New Companies Act might dent profits of firms relying on revaluation reserve

Under the new Companies Act, 2013 depreciation of an asset has to be taken as the cost of an asset or 'other amount substituted for cost'. Revaluation reserve is the amount added to the original acquired value of an asset in order to show its true market value. Any company may choose to revalue its fixed assets from its original acquired value to market value, provided such revaluation is done for all the assets forming part a class of such assets."For instance, if a company chooses to revalue its buildings, it will have to do so for all 'buildings' owned by the company.
The old Companies Act, 1956, along with a guidance note issued by the Institute of Chartered Accountants of India in 1982 allowed companies to show old figures of depreciation prior to revaluation of the asset concerned in profit and loss account. This was done by an accounting method of transferring a higher amount of depreciation due to the changed value of asset from revaluation reserve and then nullifying it. Thus, if the depreciation charge due to revaluation was Rs 10, companies were allowed to take this much amount from the 'revaluation reserve' in their profit and loss account and nullify it. Consequently, such depreciation due to revaluation would not affect the companies' profits. For example, Ashok Leyland transferred about Rs 15 crore from its revaluation reserve of Rs 1,296 crore to its profit and loss account in FY14. However, under the new Companies Act, 2013, depreciation of an asset has to be taken as the cost of an asset or 'other amount substituted for cost'. This means, for the purposes of computing profits, depreciation will include additional charge arising out of revaluation of assets. Experts are, however, divided over the applicability of the 1982 guidance note now. If the companies are not able to recoup their additional depreciation from the revaluation reserve - as prescribed by 1982 guidance note - they will have to take a substantial hit in their profits. Consequently, it will hit their dividends and managerial remuneration. In the absence of any such guidance note, the new law does not allow any money to be transferred from the revaluation reserve in order to recoup the depreciation.