Depreciation Provisions under the Companies Act, 2013

CA. Mohan Mittal (9811024242, [email protected])

Overview of some of the key changes in the Schedule II as compared to erstwhile Schedule XIV • Schedule II prescribes indicative useful lives of various assets instead of: Straight Line Method (SLM) Written Down Value (WDV) • For tangible assets only • No life prescribed for intangible assets. Accounting standard-26 to govern the same • Depreciation is systematic allocation of the depreciable amount of an asset over its useful life.

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The depreciable amount of an assets is the cost of an asset or other amount substituted for cost, less its residual value Useful life 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. Schedule XIV of Companies Act, 1956 does not include such requirement. Companies are allowed to follow different useful lives/residual value if an appropriate justification is given supported by technical advice. Component accounting and useful life of a significant part of an asset to be determined separately No separate rate for double/ triple shift; depreciation to be increased based on the double shift/triple shift use of the assets Useful lives of fixed assets prescribed under schedule II are different from those envisaged under Schedule XIV of the Companies Act, 1956. No reference to depreciation on low value assets.

Is it mandatory to provide depreciation every year? • Even if the company is not declaring dividend under section 123? • Even if it is a private company to which section 198 is not applicable? • Answer is “YES”.

Overview • Section 123- Declaration of dividend. • Section 198- computation of net profit for the purpose of calculation of overall maximum managerial remuneration under section 197. • AS 6 - Depreciation accounting. • AS-26- Intangible assets. • Schedule II old Schedule is XIV

Section 123- Declaration of dividend • Sec 123. (1) No dividend shall be declared or paid by a company for any financial year except— – (a) out of the profits of the company for that year arrived at after providing for depreciation in accordance with the provisions of sub-section (2), or out of the profits of the company for any previous financial year or years arrived at after providing for depreciation in accordance with the provisions of that sub-section and remaining undistributed, or out of both; or…

Section 123- Declaration of dividend • 123 (2): For the purposes of clause (a) of subsection (1), depreciation shall be provided in accordance with the provisions of Schedule II.

Sec 197- Managerial Remuneration • 197. (1) The total managerial remuneration payable by a public company, to its directors, including managing director and whole-time director, and its manager in respect of any financial year shall not exceed eleven per cent of the net profits of that company for that financial year computed in the manner laid down in section 198 except that the remuneration of the directors shall not be deducted from the gross profits.

Sec 198- computation of net profits • 198. (1) In computing the net profits of a company in any financial year for the purpose of section 197…. • (4) In making the computation aforesaid, the following sums shall be deducted, namely… – (k) depreciation to the extent specified in section 123;

Schedule II- Useful Lives to Compute Depreciation • Part A• Depreciation is a systematic allocation of the depreciable amount of an asset over its useful life. Useful life is the period over which an asset is expected to be available for use by an entity or the number of production units expected to be obtained from the asset by the entity. • The useful life of an asset shall not be longer than the useful life specified in Part C. • Residual value shall be 5% of the original cost of the asset.

Schedule II- Useful Lives to Compute Depreciation • Part A• Where a company uses a useful life which is different from the limits in Part C, justification for the difference shall be disclosed in its financial statement.

Schedule II- Useful Lives to Compute Depreciation • Part A• For intangible assets, the provision of accounting standards applicable for the time being in force shall apply except for toll roads for which method is prescribed in the Schedule.

Schedule II- Useful Lives to Compute Depreciation • Part B• The useful life and residual value of any specific asset, as notified for accounting purposes by a Regulatory Authority constituted under an Act of Parliament or the Central government shall be applied in calculating the depreciation to be provided for such asset irrespective of the requirement of this Schedule.

