Depreciation is a fundamental accounting concept that involves allocating the cost of tangible assets over their useful lives. In India, the Companies Act, 2013, provides specific guidelines for calculating and accounting for depreciation. This comprehensive guide delves into the intricacies of depreciation as per the Companies Act, including methods, rates, and compliance requirements.

Understanding Depreciation

Depreciation refers to the systematic allocation of the depreciable amount of an asset over its useful life. The depreciable amount is the cost of an asset minus its residual value. This allocation reflects the wear and tear, usage, or obsolescence of the asset over time. Accurate depreciation accounting ensures that a company’s financial statements present a true and fair view of its financial position.

Legal Framework: Companies Act, 2013

The Companies Act, 2013, governs corporate affairs in India and includes provisions related to depreciation. Section 123 of the Act mandates that depreciation should be provided in accordance with Schedule II, which specifies the useful lives of various tangible assets. This approach ensures uniformity and consistency in depreciation practices across companies.

Schedule II: Useful Lives of Assets

Schedule II of the Companies Act, 2013, outlines the useful lives of different categories of assets. Unlike the earlier regime under the Companies Act, 1956, which prescribed specific depreciation rates, the 2013 Act focuses on the useful life of assets. This shift allows companies to estimate depreciation based on the actual usage and expected utility of the asset.

Key Provisions of Schedule II

  • Depreciable Amount: The cost of an asset minus its residual value.

  • Useful Life: The period over which an asset is expected to be available for use by an entity.

  • Residual Value: The estimated amount that an entity would currently obtain from the disposal of the asset after deducting the estimated costs of disposal.

Companies are permitted to adopt a useful life or residual value different from those prescribed in Schedule II, provided they disclose such differences and justify them with technical advice.

Methods of Depreciation

The Companies Act, 2013, does not prescribe a specific method for calculating depreciation, allowing companies to choose a method that best reflects the pattern in which the asset’s future economic benefits are expected to be consumed. The two most commonly used methods are:

1. Straight Line Method (SLM)

Under SLM, an equal amount of depreciation is charged each year over the useful life of the asset. This method is straightforward and is suitable for assets that provide consistent utility over time.

Formula:


Annual Depreciation = Cost of Asset − Residual Value Useful Life \text{Annual Depreciation} = \frac{\text{Cost of Asset} – \text{Residual Value}}{\text{Useful Life}}

2. Written Down Value Method (WDV)

In the WDV method, depreciation is charged at a fixed percentage on the reducing balance of the asset’s book value each year. This method is appropriate for assets that lose value more rapidly in the initial years of use.

Formula:


Depreciation = Book Value at Beginning of Year × Depreciation Rate \text{Depreciation} = \text{Book Value at Beginning of Year} \times \text{Depreciation Rate}

Depreciation Rates as per Companies Act

While Schedule II specifies the useful lives of assets, companies can derive depreciation rates based on these useful lives. For instance, if an asset has a useful life of 10 years, the depreciation rate under the Straight Line Method would be 10% per annum.

Example: Depreciation on Furniture

  • Useful Life: 10 years (as per Schedule II)

  • Depreciation Rate (SLM): 10% per annum

  • Depreciation Rate (WDV): Derived using the formula:


    R = [ 1 − ( Residual Value Cost ) 1 Useful Life ] × 100 R = \left[1 – \left(\frac{\text{Residual Value}}{\text{Cost}}\right)^{\frac{1}{\text{Useful Life}}}\right] \times 100

It’s important to note that the residual value should not exceed 5% of the original cost of the asset.

CA2013

Transitional Provisions

For assets existing as of April 1, 2014, companies were required to adjust the remaining useful life of the asset as per the new provisions. If the remaining useful life was nil, the carrying amount after retaining the residual value could be adjusted against the opening balance of retained earnings or charged to the Profit and Loss account.

Depreciation on Furniture as per Companies Act

Furniture is classified under tangible assets in Schedule II of the Companies Act, 2013. The Act prescribes a useful life of 10 years for furniture and fittings used in general. However, companies can determine a different useful life based on technical evaluation, provided such deviation is disclosed and justified.

Key Considerations:

  • Material Quality: High-quality materials may extend the useful life beyond the standard 10 years.

  • Usage Intensity: Furniture in high-traffic areas may experience more wear and tear, potentially reducing its useful life.

  • Maintenance Practices: Regular maintenance can prolong the useful life of furniture.

