This article is written by Ms. Sushree Surekha Choudhury, a law graduate from KIIT School of Law, Bhubaneswar. The article talks about the Schedule II of the Companies Act, 2013 and its role in calculating depreciation and amortisation which is essential for any company or business.
It has been published by Rachit Garg.
Table of Contents
Introduction
Anywhere you read or anyone you ask will tell you that depreciation refers to the “loss in the monetary value of an asset.” Well, because it is true (smiles). Since you hear it almost everywhere, I think you already know this term and its meaning. So, how about we make an attempt to understand the concept in an easier and more fun way? Fun ways and practical explanations go hand in hand when it comes to law. Therefore, let us assume a situation. A situation where you are a multimillionaire. You regularly buy, possess and sell different assets, both for business purposes as well as for personal uses. Now let us suppose you buy an asset recently. It can be anything. Let us go with the example of a mobile. You buy the latest version of your favourite mobile series. You use it for, say 4 years, and then update it with the newer version of it. It might seem like a normal mobile buying and exchanging procedure, no? But have you thought about why you do it? There can be plenty of reasons. You may have bought the newer version because, with its launch, the older version seems to have lost its value. It may also so happen that your old mobile is no longer useful due to different technical or other problems that have started occurring. Therefore, deciding to acquire a new mobile and let go of the old one.
Now, in this very example, let us understand the concept of depreciation. When you bought your mobile 4 years ago, it was in its best condition and supported by the latest technology. It possessed high value due to these factors. Over the period of time in which you used it, it started depreciating in its value due to wear and tear, usage over a period of time and finally with the launch of an updated version of it. Therefore, at the time when you exchanged this mobile, it was sold at a much cheaper value than what you bought it for. Sounds about right? The price at which you bought this mobile is its “initial or original cost.” The period over which it gradually depreciated in value is known as its “useful life.” The total amount depreciated in its value is its “depreciable amount” or “salvage value.” When the depreciable amount is computed and deducted from the initial cost of the asset, what remains is known as its “residual value.” Thus, the mobile depreciates in monetary value over a period of time due to different factors and this is known as “depreciation.”
Schedule II of the Companies Act, 2013 provides guidelines on the useful life of assets for calculating depreciation. The data in Schedule II specifies the duration for which assets can be economically used and outlines minimum depreciation rates based on different asset categories. Certain other provisions of the Companies Act, 2013 are relevant in computing depreciation under Schedule II, such as Section 123 and Section 198 of the Act. The calculation of depreciation is crucial for any company or business in order to determine its financial statement and find out whether the company has gained profits or incurred losses in a given financial year. Depreciation also helps in understanding the revenues generated by an asset or class of assets as compared to the cost incurred in its acquisition and maintenance over a specified period of time. While depreciation determines the loss in the monetary value of tangible assets, it is also necessary and possible to do so for intangible assets. This process of calculating the loss in value of intangible assets is known as amortisation. Similarly, depreciation is calculated for all kinds and forms of assets, such as tangible and intangible assets, movable and immovable assets, etc.
In this article, we will learn everything about depreciation, amortisation and all the relevant concepts. Most importantly, we will learn about the Schedule II of the Companies Act, 2013 in detail and understand how the schedule is used in the calculation of depreciation and amortisation using different methods and formulae.
What is depreciation
Depreciation, in simple terms, refers to the decrease in the monetary value of an asset over a period of time which is called the ‘useful life’ of that asset. The term is used frequently in businesses, factories, industries, and even corporate offices where different kinds of assets form part of everyday use. These assets can be long term or short term, tangible assets or intangible assets, etc. Short term assets are those which the company acquires for a limited period of time, for instance, a machinery for a specific assignment or project. Contrarily, long terms assets are held by the company for indefinite period of time, until their value depreciates or needs replacement. When assets are used over a period of time, their monetary value decreases or in other words, depreciates. This depreciation is due to different factors like wear and tear of the asset, declining demand or usefulness of it, repairs, etc.
