Depreciation Rules Under New Companies Act 2013

The Companies Act, 2013 [henceforth ‘the act’] has become new legislation for corporate India. The act has replaced six decades old legislation and overhauled the corporate functioning. The act marks a major step forward and appreciates the current economic environment in which companies operate. It goes a long way in protecting the interests of shareholders and removes administrative burden in several areas. The act is also more outward looking and in several areas attempts to align with international requirements. The act is landmark legislation and is likely to have far-reaching consequences on all companies operating in India. We are getting close to 1 million registered companies in India. A strong company legislation is therefore imperative.

There are lot many changes in new companies act as compared to old act. The scale of change can be assessed from the rules those are finally issued. These changes would need to be assimilated as most of the sections of the act have come into force as on 1^st April, 2014. One of such key changes is related to regulations governing depreciation provisions.

Depreciation

As per Accounting Standard-6, 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 a non-cash flow expense for an entity. The purpose of depreciation is to charge to expense a portion of an asset that relates to the revenue generated by that asset. Depreciation has a significant effect in determining and presenting the financial position and results of operations of an enterprise.

Section 123 of the act stipulates that depreciation shall be provided in accordance with the provisions of Schedule II. And section 123 along with Schedule II of the act has been notified w.e.f 1^st April, 2014. The act has brought a major alteration in the regulations governing depreciation provisions.

As per Schedule II of the act, Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. It is further stated that the term depreciation includes amortization.  Amortization of intangible assets is to be done as per notified accounting standard.

Applicability of section 123 & Schedule II

Ministry of Corporate Affairs [MCA] vide General Circular 08/2014, has clarified that although Provisions of Schedule II (Useful lives to compute depreciation) and Schedule III (Format of financial statements) have also been brought into force from 1^st April, 2014; the said provisions would become applicable in respect of financial statements of financial years commencing on or after 1* April, 2014.

So for F.Y. 2013-14, depreciation rules stipulated under the Companies Act, 1956 are to be adhered. And from F.Y. 2014-15 onwards, provisions stated in The Companies Act, 2013 will come into force.

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.

The Companies Act, 1956 requires depreciation to be provided on each depreciable asset so as to write-off 95% of its original cost over a specified period. The remaining 5% is treated as residual value. 100% Depreciation can be charged on assets whose actual cost does not exceed Rs.5,000/-

In Companies Act, 2013 it is clarified that residual value of the asset can not exceed 5% of original cost of the asset. Further, the provision for 100% Depreciation on immaterial items i.e., assets whose actual cost does not exceed Rs.5,000/-. is omitted.

v  Useful life :

‘Useful life’ may be considered as a period over which an asset is available for use or as the number of production or similar units expected to be obtained from the asset by the entity. Part-C to Schedule II has prescribed the useful life for various categories of tangible fixed assets. There are 15 categories of assets mentioned. And the useful life mentioned under it is different than that of The Companies Act, 1956.

Hence, due to such change in the useful lives of the assets many companies will now need to charge much higher depreciation in the books of accounts as compared to earlier rates, specially considering the fact the backlog of depreciation not provided will have to be divided amongst the remaining residual life of the asset.

Eg:-  X Ltd. has purchased Machinery whose 10 years of life has already expired. Now up to 10 years company was providing depreciation at the rate of 4.52% (95/21). That means X Ltd. has already provided 45% (4.52*10 years). So, now as per Schedule II the remaining useful life is only 5 years. Hence, for these 5 years it will have to provide depreciation at a higher rate of 10% (50/5 years).

v  Component approach :

Schedule II of the act also states that the specified useful lives are for the whole of the asset. When the cost of a part (component) 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 should be determined separately.

This indicates that companies are now required to adopt what is known as the ‘component approach’ to compute depreciation on fixed assets. A company will have to estimate the useful life of such a component (since it may not be provided in Schedule II) and depreciate the cost of that specific component over this estimated useful life.

