Depreciation as per Companies Act, 2013

CA Varun Jajoo

With the introduction of the revamped Companies Act, changes have been brought about in quite a few areas in comparison to the erstwhile Companies Act, 1956. Amongst those, depreciation is a key area which needs to be looked into.

1. What has changed

Schedule XIV of the Companies Act, 1956 (‘the Old Act’) prescribed minimum SLM (straight line method) and WDV (written down value) rates for depreciation. The Companies could charge higher depreciation, if the useful life of an asset was shorter than that envisaged under Schedule XIV.

The Companies Act, 2013 (‘the New Act’) replaces Schedule XIV by Schedule II which requires systematic allocation of the depreciable amount of an asset over its useful life.

Useful Life

Useful life may be considered as:

• a period over which an asset is available for use; or
• the number of production or similar units expected to be obtained from the asset by the entity; or
• specified time after which the assets are planned to be disposed off; or
• after consumption of a specified proportion of the future economic benefits embodied in the asset.

The useful life of the asset may therefore be shorter than its economic life. The estimation of the useful life of the asset is a matter of judgement based on the experience of the entity with similar assets. The useful lives specified in Part C of Schedule II of the New Act for various assets will result in their depreciation over a different period than what was previously applicable under Schedule XIV of the Old Act.

The useful life of asset shall not be taken longer than prescribed in Schedule II of the New Act. In case a Company chooses to calculate depreciation on the basis of useful lives which are less than the life specified in the Schedule, the information will have to be disclosed in the financial statements.

Component Accounting

As per note 4 of the Schedule II of the New Act:

“Useful life specified in Part C of the Schedule is for whole of the asset. Where cost of a part of the asset is significant to total cost of the asset and useful life of that part is different from the useful life of the remaining asset, useful life of that significant part shall be determined separately.”

It is thereby implied that Companies will need to identify and depreciate significant components with different useful lives separately. What qualifies as a ‘significant’ component is a judgment call which the management of every Company shall be required to make on a case to case basis, based on the facts and circumstances of each case.

Treatment of depreciation on asset up to Rs 5,000

The Old Act specifies 100% depreciation to be charged on assets whose actual cost does not exceed Rs. 5,000 but the New Act omits to provide for 100% depreciation on immaterial items whose actual cost does not exceed
Rs. 5,000. The determination as to whether a part of an asset is significant requires a careful assessment of the facts and circumstances.

However, life of the asset is a matter of estimation, therefore the materiality of impact of such charge should be considered with reference to the cost of asset and a policy shall be put in place by the Company. The size of the Company will also be a factor to be considered while forming the policy. Accordingly, a Company may have a policy to fully depreciate assets up to certain threshold limits considering materiality aspect in the year of acquisition.

2. Method of Calculation

The depreciation method used shall reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the entity. The depreciable amount of an asset can be allocated on a systematic basis over its useful life through:

• straight-line method; or
• the diminishing balance method; or
• the units of production method.

That method is applied consistently from period to period unless there is a change in the expected pattern of consumption of those future economic benefits.

Additions During The Year

Companies seldom purchase assets on the first day of a fiscal period or dispose them on the last day of a fiscal period. Depreciation in such cases will be required to be calculated for partial periods. In computing depreciation for partial periods, companies must determine the depreciation expense for the full year and then prorate this depreciation expense for the period of use. This process should continue throughout the useful life of the asset.

3. What now

Every Company will need to calculate the number of years for which an asset has already been put to use. However, at times, it can be very difficult to recollect the year in which the asset was purchased.

Nonetheless, it is not difficult to estimate the remaining useful life of the asset. Accordingly, every Company shall prepare a statement detailing the estimated remaining useful life of the asset.

Transition Period

The Application Guide to Schedule II of the Companies Act 2013 issued by the Institute of Chartered Accountants of India states that the carrying amount of the asset as on 1 April 2014 will be depreciated over the useful life as per the New Act and if remaining useful life is NIL then the carrying amount left apart from residual value will be recognized in retained earnings.

Hence, every Company will have to reassess the useful life of its existing fixed assets in accordance with Schedule II.

This will not pose a problem when the Company uses SLM of depreciation. However, if a Company uses WDV method of depreciation, it will need to calculate a new rate for depreciation to depreciate the asset over their remaining useful life using the formula for calculation of rate for depreciation as per WDV method which is as follows:

R= {1 – (s/c)^1/n } x 100

Where

R = Rate of Depreciation (in %);

n = Remaining useful life of the asset (in years);

s = Scrap value at the end of useful life of the asset; and

c= Cost of the asset/Written down value of the asset

Consequentially, Companies may end up having different rates of depreciation for individual assets within the same class in case of existing assets as there will be a different remaining useful life for each asset.

In case a Company wishes to change the method of depreciation from WDV to SLM, then it is a case of change in accounting policy and is not covered by the transitional provisions of Schedule II. In such a case, it needs to first calculate the impact on account of change in the method and difference needs to be accounted through the Profit & Loss A/c.

(The author is a practicing Chartered Accountant who can be contacted at +91 98338 44156 or jajoovarun@gmail.com)