Calculating depreciation is essential for any company or business as it helps in obtaining accurate numbers when it comes to understanding the financial statements of the company. Running a business comes with different added costs such as operating costs, distribution and sales, logistics, etc. Depreciation in value of assets includes periodic additions and deductions in the operating cost of the company. It is important to remove expenditures that a company makes every year in the form of payment of interests, loans, taxes, depreciation, and other expenses in order to assess the actual profits made or loss incurred by the company or business. Cumulative depreciation is calculated by clubbing individual depreciation of each asset, and the whole is deducted from the revenue or EBITDA (Earnings Before Interest, Taxes, Depreciation, and amortisation) of the company to obtain an accurate profit or loss statement.
Deducting depreciation is necessary to calculate the net income of the company for each financial year. Only after calculating the net income the profit or loss statement can be estimated accurately. For accuracy in numbers of net income, it is important to deduct variable as well as fixed expenses and depreciation from the gross revenue in each financial year. The Companies Act, 2013 provides a systematic regulatory framework to govern and calculate depreciation. Different provisions of the Act help in the calculation of depreciation using the useful life of assets as mentioned under Schedule II of the Act. While calculating depreciation, a ‘fair proportion value’ of the original value, meaning a proportion from the total value of the asset at the beginning of its purchase is taken into consideration. This proportion value is then deducted from the initial value of the asset to obtain the depreciated value of the asset. While calculating these values, the useful life of an asset is taken into consideration and the calculation is made accordingly.
For instance, an asset is brought for Rs. X, the calculation of its depreciation shall be done at the end of its useful life. The computed depreciable amount will be a ‘fair proportion’ or fragment of Rs. X, which is calculated using the methods of computing depreciation.
For example, suppose a mobile was purchased for Rs. 60,000/- Its depreciation over the useful years will be computed and the amount (suppose Rs. 20,000/- in this case) will be calculated. This amount will be deducted from the initial cost to obtain the cost of the asset at the end of its useful life. This amount that is deducted from the initial cost is known as its ‘fair proportion value.’ Depreciation in the value of different assets at the end of their useful lives is considered as ‘business expenses.’ This includes tangible assets like furniture, machinery, vehicles, etc., as well as intangible assets like patents, copyrights, and trademarks. Depreciation exists and is calculated for both, movable objects like cars, furniture, etc., as well as for immovable property like land and building.
What is amortisation
Amortisation is similar to depreciation in accounting terms as it can be said to be the calculation of ‘depreciation for intangible assets.’ Depreciation is calculated to determine the loss in monetary value of an asset or class of assets that are tangible due to use. Similarly, amortisation is calculated to determine the loss in monetary value of intangible assets. In accounting terms, it is referred to the technique which is used to decrease the book value of a loan or an intangible asset (or class of assets) over a period of time. Therefore, amortisation is used twofold, first, for payment of debts and the accounts thereby, and secondly, in calculating the reduction in the value of intangible assets over a period which is known as their useful life.
Amortisation, helps in determining the accurate profit or loss statement of a company by deducting the amortised value of assets. This also helps in decreasing the tax liability for accounting purposes. Amortisation is relatively more complex to be determined. Amortisation determines the gap between the cost of the asset and the revenue it generates over a period of time. This is measured in reference to the use or consumption of an intangible asset over a period of time which is its useful life. The useful life of any asset is determined as the number of years for which an asset will be and can be used (till the time it produces revenue or other forms of economic benefit), or the total number of units that the asset can produce.
In amortisation, the cost of an asset is written off in value terms over the years as the assets are expensed or used. The useful life of these assets varies depending upon the kind of asset used. The useful life of intangible assets is usually taken to be 10 years in accordance with AS 26. AS 26 is the regulatory norm that sets accounting standards for intagile assets. This data is used in computing amortisation of these assets. However, it can exceed 10 years as well depending upon the use of the asset over a period of time after which its usage decreases or stops. This is also associated with the economic benefits of these assets. An intangible asset’s useful life is till the time it continues to generate revenue or give economic benefits.
