Comparative Study Regarding Treatment of Depreciation

As per

Companies Act, 2013 and Income-tax Act, 1961

This Article Provides the Comparative Study on Depreciation as per Companies Act, 2013 and Income-tax Act, 1961. Depreciation is calculated by business enterprises for two purposes –

1.) Accounting Purpose: In accountancy, depreciation refers to two aspects – decrease in the value of assets and allocation of cost of assets to the useful life of assets. So for the Accounting Purpose we refer Companies Act, 2013

As per Companies Act, 2013 “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”

2.) Taxation Purpose: In taxation, depreciation refers to reduction in net taxable income to reduce the amount of tax payable. So for the Taxation Purpose we refer Income-tax Act, 1961

As per Income-tax Act, 1961” Depreciation is a reduction in the value of the asset due to wear and tear of the asset. … You can claim the deduction on depreciation on those assets which have been used by the assessee for the purpose of business or profession during the previous year.”

The method of calculating depreciation under the Income Tax Act, 1961 is in continuance till date where block of assets criteria is used to calculate depreciation. However, Companies Act, 2013 is applicable for the purpose of depreciation of assets, with effect from 1st April, 2014 in case of a company. Method of computation of depreciation has changed with the implementation of Schedule II. From rate based approach the shift is made towards useful life of assets as a basis for determining the rate of depreciation.

Depreciation methods differ for accounting purpose and for taxation purpose. Resultantly, the amount of depreciation as per Companies Act and as per Income Tax Act also differs. This gives rise to a timing difference, which requires to be quantified in financial statements in the form of deferred tax liability / asset.

Schedule II to the Companies Act, 2013

  • Schedule II of the Companies Act, 2013, is indicative in nature as it indicates instead of specifying the rates of depreciation for various assets, and specifies that depreciation should be provided on the basis of useful life of an asset.
  • It prescribes useful life of an asset for the purpose of calculating depreciation. The useful life of an asset shall not be ordinarily different from the life specified in Part C* of Schedule II. Company may adopt useful life separate from that specified in Part C provided it makes a proper disclosure in financial statements and provides justification supported with technical advice.
  •  Methods of Depreciation As per Companies Act, 2013 (Based on Useful Life of assets):
    • Straight Line Method
    • Written Down Value Method
    • Unit of Production Method
  • It specifies that the residual value of an asset shall not exceed 5% of its original cost. Company can adopt a residual value different from the limit specified above if it makes proper disclosure and provides justification supported by a technical advice.
  • It specifies that intangible assets shall be amortized as per the provisions of AS – 26 Intangible Assets. AS – 26 specifies that intangible assets should be amortized in the ratio of future economic life of the asset.
  • It specifies for 50% increase in depreciation for the period for which the asset is used for double shift and 100% increase in depreciation for the period for which the asset is used for triple shift.
  •  Formula for Calculating Depreciation

> Schedule II prescribes useful life of an asset as a base for calculating depreciation. The rate of depreciation shall be determined on the basis of useful life of an asset as follows:

    • Straight Line Method
      • Rate of Depreciation = [ (Original Cost – Residual Value) / Useful Life ] * 100 Original Cost
      • Depreciation = Original Cost * Rate of Depreciation under SLM
    • Written Down Value Method
      • Rate of Depreciation = [1 – (s/c) Ù 1/n] * 100

Where,

s = Scrap Value of the asset at the end of useful life

c = Original Cost of the asset

n = Useful life of the asset

  • Depreciation = WDV * Rate of Depreciation under WDV

Depreciation provisions under Income Tax Act, 1961

Income tax act, 1961 prescribes block of assets for calculating depreciation. A block of asset means a group of assets clubbed in one block for the purpose of calculating depreciation. Similar assets with same rate of depreciation are grouped to form a block of asset. Individual assets lose identity under Income Tax Act as depreciation is calculated on the block of assets rather than on individual asset

Income Tax Act, 1961 The expressions Assets and Blocks of Assets w.e.f. 1-4-1999 shall mean a group of assets falling within a class of assets comprising:–

a. Tangible Assets being buildings, machinery, plant or furniture;

b. Intangible Assets being knowhow, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature; in respect of which same percentage of depreciations is prescribed.

