Depreciation treatment under Companies Act, Income Tax Act, GAAP, Ind As & AS

Depreciation is a common accounting concept which the accountant comes across in their regular course of employment or in regular course of their business. This article will explore the treatment of depreciation under Companies Act, Income Tax Act and in Indian and internationally accepted Accounting Standard.

DEFINITION AND TREATMENT OF DEPRECIATION AS PER COMPANIES ACT 2013

Section 123 read with Schedule II read as under:

“Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. The depreciable amount of an asset is the cost of an asset or other amount substituted for cost, less its residual value. The useful life of an asset is the period over which an asset is expected to be available for use by an entity, or the number of production or similar units expected to be obtained from the asset by the entity.

Where, during any financial year, any addition has been made to any asset, or

where any asset has been sold, discarded, demolished or destroyed, the depreciation on such assets shall be calculated on a pro rata basis from the date of such addition or, as the case may be, up to the date on which such asset has been sold, discarded, demolished or destroyed”. 

AS 10

Depreciation under AS 10 Properties, Plant and Equipment

• As per the standard, depreciation charge for every period must be recognized in the P/L Statement unless it’s included in carrying the amount of any another asset.
• Depreciable amount of any asset should be allocated on a methodical basis over the useful life of the asset.
• Every part of property or P&E (Plant and Equipment) whose cost is substantial with respect to the overall cost of the item must be depreciated separately.
• The standard also prescribes, that the residual value and useful life of an asset must be reviewed at the end of each financial year and, in case the expectations vary from the previous estimates, changes must be accounted for as changes in accounting estimate as per Accounting Standard 5 – Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies.
• The method of depreciation employed must reflect the pattern of future economic benefits of the asset consumed by an enterprise.

Ind As 16

Ind AS 16 Property Plant Equipment is applicable to all Property and P&E (Plant & Equipment) unless and until any other accounting standard asks for a different treatment. It has replaced AS6 and As 10 in respect to depreciation. IND As 16 introduced to ensure that it is conformity with International Accounting Standard (IAS)

Ind AS 16 permits two accounting models:

Cost model.

• The asset is carried at cost less accumulated depreciation and impairment Revaluation model.
• The asset is carried at a revalued amount, being its fair value at the date of revaluation less subsequent depreciation and impairment, provided that fair value can be measured reliably.
• Under the revaluation model, revaluations should be carried out regularly, so that the carrying amount of an asset does not differ materially from its fair value at the balance sheet date.
• If an item is revalued, the entire class of assets to which that asset belongs should be revalued.
• Revalued assets are depreciated in the same way as under the cost model (see below).

Depreciation (cost and revaluation models)

For all depreciable assets:

• The depreciable amount (cost less residual value) should be allocated on a systematic basis over the asset’s useful life
• The residual value and the useful life of an asset should be reviewed at least at each financial year-end and, if expectations differ from previous estimates, any change is accounted for prospectively
• The depreciation method used should reflect the pattern in which the asset’s economic benefits are consumed by the entity
• Depreciation should be charged to profit or loss, unless it is included in the carrying amount of another asset
• Depreciation begins when the asset is available for use and continues until the asset is derecognized, even if it is idle. [IAS 16.55]

The standard also requires:

The method of depreciation used should reflect an asset’s pattern of future economic benefits

At each balance sheet date, the standard requires review of

(i) Residual value and the useful life of assets

(ii) Depreciation method employed

De recognition of the asset 

The carrying amount of items of PPE should be derecognized:

(a) At the time of their disposal; or

(b) When there is no future economic benefits anticipated from the use or disposal of such asset

Any gain or loss arising from such de recognition should be included in the P/L statement when such item is derecognized. Gains arising from such de recognition shouldn’t be classified as part of revenue.

GAAP  Definition of Depreciation

Depreciation is how the costs of tangible and intangible assets are allocated over time and use.

Methods of Depreciation

1) Straight Line Method

2) Written Down Value  Method

3) Declining Balance Method.

4) Units of Production Method.

5) Sum of the year’s digits depreciation Method.

Example for SLM and WDV

1) Xyz Enterprises has purchased Plant and Machinery worth INR 18,00,000/- on 1-4-2017. It has also sold a some of its Plant and Machinery purchased on 1-4-2017 worth INR 10,00,000/- for INR 7,00,000/- on 15-2-2019. Depreciation as on 31-3-2020 assuming rate of 15% would be calculated as follows under SLM Method.

Particulars	Amount( Rs)
Value of Plant and Machinery 1-4-17	18,00,000/-
Less: Depreciation at 15%	2,70,000/-
Value of Plant and Machinery as on 31-3-18	15,30,000/-
Less: Depreciation at 15%	2,36,712/-
(For 1-4-18 to 15-2-19) on INR 18,00,000/-
(18,00,000*0.15*320/365)
Less: Depreciation at 15% (For 15-2-2019 to 31-3-2019) (8,00,000*0.15*45/365)	14,794/-
Value of Plant and Machinery as on 31-3-19	12,78,494/-
Less: Depreciation at 15% (8,00,000*0.15)	1,20,000/-
Value of Plant and Machinery as on 31-3-20	11,58,494/-

Loss on Sale of Asset which should be charged off to P&L Account would be calculated as follows.

