In recent years, due to an abnormal rise in the price level, it has been suggested in many quarters that accountants should modify the practice that so far prevailed of calculating the provision for depreciation on historical cost (i.e., original cost of fixed assets) and may, for the purpose adopt the replacement cost basis. In support of such a view, it has been argued that, as a result of the rise in the price level, replacement costs of assets have gone up to such an extent that the depreciation provision, based on the original costs, does not leave in the business sufficient funds enabling it to replace its fixed assets.
Thus when financial statements are prepared on a basis other than historical cost basis, it is necessary that depreciation should also be computed accordingly on the revised book value of the assets. The revalued amounts of fixed assets are presented in financial statements either by restating both the gross book value and accumulated depreciation so as to give a net book value equal to the net revalued amount or by restating the net book value by adding therein the net increase on account of revaluation. An upward revaluation does not provide a basis for crediting to the profit and loss statement the
accumulated depreciation existing at the date of revaluation. Further an increase in net book value arising on revaluation of fixed assets is normally credited directly to owner’s interests under the heading of revaluation reserves and is regarded as not available for distribution. A decrease in net book value
arising on revaluation of fixed assets is charged to profit and loss statement except that, to the extent that such a decrease is considered to be related to a previous increase on revaluation that is included in revaluation reserve, it is sometimes charged against that earlier increase. It sometimes happens that an increase to be recorded is a reversal of a previous decrease arising on revaluation which has been charged to profit and loss statement in which case the increase is credited to profit and loss statement to the extent that it offsets the previously recorded decrease.
On disposal of a previously revalued item of fixed asset, the difference between net disposal proceeds and the net book value is normally charged or credited to the profit and loss statement except that, to the extent such a loss is related to an increase which was previously recorded as a credit to revaluation reserve and which has not been subsequently reversed or utilised, it is charged directly to that account. The amount standing in revaluation reserve following the retirement or disposal of an asset which relates to that asset may be transferred to general reserve. AS-6 on “Depreciation Accounting, requires where the depreciable assets are revalued, the provision for depreciation should be based on the revalued amount and on the estimate of the remaining useful lives of such assets. A question may arise, as to whether the additional depreciation required in consequence of revaluation can be adjusted against revaluation reserve or charge to profit and loss account. As per requirement of Part-II of Schedule-VI to the Companies Act, 1956 the company will have to provide the depreciation on the total book value of fixed assets (including the increased amount as a result of revaluation). However, for certain statutory purpose, e.g., dividends, managerial remuneration, etc., only depreciation relatable to the historical cost of the asset is to be provided out of the current profit of the company. After taking into consideration both these points, the guidance note on “Treatment of Reserve Created on Revaluation of Fixed Assets” provides that the company can charge the depreciation on the total book value of the fixed assets (including the increased amount as a result of revaluation) in the profit and loss account of the relevant period and thereafter the company can transfer an amount equivalent to the additional depreciation from the revaluation reserve. Such transfer from revaluation reserve should be shown in profit and loss account separately and a proper disclosure by way of notes to account.