Depreciation Provisions for Companies: By CA Nitesh More
ENABLING PROVISION: Sec198 relating to computation of net profits states that In computing the net profits of a company in
any financial year , among other things , inter alia, depreciation to the extent specified in “section 123” shall be deducted. Sec
123(2) states that depreciation shall be provided in accordance with “Schedule II”.
Applicable Date: Schedule II came into force with effect from the 1st April, 2014 . “Component Accounting” have been
made voluntary in respect of the financial year commencing on or after the 1st April, 2014 and mandatory for financial
statements in respect of financial years commencing on or after 1st April, 2015.(notification dated 29th August, 2014).
Useful Life & Residual Value:“Useful life” of an asset has been specified in Part C of Schedule II . “Residual value” of an
asset shall not be more than five per cent. of the original cost of asset. However, Where a company adopts a useful life
different from above, the financial statements shall “disclose” the same and provide justification in this behalf duly supported
by “technical advice”. [vide Notification no. G.S.R. 627(E) dated 29th August, 2014].
AS 6: Whether applicable on company? AS 6 is applicable to companies in all matters where there are no specific
requirements under the Companies Act i.e. Depreciation methods, revaluation, foreign exchange fluctuation etc(Para 1 of
Application Guide on Provisions of schedule II issued by ICAI) AS 6 to the extent not inconsistent with schedule II,should be
harmonized to Schedule II and applied, as far as possible. Example: AS 6 states that depreciation rates prescribed under the
statute are minimum, if management’s estimate of useful life of an asset is shorter than that envisaged under statute,
depreciation is computed by applying the higher rate. However, as per Schedule II, company can adopt a useful life other that
specified in part C for the purpose of calculating depreciation. Company shall follow both provisions.
Illustration 1: The management has estimated useful life(AS6 useful life) of an asset to be 8 years. The life envisaged under
Schedule II is 10 years.
Ans: In this case, AS 6 requires the company to depreciate the asset using 8 year life only. In addition, Schedule II requires
disclosure of justification for using the lower life. The company cannot use 10 year life envisaged under Schedule II for
depreciation.
Illustration 2: The management has estimated the useful life of an asset to be 12 years. The life envisaged under the Schedule
II is 10 years.
Ans: In this case, the company has an option to depreciate the asset using either a) 10 year life prescribed in the Schedule II
or b) the estimated useful life, i.e., 12 years. If the company depreciates the asset over the 12 years, it needs to disclose
justification for using the higher life.
Illustration 3: The management has estimated that estimated AS 6 residual value of the asset is nil. The residual value
envisaged under the Schedule II shall not be more than 5%.
Ans: In this case, company cannot use 5% residual value. In addition, Schedule II requires disclosure of justification only in
case residual value exceeds 5% of the cost. No disclosure is required.
Illustration 4 : The management has estimated AS 6 residual value of the asset to be 10% of the original cost, as against 5%
value envisaged in the Schedule II.
Ans: In this case, the company has an option to depreciate the asset using either a) 5% residual value prescribed in the
Schedule II or b) the estimated AS 6 residual value, i.e., 10% of the original cost. If the company depreciates the asset using
10% estimated residual value, it needs to disclose justification for using the higher residual value. The company should apply
the option selected consistently
Component Accounting : 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
.Currently, companies need to “expense” replacement costs in the year of incurrence. Under component accounting,
companies will “capitalize” these costs as a separate component of the asset, with consequent “expensing” of net carrying
value of the replaced part . When it is not practicable to determine the carrying amount of the replaced part, the cost of the
replacement may be used as an indication of what the cost of the replaced part was at the time it was acquired or constructed.
Example: A Building may be split up into the following components - (i) Structural design (ii) Elevators (iii) Heating system
(iv) Water system (v) Electrical system
Significant component to be depreciated separately: A company needs to identify only material/significant components
separately for depreciation. The Company may consider 10% of original cost of the asset as a threshold to determine whether
a component is material/ significant. Each significant component having useful life, which is different from the useful life of the
remaining asset, should be depreciated separately. If useful life of the component is lower than the useful life of the principal
asset as per Schedule II, such lower useful should be used. On the other hand, if the useful life of the component is higher
than the useful life of the principal asset as per Schedule II, the company has a option of using either the higher or lower useful
life.