Particulars	Amount( Rs)
Value of Plant and Machinery 1-4-17	10,00,000/-
Less: Depreciation at 15% for FY 17-18	1,50,000/-
Value of Plant and Machinery as on 1-4-2018	8,50,000/-
Less: Depreciation at 15% for FY 18-19 (10,00,000*15%*320/365)	1,31,506/-
Value of Plant and Machinery as on 15-2-2019	7,18,494/-
Sale Value of Plant and Machinery	7,00,000/-
Loss on Sale of Plant and Machinery to be charged to P/L Acct	18,494/-

Depreciation for the above example on WDV basis would be calculated as follows:

Particulars	Amount( Rs)
Plant and Machinery on 1-4-2017	18,00,000/-
Less: Depreciation for FY 17-18 at 15%	2,70,000/-
Closing WDV of Plant and Machinery on 31-3-2018	15,30,000/-
Less: Depreciation for FY 18-19 at 15% (15,30,000*0.15*320/365)	2,01,205/-
Less: Depreciation on balance WDV (15,30,000-7,00,000)*0.15*45/365	15,349/-
Closing WDV of Plant and Machinery on 31-3-2019	13,13,446/-
Less: Depreciation for FY 19-20 at 15%	1,97,017/-
Closing WDV of Plant and Machinery as on 31-3-2020	11,16,429/-

 Note

When calculating depreciation on Written Down Value Method the sale Value should be reduced from the block of Assets.

Moot question

Whether depreciation is to be calculated if the asset is not put into use ?

Depreciation must be calculated from the date when the asset is ready to put to use. If assets is ready to put into use and not yet commenced to use, even then depreciation needs to be calculated.

How is deferred Tax calculated as per Accounting Standards?

Deferred Tax is calculated as a result of temporary timing differences. Difference in depreciation between Income Tax and Companies Act gives rise to deferred Tax. Assuming the depreciation as per Income Tax is higher compared to Companies Act then this would give rise to deferred Tax Liability as the profits would be lesser in Income Tax thereby we would end up paying lesser Tax.

Whether Depreciation can be calculated on Capital Work In Progress  ?

No depreciation cannot be calculated on Capital Work in Progress as the asset is not yet ready to use depreciation would be calculated only from the date the asset is being put to use. Depreciation would be started once the asset has been transferred from Capital Work in Progress to Fixed Assets.

Depreciation treatment under GST

Whether Depreciation will be allowed if Input GST Credit has been claimed on Capital Goods under GST?

As per Section 16(3) of the CGST Act, in case the registered taxable person has claimed depreciation on the tax component of the Capital Goods then input credit of the said tax component would not be allowed. This would be illustrated as below.

XYZ Enterprises purchases Capital Goods worth INR 1,00,000/- for the purpose of use in business or profession. GST charged is INR 18,000/- hence the total Value including the GST amount to INR 1,18,000/- XYZ enterprises in order to claim depreciation on the entire value of INR 1,18,000/- should not claim GST Credit of INR 18,000/- and should consider the entire Value of INR 1,18,000/- as an Asset.

Depreciation as per Income Tax Act

As per Section 32 an assessee can claim depreciation on Fixed Assets only if the following conditions are satisfied

1) Assessee must be the owner of the Asset. (Registration of the Owner need not be necessary).

2) The Asset must be used during the Previous Year.

3) The Asset must be used for the purpose of Business or Profession.

The use of the Asset may be active use or passive use i.e. kept ready for use.

Case laws

In ACIT Vs. Victory Aqua Farm Ltd. 379 ITR 335 (SC)  depreciation was allowed on ponds by applying the functional test’, since the ponds were specially designed for rearing/breeding of the prawns, they have to be treated as tools of the business of the assessee and the depreciation was admissible on these ponds.

In CIT Vs. Dhampur Sugar Mills Ltd. 375 ITR 296 (All) it was held by the court that Tubewell was held to be plant

In CIT Vs. Express Resorts & Hotels Ltd. [230 Taxman 424(Guj) ]it was held that Electrical Installations and Sanitary Fittings in hotel treated as plant.

In CIT vs. Sonic Biochem ITA No. 598 of 2009 (Bom HC), It was held in this case, that user test is to be satisfied only for the first time the purchased asset becomes a part of block asset. If it becomes a part of the block asset even though if the individual asset is not put into use the depreciation will be allowable.

In CIT Vs. Swastik Industries 240 Taxman 510 (Guj) it was held that payment of compensation made by assessee-firm to its retiring partners was to be treated as goodwill and, since, goodwill is an asset under Explanation 3(b) to section 32(1), assessees claim for depreciation on said payment was to be allowed.