The requirement to adopt a ‘component approach’ similar to that envisaged in Ind-AS, may be an onerous requirement for capital intensive companies since there will be significant effort involved in estimating useful lives for components.

v  Depreciation rates :

In Schedule XIV of The Companies Act, 1956 the rates provided were minimum rates; hence a company was having liberty to charge depreciation at the rates more than minimum one. And on the other hand, in Schedule II of The Companies Act, 2013 nowhere depreciation rates are specified. So, it is to be construed that a company has to charge depreciation at  the same rates over the years. 

Schedule XIV of The Companies Act, 1956 provides separate depreciation rates for double shift and triple shift use of assets.

No separate rates are prescribed for extra shift depreciation. Schedule II provides that Extra Shift Depreciation [ESD] is not applicable to items marked NESD. ESD will apply to plant and machinery items subject to general rate- i.e., useful life of 15years. It has further specified the working of ESD. It provides:-

Ø  50% more depreciation for that period for which asset is used for double shift and

Ø  100% more depreciation for that period for which asset is used for triple shift.

v  Method of Depreciation :

The Schedule XIV to the Companies Act, 1956 prescribes the rates of Straight Line Method [SLM] and Written Down Value[WDV] at which depreciation on various assets need to be provided.

In Schedule II, only useful life is provided, therefore the entity is required to calculate the appropriate rate of depreciation as per the method used by it (SLM or WDV).

v  Classification of Companies :

All companies are divided into the following three classes to decide application of depreciation

(1)   Class of companies as may be prescribed and whose financial statements comply accounting standards prescribed for such class of companies -

These companies will typically use useful lives and residual values prescribed in the schedule II. However, these companies will be permitted to adopt a different useful life or residual value for their assets, provided they disclose jurisdiction of the same.

(2)   Class of companies or class of assets where useful lives or residual value are prescribed by a regulatory authority constituted under an act of the Parliament or by the Central Government -

These companies will use depreciation rates or useful lives and residual values prescribed by the relevant authority for depreciation purposes.

(3)   Other companies -

For these companies, the useful life of an asset will not be longer than the useful life and the residual value will not be higher than that prescribed in the proposed Schedule II.

v  Carrying amount of the asset :

From the date of the Companies Bill coming into effect, the carrying amount (WDV) of the asset as on that date:

§  Will be depreciated over the remaining useful life of the asset according to Schedule II;

§  After retaining the residual value, will be recognized in the opening retained earnings where the remaining useful life is nil.

Potential issue

u The useful life of an asset can be the number of production or similar units expected to be obtained from the asset. This indicates that a company may be able to use Units of Production method for depreciation, which is currently prohibited for assets covered under Schedule XIV of The Companies Act, 1956.

u Companies, covered under class (i) above, will be able to use different useful lives or residual values, if they have jurisdiction for the same. It appears that this provision is aimed at ensuring compliance with Ind-AS 16 for such companies. However, they are likely to be able to start using this option immediately, and need not wait for Ind- ASs to become applicable.

u The application of component accounting is likely to cause significant change in accounting for replacements costs. Currently, companies need to expense such costs in the year of incurrence. Under the component accounting, companies will capitalize these costs, with consequent expensing of net carrying value of the replaced part.

u In case of revaluation, depreciation will be based on the revalued amount. Consequently, the ICAI guidance may not apply and full depreciation on the revalued amount is expected to have significant negative impact on P & L account.

u In case of assets with a nil remaining useful life on the date Schedule II of the act comes into effect, the transitional provisions require that the carrying amount is written off to retained earnings. In other words, the carrying value never gets charged to the P&L account.

u Overall, many companies may need to charge higher depreciation in the P&L because of pruning of useful lives as compare to earlier specified rates. However in some cases, the impact will be lower depreciation, i.e., when the useful lives are much longer compared to the earlier specified rates, such as metal pot line, bauxite  crushing and grinding section used in manufacture of non-ferrous metals.

Conclusion

Although section 123 & Schedule II of the act has been notified, the depreciation provisions are not to be considered for F.Y. 2013-14. But, from next year onwards, the said provisions would have a lot of impact on all the companies in India. So it is a dire need for all of us to understand these provisions, as it would affect accounting of depreciation of companies. Also, while doing audit, it is to be checked that depreciation charged is as per Schedule II of the act.

This Article has been shared by Saurabh Wagle. He can be reached at saurabh.wagle@gmail.com