Depreciation under Companies Act, 2013 – A Practical Approach

Reference sections: 123(2) and Schedule II

Schedule II to the Companies Act, 2013 requires depreciating the asset over its useful life unlike Schedule XIV of the Companies Act, 1956 which specifies minimum rates of depreciation to be provided by a company.

Normally, prescribed companies who have to follow the accounting standard prescribed under the new act should depreciate the asset over the useful life as prescribed under the act but there is no compulsion. They can use shorter life to depreciate the asset but the same should be disclosed along with the reason of using such shorter life period in “Notes to Account”. Other companies can also depreciate the asset over shorter useful life, but note that useful life cannot exceed the life as prescribed under the act.

Before starting the analysis, let’s go through the Schedule II of the act:

PART ‘A’

1. 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.
2. For the purpose of this Schedule, the term depreciation includes amortisation.
3. Without prejudice to the foregoing provisions of paragraph 1,—

i. In case of such class of companies, as may be prescribed and whose financial statements comply with the accounting standards prescribed for such class of companies under section 133 the useful life of an asset shall not normally be different from the useful life and the residual value shall not be different from that as indicated in Part C, provided that if such a company uses a useful life or residual value which is different from the useful life or residual value indicated therein, it shall disclose the justification for the same.

ii. In respect of other companies the useful life of an asset shall not be longer than the useful life and the residual value shall not be higher than that prescribed in Part C.

iii. For intangible assets, the provisions of the Accounting Standards mentioned under sub-para (i) or (ii), as applicable, shall apply.

PART ‘B’

1. The useful life or residual value of any specific asset, as notified for accounting purposes by a Regulatory Authority constituted under an Act of Parliament or by the Central Government shall be applied in calculating the depreciation to be provided for such asset irrespective of the requirements of this Schedule.

Notes

1. “Factory buildings” does not include offices, godowns, staff quarters.
2. 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.
3. The following information shall also be disclosed in the accounts, namely:—

i. depreciation methods used; and

ii. the useful lives of the assets for computing depreciation, if they are different from the life specified in the Schedule.

1. 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.
2. Depreciable amount is the cost of an asset, or other amount substituted for cost, less its residual value. Ordinarily, the residual value of an asset is often insignificant but it should generally be not more than 5% of the original cost of the asset.
3. The useful lives of assets working on shift basis have been specified in the Schedule based on their single shift working. Except for assets in respect of which no extra shift depreciation is permitted (indicated by NESD in Part C above), if an asset is used for any time during the year for double shift, the depreciation will increase by 50% for that period and in case of the triple shift the depreciation shall be calculated on the basis of 100% for that period.
4. From the date this Schedule comes into effect, the carrying amount of the asset as on that date—

a. shall be depreciated over the remaining useful life of the asset as per this Schedule;

b. after retaining the residual value, shall be recognised in the opening balance of retained earnings where the remaining useful life of an asset is nil.

1. ‘‘Continuous process plant’’ means a plant which is required and designed to operate for twenty-four hours a day.

Analysis:

Firstly let us understand the concepts related to depreciation:

i. Useful Life: life over which asset can be used subject to maximum as specified in the act.

ii. Depreciable Amount: Cost of Asset – Residual Value

iii. Residual Value: Generally not more than 5% of original cost (Note 5 of Schedule II)

iv. Carrying Amount: Not defined in the act. AS-28 defines carrying amount as the amount at which an asset is recognised in the Balance Sheet after deducting any accumulated Depreciation (amortization) and accumulated impairment losses thereon”.

Issue: Problem which arises here is that note 7 of Schedule II of the act says the asset is to be depreciated over its carrying amount but AS-28 doesn’t give any reference of residual value. So, on which value the asset is to be depreciated – WDV or WDV less residual value??

Our Opinion: Many of the articles & notes we have gone through say carrying amount is WDV of the asset. Residual value is not to be considered again while calculating depreciation under the new act i.e. (SLM method):

1.	Original Cost	100
2.	Original Useful Life (Co Act, 1956)	20 years
3.	Depreciation rate (Co Act, 1956)	4.75 years
4.	New Useful Life (Co Act, 2013)	15 years
5.	Expired Life	10 years
6.	Accumulated Depreciation	47.50
7.	Carrying Amount (1-6)	52.50
8.	Depreciation per year for next 5 years (52.50/5)	10.50

But if we depreciate without taking into account residual value:

1.	Original Cost	100
2.	Accumulated Depreciation under old act	47.50
3.	Depreciation for the next 5 years (10.50*5)	52.50
4.	Total Depreciation (3+4)	100
5.	Residual Value (1-4)	0

That means we are ignoring the residual value. At the end of the useful life, value in balance sheet will be zero which is against the basic concept of the act. Note 7(b) of the schedule says to retain the residual value and transfer the rest to retained earnings. So, the same concept must apply here. Therefore, it should be in this way:

1.	Original Cost	100
2.	Original Useful Life (Co Act, 1956)	20 years
3.	Depreciation rate (Co Act, 1956)	4.75 %
4.	New Useful Life (Co Act, 2013)	15 years
5.	Expired Life	10 years
6.	Accumulated Depreciation	47.50
7.	Carrying Amount (1-6 –Residual Value [5%])	47.50
8.	Depreciation per year for next 5 years (47.50/5)	9.50
9.	Depreciation for the next 5 years (9.50*5)	47.50
10.	Total Depreciation (6+9)	95
11.	Residual Value (1-4)	5

 We welcome suggestions on this aspect, kindly mail your opinions/suggestions at the email id given at the end.

Calculating Depreciation under WDV method:

1.	Original Cost	100
2.	Original Useful Life (Co Act, 1956)	20 years
3.	Depreciation rate (Co Act, 1956)	13.91 %
4.	New Useful Life (Co Act, 2013)	15 years
5.	Expired Life	5 years
6.	Remaining Useful Life (4-5)	10 years
7.	Accumulated Depreciation	52.71

 Depreciation will not be calculated over 15 years. It will be calculated over 5 years only.

Formula to calculate WDV rate:

We will like to discuss how to calculate such square root:

First divide 5,000/1,00,000 : 0.05

Press under root button 12 times

Subtract 1

Divide by factor, here 10

Add 1

Press (* =) 12 times

After these, amount 0.7412

Now, 1 – 0.7412 = .2588 i.e. 25.88 %

Here, Carrying Amount = 100 – 52.71 = 47.29

Year	Closing Balance
1	35.05
2	25.98
3	19.26
4	14.27
5	10.58
6	7.84
7	5.81
8	4.31
9	3.19
10	2.37

 Though residual value is not 5% of the original cost, its 5% of carrying cost. This method can be applied. More appropriate method is welcomed.

Now, what if asset has served for than useful life as prescribed under Companies Act, 2013!!

If say, asset has served 15 years till now and Schedule II specifies useful life of 15 years only, then transfer the amount i.e. Carrying Amount – Residual Value (5% of original cost) to retained earnings (reserves) – Note 7b of the schedule.

The problem which will arise here is that companies will have to calculate depreciation of each asset differently according to its useful life.

Suggestions are welcomed. Also, kindly brief us if more appropriate method can be used.