Compliance and Disclosure Requirements

Companies must ensure compliance with the depreciation provisions of the Companies Act, 2013, and related accounting standards. Key compliance aspects include:

  • Accurate Calculation: Depreciation should be calculated based on the actual cost, residual value, and useful life of the asset.

  • Disclosure: Financial statements should disclose the depreciation methods used,

  • Disclosure: Financial statements must specify the method of depreciation used (Straight Line Method or Written Down Value Method), the useful lives or rates of depreciation adopted, and any deviation from the standard provisions of Schedule II of the Companies Act, 2013. These disclosures enhance transparency and allow stakeholders to understand the company’s accounting policies.

  • Audit and Verification: Depreciation calculations are subject to audit. Companies must maintain accurate records of fixed assets, including their cost, installation date, and accumulated depreciation.

  • Revaluation of Assets: If a company revalues an asset, it must disclose the revised figures and adjust depreciation accordingly.

Depreciation Rate as per Companies Act

How to Determine the Depreciation Rate:

  • The depreciation rate is derived based on the useful life of an asset as prescribed in Schedule II.
  • Companies adopting different useful lives than those specified must calculate depreciation rates accordingly.

Example Calculation:

  1. Straight Line Method (SLM):
    If an asset’s useful life is 5 years, the annual depreciation rate under SLM will be 20% (100/5).
    For furniture with a cost of ₹50,000 and a residual value of ₹2,500:
    Depreciable Amount = ₹50,000 – ₹2,500 = ₹47,500
    Annual Depreciation = ₹47,500 ÷ 5 = ₹9,500.

  2. Written Down Value Method (WDV):
    Using the WDV formula, companies must calculate the depreciation percentage annually, which reduces the asset’s book value progressively.

Special Cases of Depreciation

1. Depreciation on Leased Assets

  • Leased assets follow the same depreciation rules under the Companies Act.
  • The lessor accounts for depreciation, while the lessee discloses lease rentals.

2. Depreciation for Intangible Assets

  • Intangible assets like patents and copyrights are amortized over their useful lives.
  • The useful life for intangible assets must align with the Companies Act and applicable accounting standards.

3. Depreciation on Low-Value Assets

  • Low-value assets can be fully depreciated in the year of acquisition if their value is below a threshold specified by the company.

4. Depreciation During Idle Periods

  • Even if an asset is not in use, depreciation continues to be charged as it reflects the passage of time and obsolescence.

Challenges in Depreciation Accounting

  • Estimation of Useful Life: Determining the correct useful life requires technical expertise and experience.
  • Residual Value: Estimating the residual value involves predicting future market conditions.
  • Asset Revaluation: Changes in the market value of assets complicate depreciation calculations.
  • Regulatory Changes: Amendments to the Companies Act or accounting standards may require adjustments in depreciation policies.

Depreciation as a Tax Shield

  • Tax Savings: Depreciation is a non-cash expense that reduces taxable income, thereby offering a tax shield.
  • Deferred Tax Liability: If depreciation methods differ between accounting and tax reporting, it may create deferred tax liabilities or assets.

FAQs about Depreciation as per Companies Act

What is Depreciation as per Companies Act?

Depreciation as per the Companies Act involves allocating the depreciable amount of a tangible asset over its useful life, following the provisions outlined in Schedule II.

What are the Methods of Depreciation under the Companies Act?

The two main methods are the Straight Line Method (SLM) and the Written Down Value Method (WDV).

How is Depreciation on Furniture as per Companies Act Calculated?

Depreciation on furniture is based on its useful life, typically 10 years, and can be calculated using SLM or WDV.

Can Companies Adopt Different Useful Lives than Schedule II?

Yes, companies can adopt different useful lives if supported by technical advice and disclosed in financial statements.

Is Depreciation Mandatory for All Companies?

Yes, depreciation is mandatory for all companies holding tangible or intangible assets.

What Happens if an Asset’s Useful Life Expires?

If an asset’s useful life expires, its book value (after deducting residual value) is charged to the profit and loss account or adjusted against retained earnings.

Does Depreciation Apply to Leased Assets?

Yes, leased assets are subject to depreciation as per the Companies Act.

How is Depreciation Accounted for During Asset Revaluation?

Depreciation is recalculated based on the revised value of the asset post-revaluation.

Conclusion

Depreciation as per the Companies Act, 2013, is a critical aspect of corporate accounting in India. It ensures the accurate representation of asset value and compliance with statutory requirements. By understanding the nuances of depreciation methods, rates, and disclosure requirements, companies can maintain transparent financial records and make informed decisions about asset management.