. 37,22,400 • Carrying Value as on 1st April, 2014 • Cost less accumulated depreciation till FY 2013-14 • Rs. 40,00,000 – Rs. 37,22,400 •  Rs. 2,77,600 • The carrying value as on 1st April, 2014 will be depreciated over the remaining useful life of the asset as per Schedule II of the Companies Act, 2013.

44. The remaining useful life as per new Schedule is (20-9) 11 years. Accordingly, depreciable amount of Rs. 2,77,600 will be depreciated over 11 years. So, annual depreciation to be charged to Profit and loss account from FY 2014-15 onwards would be Rs. 2,77,600/11 yrs , i.e., Rs. 25,236. (assuming residual value to be nil) • Impact • After 11 years from FY 2014-15, i.e., from FY 2025-26 onwards no depreciation would be charged • For 11 years, i.e., from FY 2014-15 to FY 2024-25, lower depreciation would be charged. If Schedule II would not have been introduced, depreciation charged annually would have been Rs. 40 lakhs * 10.34% = Rs. 4,13,600 till the time the asset is fully depreciated. After the introduction of Schedule II of the Companies Act, 2013, depreciation charged for these 11 years would be Rs. 25,236 which is lower by Rs. 3,88,364

45. B. If the reactor is acquired on 1st April, 1993 • If the reactor would have been purchased on 1st April, 1993, then as on 1st April, 2014, useful life of 20 years as per new Schedule has already expired. • In such case, the carrying value as on 1st April, 2014 would be recognised in the opening balance of retained earnings. • The reactor would have been fully depreciated by the end of 10th year from 1st April, 1993. Accordingly there would be no carrying value as on 1st April, 2014. • Impact • There would be no effect on retained earnings. • No depreciation from FY 2014-15 onwards shall be charged to the profit and loss account, which would have been the same if Schedule II would not have come into force. Hence, there would be no effect on the Statement of Profit and Loss as well.

46. Other provision relating to depreciation • Dividend should be declared by a company for any financial year at a general meeting out of the profits for that year or any previous year or years arrived at after providing for depreciation. • The section also provides that the depreciation shall be provided in accordance with Schedule II. • (Section 123 of the Companies Act, 2013)

47. INTERNAL AUDIT (Section 138 of the Companies Act, 2013)(Rule 13 of Companies (Accounts) Rules, 2014)(Provisions to be complied within 6 months of commencement of section)(No provision for mandatory audit in the 1956 Act) Prescribed class of companies would be required to appoint an internal auditor, who shall either be a chartered accountant or a cost accountant, or such other professional as may be decided by the Board to conduct internal audit of the functions and activities of the company.

48. Internal Auditor may or may not be an employee of the company. • Chartered accountant may or may not be in practice.

49. >=Rs. 50 cr >=Rs. 200 cr >=Rs. 100 cr >=Rs. 25 cr >=Rs. 200 cr >=Rs. 100 cr

50. MANNER AND SCOPE The Central Government may, by rules, prescribe the manner and the intervals in which the internal audit shall be conducted and reported to the Board. (Section 138(2) of the Companies Act, 2013) Audit Committee/Board shall, in consultation with the Internal Auditor, formulate the scope, functioning, periodicity and methodology for conducting the internal audit. (Rule 13(2) of Companies (Accounts) Rules, 2014)