Thursday, June 12

Depreciation under Companies Act 2013

Method of Depreciation - Straight Line or Written Down Value (WDV) / Double Declining Balance Method

The new Companies Act 2013 prescribes the Useful life of assets (Schedule II) as opposed the rate of depreciation in the Companies Act 1956.

The plain reading of the act implies that the Ministry of Corporate Affairs (MCA) expects the companies to follow the Straight Line Method of Depreciation as opposed to the Written Down Value of Depreciation. Although it is not prescribed which method of depreciation is required to be used.

If this implication is drawn, this may impact the financial statements significantly as this would result in change of depreciation method for all companies. Moreover, the change in depreciation method would imply retrospective application which can change the financial statements significantly.

There is a breather though. Companies can still opt to continue the Written Down Value Method of Depreciation under the New Companies Act 2013.

Using a simple (huh!) formula, companies can calculate the rate of Depreciation to be charged under Written Down Value Method using the useful life prescribed under the new Companies Act 2013.

Rate of Depreciation = 1 - (Scrap Value / Cost of Asset)^(1/N)
where N is the useful life of the asset.

This method can be applied and accordingly, companies will be able to maintain WDV method of depreciation. Also, even if the rate changes accordingly, since this is a change in estimate, only prospective application would be required.

Residual value
As a general prescription, the Companies Act prescribes that the residual value of the assets should not be more than 5% of the cost of the asset.

Transition Provisions
From the date Schedule III 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 Schedule III;
(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.
Useful Life for specific class of companies
The New Companies Act also mentions that the useful life and residual value of assets should not be different than those mentioned in the Schedule III for specific class of companies (who are complying with Accounting Standards). In case they are different, it should be justified in the financial statements. For other companies, it retains that the useful life is the minimum useful life prescribed for such assets.
  

2 comments:

  1. This formula( 1 - (Scrap Value / Cost of Asset)^(1/N)) proven wrong when asset already depreciated in any of previous years.
    Example if asset purchased on 30.9.2013, Rs 100 old rate of Depre-5% and useful life is 5 years.
    WDV on 31.3.2014=97.5
    This should be depreciated in next 4.5 years.
    Now, after applying this formula we don't get Rs.4.875 after 4.5 years.

    Kindly Suggest the solution for this problem.
    Mail ID: thaker.yash786@gmail.com

    ReplyDelete
  2. What will happen for partial year depreciation for new assets?. This formula doesn't cover the partial year depreciation. So if I buy a machinery on 1.6.2014 how will I calculate the depreciation?

    ReplyDelete