Depreciation as per IT Act is Calculated on Written down Value Basis and it is calculated based on the rates prescribed under the Income Tax Act for Various category of Assets.

Illustration

1) ABC Limited which is in the business of manufacturing auto mobile parts has started its business on April 20^th 2020 and has bought Plant and Machinery on 1^st May 2020 amounting to INR 20,00,000/- GST on the same is INR 3,60,000/- total including GST is INR 23,60,000/-. The date of Put to use of the Asset is on 15^th May 2020. Depreciation would be calculated as follows assuming that GST Credit is claimed.

Particulars	Amount (INR)
Cost of Asset	20,00,000/-
Depreciation at 15%	3,00,000/-
Closing WDV as on Mar 31 2021	17,00,000/-

Notes

1) As the Asset has been used for more than 180 days in FY 20-21(April 2020 to March 2021) full rate of 15% would be applicable.

2) Assumed that the entity has claimed the GST Credit of INR 3,60,000/-.

In case the GST Credit has not been claimed by the entity then the depreciation calculation would be as follows:

Particulars	Amount (INR)
Cost of Asset	23,60,000/-
Depreciation at 15%	3,54,000/-
Closing WDV	20,06,000/-

SOLUTION

1) As illustrated above we find that in case the entity claims the GST Credit then the depreciation is INR 3,00,000/- whereas in case GST Credit is not claimed then the depreciation is INR 3,54,000/- which means the entity would be paying lesser tax to the extent of INR 16,200/-(INR 54,000*0.30). 30% is assumed to be the Tax rate.

2) Whether to claim the GST or not is the choice of the entity?

In the above illustration depreciation as per Companies Act would be as follows. Under the Companies Act the depreciation would be calculated on the basis of Useful life of the Asset. For Plant and Machinery the Useful life is 15 Years as per Companies Act 2013. Let us assume residual Value at the end of the useful life to be 5% which amount to INR 1, 00,000/- The depreciation would be as follows:

Particulars	Amount (INR)
Cost of Asset	20,00,000/-
Depreciation at 6.66% for the period 15-May-20 to 31-Mar-21(320 days)	1,11,039/-
Closing WDV as on Mar 2021	18,88,961/-

Notes

1) Assuming that GST Credit is claimed by the entity.

2) Depreciation is 6.66% as the useful life is 15 years. (100/15) would be 6.66%

3) Depreciation would be calculated on INR 19,00,000/-(INR 20,00,000-INR 1,00,000-Residual Value) at 6.66% per annum for 320 days.

Assuming the entity is paying Tax at 30%. Deferred Tax for FY 20-21 would be calculated as follows.

A) In case entity is claiming GST Credit.

Depreciation as per Income Tax	INR 3,00,000/-(INR 20,00,000*0.15)
Depreciation as per Companies Act	INR 1,16,883/- (INR 20,00,000*6.66%*320/365)
Difference in Depreciation	INR 1,83,117/-

Deferred Tax would be calculated as follows:

(INR 1, 83,117*0.30)

INR   54,935/-

B) In case entity is not claiming GST Credit.

Depreciation as per Income Tax	INR 3,54,000/-(INR 23,60,000*0.15)
Depreciation as per Companies Act	INR 1,37,922/- (INR 23,60,000*6.66%*320/365)
Difference in Depreciation	INR 2,16,078/-

Deferred Tax would be calculated as follows:

(INR 2, 16,078*0.30)

INR    64,823/-

Income Computation Disclosure Standard (ICDS)

The Central Government has vide Notification No. 32/2015 [F. No. 134/48/2010-TPL] dated 31st March, 2015 notified ten ICDS under section 145(2) of the Income-tax Act, 1961 (‘the Act’).

Hon‘ble Delhi High Court in case of Chamber of Tax Consultants vs. UOI (400 ITR 178) vide order dated 08.11.2017, quashed certain ICDS and certain portion of other ICDS and read down the powers of the Government u/s.  145(2).Amendments brought out by Finance Act, 2018 w.r.e.f. AY 2017-18 to overrule the judgment of the Hon‘ble Delhi High Court.

As per ICDS V following disclosure shall be made in respect of tangible fixed assets, namely:

• Description of asset / block of assets;
• Rate of depreciation;
• Actual cost or written down value, as the case may be;
• Additions or deductions during the year with dates; in the case of any addition of an asset, date put to use;
• Change in value on account of change in rate of exchange of currency;
• Subsidy or grant or reimbursement, by whatever name called;
• Depreciation allowable; and Written down value at the end of year.

Conclusion

Depreciation is a measure of the wearing out, consumption or other loss of value of a depreciable asset arising from use, effluxion of time or obsolescence through technology and market changes. Depreciation is allocated so as to charge a fair proportion of the depreciable amount in each accounting period during the expected useful life of the asset. From the above discussion we saw how depreciation needs to calculated under various laws and in internationally accepted accounting standard.

Gayathri S. and CA Sujit Venkatesh