Schedule II- Useful Lives to Compute Depreciation Part CNature of asset and their useful life No extra shift depreciation of certain assets. For double shift- 50% more for no. of days worked • For triple shift – 100% more • • • •

Comparative rates- Factory building Schedule II

Schedule XIV

• Useful life - 30 Years

• WDV rate - 10 %

• SLM rate – 3.17 %

• SLM rate - 4.34%

• WDV rate - 9.5 % • Rate of Dep=[1-nth root of R/C}\]*100 • N useful Life. Residual. Cost

• Useful life - 23 years

Comparative rates- other than factory building Schedule II

Schedule XIV

• Useful life - 60 Years

• WDV rate - 5%

• SLM rate - 1.58 %

• SLM rate - 1.63%

• WDV rate - 4.87 %

• Useful life - 58 years

Comparative rates- temporary structure Schedule II

Schedule XIV

• Useful life - 3 Years

• SLM rate - 100%

• SLM rate - 31.67%

• WDV rate - 100%

• WDV rate - 63 %

• Useful life - 0 year

Comparative rates- P & M (General rate) Schedule II

Schedule XIV

• Useful life - 15 Years

• SLM rate - 4.75%

• SLM rate - 6.33%

• WDV rate - 13.91%

• WDV rate - 18.10%

• Useful life - 20 years

Comparative rates- P & M (Continuous process) Schedule II

Schedule XIV

• Useful life - 25 Years

• SLM rate - 5.28%

• SLM rate -

• WDV rate - 15.33%

3.80%

• WDV rate - 11.29%

• Useful life - 18 years

Comparative rates- Furniture & Fixtures Schedule II

Schedule XIV

• Useful life - 10 Years

• SLM rate - 6.33%

• SLM rate - 9.5%

• WDV rate - 18.10%

• WDV rate - 25.89%

• Useful life - 15 years

Comparative rates- Motor vehicle Schedule II

Schedule XIV

• Useful life - 10 Years

• SLM rate - 9.5%

• SLM rate - 9.5%

• WDV rate - 25.89%

• WDV rate - 25.89%

• Useful life - 10 years

SEC. 123 – SCHEDULE –II – PART C OF COMPANIES ACT, 2013 USEFUL LIFE OF VARIOUS ASSETS & RATES OF DEPRECIATION UNDER SLM & WDV CALCULATED TAKING 5% AS RESIDUAL VALUE GeneralRates

Nature ofAssets

UsefulLife SLM InYears Rate

Double Shift

WDVRat SLM e Rate

Triple Shift

WDVRat SLM e Rate

WDVRat e

I BUILDINGS [NESD] (a)

Buildings (other than factory buildings)RCC Frame Structure

601.58%

4.87%

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-

-

-

(b) Buildings (other than factory buildings)other than RC C Frame Structure

303.17%

9.50%

-

-

-

-

(c)

303.17%

9.50%

-

-

-

-

Factory buildings

(d) Fences, wells, tube wells

519.00%

45.07%

-

-

-

-

(e)

331.67%

63.16%

-

-

-

-

Others (including temporary structure,etc.)

I BRIDGES, CULVERTS, BUNDE I RS,ETC. [NESD]

303.17% 9.50%

II ROADS [NESD] I

(a) Carpeted roads (i) Carpeted Roads-RCC

(ii) Carpeted Roadsother than RCC (b) Non-carpeted roads

109.50% 25.89%

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-

-

-

519.00 45.07% %

-

-

-

-

331.67 63.16% %

-

-

-

-

I PLANT AND MACHINERY V General rate applicable to plant andmachinery not covered under special plant and machinery (a) Plant and Machinery other than continuous process plant not cove red under specific industries

156.33% 18.10%9.50% 27.16 12.66 36.21 % % %

(b) continuous process plant for which no special rate has been prescribed under(ii) be low [NESD]

253.80% 11.29%

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Schedule II- Useful Lives to Compute Depreciation • Part C• From the date this schedule comes into effect, the carrying amount of asset on that date: – shall be depreciated over the remaining useful life of the asset as per this schedule. – after retaining the residual value, may(replaced from ‘shall’) be recognised in the opening balance of retained earning where the remaining useful life of an asset is nil.