Put-to-use criteria for calculating depreciation

  • Assets put-to-use for more than 180 days in the year of purchase = Full Rate Depreciation in the year of purchase.
  • Assets put-to-use for less than 180 days in the year of purchase = Half Rate Depreciation in the year of purchase

Additional Depreciation on new Plant and Machinery

An industrial undertaking can claim additional depreciation on purchase of new plant and machinery used by the assessee in his business for the purpose of manufacture of article or things, subject to specified conditions. Additional depreciation can be claimed in the year of purchase at 20% if new plant and machinery is put-to-use for more than 180 days and at 10% if new plant and machinery is put-to-use for less than 180 days.

Methods of Depreciation As per Income Tax Act, 1961 (Based on Specified Rates):

  • Written Down Value Method (Block wise)
  • Straight Line Method for Power Generating Units

Formula for Calculating Depreciation

  • Income Tax Act, 1961

> Written Down Value Method

    • Rate of Depreciation = Rate for block of asset prescribed under Income Tax Act
    • Depreciation = WDV of block * Rate of Depreciation under WDV

In short,

Following are main differences

1 Income tax rates are higher than companies act rates.
2 Income tax method of depreciation is WDV ( except power plant) but in companies act it is based on life of asset and straight line method
3 There is no option to change rates of depreciation given by income tax act, but under companies act you can adopt different life and consequently different rates based on justification
4 Income tax depreciation is 50% if asset used for less than 180 days otherwise depreciation for full year. Companies act depreciation is proportionate to the period of use.
5 Under companies act , major components of machine are depreciated separately if they have different useful life but in income tax act no separate depreciation on components

Conclusion

Companies are required to calculate depreciation as per Companies Act as well as Income Tax Act. The methods and amount of depreciation differ under both the statutes. Companies are required to maintain two types of depreciation calculation – one for accounting purpose following Schedule II to the Companies Act, 2013 and the other for taxation purpose according to the provisions of Sec. 32 of Income Tax Act, 1961. Shift depreciation concept is specified in Schedule II which allows claiming extra depreciation in any year if the assets are used for double or triple shift. Such extra depreciation cannot be claimed under the provisions of income tax except additional depreciation in the year of purchase on new plant and machinery used for manufacture. If company is following straight line method of depreciation then the amount of depreciation will remain same for all years in accounts. Whereas the depreciation as per income tax will show a decreasing trend year after year. All such differences in the methods of depreciation under the two relevant statutes lead to a timing difference which requires creation of deferred tax asset/liability.

Due to the rigidity of method of depreciation under income tax act, the figures of financial statements and taxation figures never coincide. This makes maintenance and comparison of accounting records and taxation statements very difficult.

These facts reveal that Income tax act should allow the usage of different methods of depreciation suitable to varied industries which should accord with the governing statute too. Enterprises should have liberty to use straight line method, written down value method or unit of production method for calculating depreciation even for taxation purpose. Resultantly, the duplication of calculation could be reduced and comparison of accounting and taxation records could be made easier.

*Part C: Under Section 123 of Income-tax Act, 1961 SCHEDULE II USEFUL LIVES TO COMPUTE DEPRECIATION Specify the useful life of assets so, foe that kindly refer the Schedule 2 of Companies Act, 2013

** Also for Chart of Rates of depreciation (for income-tax) Kindly refer the income tax Act, 1961.

 References

  • Schedule XIV to the Companies Act, 1956
  • Schedule II to the Companies Act, 2013
  • Application guide to Schedule II of Companies Act, 2013’
  • GN (A) 35 – Guidance Note on Accounting for Depreciation in companies in context of Schedule II to the Companies Act, 2013
  • Accounting Standard 6 – Depreciation Accounting
  • Section 32 of Income Tax Act, 1961

About the Author: Ms. Kavita Kohli is an Article Assitant at Tarun Kandhari & Co LLP. She is involved in Accounting and Auditing.

Author Bio

Qualification: CA in Practice
Company: Tarun Kandhari & Co LLP
Location: New Delhi, IN
Member Since: 15 Jun 2020 | Total Posts: 2
TARUN KANDHARI & CO LLP was established in the year 1992. It is a leading Chartered Accountancy firm with 14 partners and having 11 branch offices in different states rendering comprehensive professional services which include audit, management consultancy, tax consultancy, accounting services, View Full Profile

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