Example: Assume that Schedule II useful life is 10 years. The management has also estimated that the useful life of principal
asset is 10 years. Useful life of component: 8 years/12 years.
Ans: If a component of the asset has useful life of 8 years, AS 6 requires the company to depreciate the component using 8
year life only. However, if the component has 12 year life, the company may depreciate the component using either 10 year
life as prescribed in the Schedule II or 12 years.
Transitional provision under Schedule II : From the date Schedule II comes into effect i.e. 1 April 2014, the carrying
amount(wdv) of the asset as on that date shall be depreciated over remaining useful life of the asset. Where remaining useful
life of an asset is nil, it may be charged off to Profit and Loss account or retained earnings. Hence company will have to
reassess the useful life of its existing fixed assets in accordance with Schedule II.
Meaning of “Retained Earning”: It has not been defined under the Companies Act. In my view, Capital reserve & reserve for
specific purpose should not be decreased for such adjustment. Debit balance in P & L a/c should also not be increased for
such adjustment. Hence, adjustment can be made with general reserve & Credit balance in P & L a/c.
Example: Useful Life of Furniture is 10 years (as per Schedule II). The furniture is 8 years old
Answer: The remaining WDV of the furniture shall be depreciated over the remaining 2 years.
Example: Useful Life of Furniture is 10 years (as per Schedule II).The furniture is 12 years old
Answer: Company has an option of charging the remaining WDV of the furniture to the retained earnings of the company or
charging the same to the statement of profit and loss.
Example: Date of acquisition is April 1, 2010 and cost incurred is RS 100 and WDV as at March 31, 2014 is 60. On transition
to Schedule II(life: 10 years), how same will be accounted in the books of account of PQR Limited.
Ans: As there is a balance useful life on the date of transition, the remaining WDV needs to be depreciated over the balance
useful life period. If the Company follows the life provided in the Schedule II, useful life will be 15 years and hence remaining
useful life is 11 years. Hence, the balance WDV of 60 needs to be depreciated over the period of 11 years.
Tax effect to be adjusted against retained earnings : If the Company opts to adjust the carrying amount of the assets to the
retained earnings in accordance with the transitional provisions of the Schedule II, the tax effect of the same has to be also
adjusted directly against the retained earnings in accordance with the ICAI announcement “Tax effect of expenses/income
adjusted directly against the reserves and/ or Securities Premium Account.
Example: Suppose Co has decided to adjust WDV of Rs 100 , after retaining 5 % as Salvage value with retained earnings, as
life as per Schedule II has been expired.
i)
Co had got benefit in Income Tax in past i.e. There is DTL for this assets to the extent of Rs say, 30 .
ii)
Co will get benefit in Income Tax in future i.e. Co have to create DTA for this assets to the extent of Rs say, 30 .
Answer: In such a case, Rs 30 shall be debited to DTL/DTA & balance shall be adjusted with Profit & Loss/General reserve.
Charging of Dep. in case of Revaluation & Treatment of Additional dep on revaluation
ICAI Guidance Note on “Treatment of Reserve Created on Revaluation of Fixed Assets” allowed an amount equivalent to the
additional depreciation on account of upward revaluation of fixed assets to be transferred from revaluation reserve to
statement of profit and loss. In contrast, schedule II to Companies Act, 2013 Act requires depreciation to be provided on
historical cost or the amount substituted for the historical cost. In case of revaluation, a company needs to charge depreciation
based on the revalued amount. Consequently, the ICAI Guidance Note, which allows an amount equivalent to the additional
depreciation on account of upward revaluation to be recouped from the revaluation reserve, may not apply. AS 10 allows
amount standing to the credit of revaluation reserve to be transferred directly to the general reserve on disposal of revalued
asset. A company may transfer the whole of the reserve when the asset is sold or disposed of. However, some of the surplus
may be transferred from revaluation reserve to general reserve as the asset is used by a Company. In such a case, the
amount of the surplus transferred would be the difference between depreciation based on the revalued carrying amount of the
asset and depreciation based on its original cost. Transfers from revaluation surplus to the general reserve are not made
through the statement of profit and loss.