Revision of depreciation rates • • • • • • • • • • • •

Useful life of machinery (under Sch XIV) -20 yrs Useful life of machinery (under Sch II( - 15 yrs Cost of machinery (installed on 1.4.2009)- Rs. 5,00,000 Depreciation applied under Sch. XIV- SLM 4.75% Per year depreciation Rs. 23,750 WDV as on 1/4/2014 Rs.3,81,250 [5,00,000-(5x23,750=118750)=3,81,250] Remaining useful life under Sch II as on 1.4.2014 - 10 yrs Dep. rate for remaining useful life –SLM 10% [100-5=95-(4.75x5=23.75)=71.25 for 10years Per year depreciation Rs. 35,625 381250-25000=356250. 10% for 10 years

Effect of change in useful life • • • • • • • • •

Useful life of machinery (under Sch XIV) -20 yrs Useful life of machinery (under Sch II( - 15 yrs Cost of machinery (installed on 1.4.1996)- Rs. 5,00,000 Depreciation applied under Sch. XIV- SLM 4.75% Per year depreciation Rs. 23,750 WDV as on 1/4/2014 (after 18 yrs) Rs. 72,500 Remaining useful life under Sch II as on 1.4.2014 – Nil Residual Value 5% of Rs.500000 Rs. 25000 Amount to be debited to opening balance of surplus account or Debited to P&L A/c -Rs. 47,500

1. ABC Limited had considered the minimum rates mentioned in the Schedule XIV of the Companies Act, 1956 for the depreciating all its fixed assets till March 31, 2014. Based on the rates mentioned for SLM and WDV in the Schedule XIV, ABC Limited has derived the useful life for the assets and considered the same useful life for its assets. Schedule II of the Companies Act, 2013 is now applicable to ABC Limited w.e.f. April 1, 2014. Whether ABC Limited needs to follow the useful lives mentioned in the Schedule II or derived useful lives considered till March 31, 2014 can be considered? Response w.e.f. April 1, 2014, ABC limited should follow the useful lives mentioned in the Schedule II for the purpose of calculating depreciation. There is no relevance of the derived useful life as per schedule XIV of the Companies Act, 1956. However, if it follows a different useful life as compared to schedule II, in financial statements it shall disclose such difference and provide justification in this behalf duly supported by technical advice. e.g. ABC Limited was following 4.75% depreciation for single shift under SLM method for its Plant and machinery and accordingly the useful life of the plant and machinery was considered to be 20 years. In accordance with the Schedule II, general plant and machinery needs be depreciated over a period of 15 years. Hence, ABC Limited has two options available either it can follow 15 years as useful life or it can also follow 20 years. If the Company decides to follow 20 years, it needs to disclose it in its financial statements and justification for the same supported by the technical advice.

2. PQR Limited has followed Schedule XIV rates for depreciation of a plant and machinery under WDV method by following rate of 13.91% as it runs under single shift. Date of acquisition is April 1, 2010 and cost incurred is ` 12,50,000 and accordingly WDV as at March 31, 2014 is ` 686,627. On transition to Schedule II, how same will be accounted in the books of account of PQR Limited. Response: In accordance with the transitional provision of Schedule II, if 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, the life of the assets will be 15 years and hence remaining useful life is 11 years. Hence, the balance WDV of ` 686,627 needs to be depreciated over the period of 11 years. Since the Company follows WDV method for depreciation, the WDV needs to be depreciated by following the WDV method over the balance useful life. Hence, the Company needs to calculate the WDV rate for the depreciation. Considering residual value of 5%, the revised WDV rate would be 20%. Hence the depreciation charge for the year 2014-15 would be ` 134,424.

3. Whether it is necessary to review useful life every year? Response: 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 year-end and, if expectations differ from previous estimates, the change(s) shall be accounted for as a change in an accounting estimate in accordance with IndAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. The entity preparing its financial statement applying Ind-AS should comply with the requirement of the Ind-AS 16. The entity preparing its financial statement in accordance with Indian GAAP should frame and implement a policy of periodical review of the useful life of assets.

4. Can a company still have a policy to fully depreciate 100% of cost of asset below certain amount?

Response: The provisions of Schedule XIV to the companies act 1956 allowed 100% depreciation of the cost of an asset having individual value of ` 5000/- or less was based on practices followed by the companies based on the materiality of the financial impact of such charge. 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. The size of the company will also be a factor to be considered for such policy. Accordingly, a company may have a policy to fully depreciate assets upto certain threshold limits considering materiality aspect in the year of acquisition.

5. How to work out Charging of depreciation on pro-rata basis?

Response: Para 24 of the existing guidance note on depreciation accounting of ICAI 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.

6. XYZ Limited a listed company follows December 31 as its financial year. Whether the requirements of the Schedule II are applicable for the year ending December 31, 2014? Response: Schedule II of the Companies Act, 2013 came into force with effect from the 1st April, 2014 and was amended (with effect from 1st April 1, 2014) vide notification number S.O. 237 (E), dated the 31st March, 2014. Further, MCA has also issues notification dated 29th August, 2014 whereby the requirements of 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. For XYZ Limited, requirements of Schedule II other than component accounting will be applicable for the year ending December 31, 2015 and the requirements of the Component accounting will be applicable mandatorily for the year ending December 31, 2016. Hence, in respect of the financial year for the year ending December 31, 2014, requirements of the Schedule XIV of the Companies Act, 1956 will be applicable.

7. DEF Limited is a manufacturing company and it uses its plant and machinery either in single, double shift or triple shift depending upon its production requirements. In accordance with the Schedule II, the useful life of the plant and machinery is15 years. The Company intends to follows the same useful life for the purpose of the depreciating its plant and machineries. How depreciation should be worked out by the Company for the purpose of its financial reporting? Response: As per Schedule II, useful life of plant and machinery is 15 years considering it is used in a single shift and if the company uses the asset on triple shift basis during any subsequent year, depreciation so computed will be increased by 100%. In case of double shift, depreciation will be increased by 50%. Accordingly, DEF limited has to increase the charge by 50% and 100% for the period in which it is using the plant and machinery in double or triple shift.

8. If a company was calculating depreciation charge as per WDV method till 31st March 2014 under the provision of Companies Act, 1956 and wants to shift to SLM method w.e.f 1st April 2014 (or vice versa) whether the same will be covered under transitional provisions as provided in Schedule II of the Companies Act, 2013??

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However, if the company wants to change its method of depreciation from WDV to SLM, it 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. Hence, revised WDV as at March 31, 2014 would be ` 7,62,500 by applying 4.75% SLM rate for five years (` 10,00,000 – ((` 10,00,000*4.75%)*5)). Difference between revised WDV as at March 31, 2014 based on SLM rate and carrying amount in the books at March 31, 2014 i.e. ` 289,606 (` 762,500 – ` 472,894) needs to be credited to the statement of profit and loss. Further, by applying the transitional provisions of Schedule II, balance WDV of ` 762,500 needs to be depreciated over the balance useful life of 10 years considering the residual value of 5%. Hence, depreciation for the year 201415 and yearly depreciation for next ten years would be Rs. 71,250. R={1-(s/c)^1/n}*100 s=50,000 , c=472,894 , n=10 R={1-(50000/472894)^1/10}*100 R={1-(0.105)^1/10}*100 R={1-0.798}*100 R= 20.2% or say 20%

AS 6- Depreciation Accounting • Para 3.1Definition of depreciation: – …Depreciation is allocated so as to charge a fair proportion of the depreciable amount in each accounting period during the expected useful life of the asset.

• Para 29- Main Principles: – The depreciable amount of a depreciable asset should be allocated on systematic basis to each accounting period during the useful life of the asset.

As- 26- Intangible assets 63. The depreciable amount of an intangible asset should be allocated on a systematic basis over the best estimate of its useful life. • There is a rebuttable presumption that the useful life of an intangible asset will not exceed ten years from the date when the asset is available for use. • Amortisation should commence when the asset is available for use.

AS-26- Intangible Asset 72. The amortisation method used should reflect the pattern in which the asset's economic benefits are consumed by the enterprise. • If that pattern cannot be determined reliably, the straight-line method should be used. • The amortisation charge for each period should be recognised as an expense unless another Accounting Standard permits or requires it to be included in the carrying amount of another asset.

The following are the useful lives of various tangible assets:

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9811024242 [email protected] Wednesday, May 06, 2015