Example: WDV as on date of revaluation: Rs 100,Revalued to Rs 150. Dep on WDV: 10, Dep on revalued amount: 15,
Additional dep on revaluation: 5
Answer: Treatment earlier: Charge dep of 15 to P/L & option to transfer Rs 5 from R/R to P/L.
Treatment now: Charge dep of 15 to P/L & option to transfer Rs 5 from R/R to General Reserve.
Whether it is necessary to review useful life every year?
Para 23 of AS 6 says that, the useful lives of major depreciable assets or classes of depreciable assets may be reviewed
periodically. Where there is a revision of the estimated useful life of an asset, the unamortized depreciable amount should be
charged over the revised remaining useful life.
Para 21 of AS 5 says that, an estimate may have to be revised if changes occur regarding the circumstances on which the
estimate was based, or as a result of new information, more experience or subsequent developments. The revision of the
estimate, by its nature, does not bring the adjustment within the definitions of an extraordinary item or a prior period item.
Ind-AS 16 Para 51 says that, the residual value and the useful life of an asset shall be reviewed at least at each financial yearend and, if expectations differ from previous estimates, the change(s) shall be accounted for as a change in an accounting
estimate in accordance with Ind-AS 8 Accounting Policies, Changes in Accounting Estimates and Errors.
Can a co still have a policy to fully depreciate 100% of cost of asset below certain amount?
Earlier , Schedule XIV allowed 100% depreciation of the cost of an asset having individual value of 5000 or less. As per
Schedule II, Life of the asset is a matter of estimation. A company may have a policy to fully depreciate assets upto certain
threshold limits considering materiality aspect in the year of acquisition (Application guidance, ICAI).
Pro-rata basis: Assets purchased/sold: 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. (Schedule II)
How to work out Charging of dep on pro-rata basis?
Para 24 of the existing “guidance note on depreciation accounting” provides that “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. Also, a company may group additions and disposals in
appropriate time period(s), e.g. 15 days, a month, a quarter etc., for the purpose of charging pro rata depreciation in respect of
additions and disposals of its asset keeping in view the materiality of the amount involved.
Can method of accounting be changed?
Example: If a co was charging dep as per WDV method till 31st March 2014 and wants to shift to SLM method w.e.f 1st April
2014.
Ans: Such cases will not be covered by transitional provision of Schedule II. It will be considered as change of accounting
policy as per AS 5. Co needs to first calculate the impact on account of change in the method and difference in the WDV
needs to be accounted through statement of profit and loss .
Practical Notes:
1) Assets of which life has been expired and depreciation charged till 31.03.2014 was lesser than 95% of Original Cost,
difference of WDV over salvage value has to be adjusted with Retained earning . Deferred tax adjustment has also to be made
for same amount. Alternatively, you can debit in Profit & Loss account (just like depreciation). [as provided in schedule II read
with application guidance on schedule II]
Example: Assets purchased on 1.4.2000, Cost: Rs 100, Salvage value: Rs 5, WDV as on 1.4.2014: 9, Dep charged till
31.3.14: 91, Schedule II useful life: 10 years,
Ans: 9-5=4 can either adjusted with retained earning or P/L( Subject to adjustment of DTA/DTL) .
2) Assets of which life has been expired and depreciation charged till 31.03.2014 was more them 95% of Original Cost of
Assets: Excess Depreciation (Already charged) not to be adjusted anywhere (neither from Reserve & Surplus nor from Current
Year Depreciation). [As no provision in schedule II for any adjustment]
Example: Assets purchased on 1.4.2000, Cost: Rs 100,Salvage value: Rs 5, WDV as on 1.4.2014: 2, Sche. II useful life: 10
years,
Ans: No adjustment is required with either retained earning or P/L. WDV is less than salvage value .
Salvage Value of Assets above, will be WDV as on 01.04.2014. Salvage Value not to be maintained @5% of Original Cost for
these assets. Law restrict us to keep the salvage value 5% for higher side and not for lower side.
4) One has to be careful for depreciation in the last year (example: if remaining life year is 2.46 years, in such a case 3rd
(third) year for depreciation of that assets, as same has to be calculated as balancing figure of depreciable amount "less"
depreciation claimed till the year immediately previous year for which deprecation to be calculated. This is due to the fact that
rates of depreciation is approximate figures & hence, if one calculate depreciation for last year by using formula, such amount
will not be an exact figure generally.