Typically, amortisation is calculated as,
Amortised expenses = [(historic cost of acquiring an intangible asset – residual value) ➗ useful life of the asset].
Here,
- The cost of an asset includes the expenses incurred in acquiring and maintaining the asset.
- Residual value refers to the value of the asset at the end of its useful life after periodic written down values.
Guidelines for different types of assets: Schedule II of Companies Act, 2013
Schedule II of the Companies Act, 2013 is an essential part of the calculation of depreciation. Schedule II of the Act talks about the useful life of different assets and classes of assets. This estimated and predetermined data of the useful lives of assets are used in the calculation of depreciation. Thus, Schedule II of the Act talks about the “useful lives to compute depreciation.” The schedule is divided into three parts, namely, Part A, B, and C. Before understanding these parts, it is important to learn about the other relevant provisions of the Companies Act to gain a systematic understanding of the concept.
Companies Act, 2013: relevant provisions
The Companies Act, 2013 talks about depreciation through its different provisions. Section 198 and subsequently, Section 123 of the Companies Act, 2013 are the provisions directly related to computing depreciation by using the Schedule II of the Act.
Section 198 of Companies Act, 2013
Section 198 of the Companies Act, 2013 talks about calculating the profits of a company in a given financial year. As we have discussed earlier, calculating the revenue statement is necessary for any company and business in order to understand their profits or loss statement made during the particular year. As per Section 198 of the Act, the profit or loss statement can be calculated and obtained by making certain inclusion and deducting expenses wherever required.
Section 198, sub-section 4 talks about all such deductions that are needed to be done in order to obtain the profit or loss accounts. Sub-section 4 talks about the following deductions like working charges, special taxes paid by the company, contributions made by the company under Section 181, etc. Sub-section (4) clause (k) talks about Depreciation as per Section 123. Thus, Section 198, sub-section 4, clause (k) talks about depreciation as a deduction to obtain the profit or loss accounts of the company in any given financial year. This clause states that depreciation shall be calculated as per the provisions of Section 123. Schedule II of the Act, too, guides us to refer to Section 123 of the Act first. Therefore, we must learn about this section before moving further with understanding Schedule II of the Act.
Section 123 of Companies Act, 2013
Section 123 is like the binding atom that binds all the relevant provisions under the Companies Act, 2013 in the calculation of depreciation. Sections 123 and 198 are greatly interconnected in the way that Section 123 talks about the declaration of dividends and the mandatory calculation of profits or loss statements in doing so. While Section 198 guides in calculating the profits made or losses incurred by the company or business in a given financial year by taking into account certain additions and deductions, Section 123 focuses on such calculation of profit or loss accounts in order to declare dividends.
Once the profit or loss statement is obtained, the company can declare dividends for a particular financial year. All these provisions ultimately lead to the most essential part of our topic in hand, i.e., Schedule II for computing depreciation. Section 123 sub-section 1 states that dividends shall be distributed by the company only when the company has made profits. In determining so, we calculate depreciation to deduct from the total revenues. Section 123 sub-section 2 states that for the purpose of this section and all others, depreciation shall be calculated using Schedule II of the Act.
Schedule II of Companies Act, 2013
Schedule II, where Section 123 kept directing us to, talks about computing depreciation using the useful life of different assets and classes of assets. The schedule is divided into three parts talking about the computation of depreciation.
Part A
Part A of the schedule is like a basic introduction to the concept of depreciation and its calculation. Part A describes depreciation as the “systematic allocation of the depreciable amount of an asset over its useful life.” As already discussed, the depreciable value of an asset refers to the reduction in its price over a period of time and it is obtained by deducting the residual value of an asset at the end of its useful life from the initial cost of the asset.
For the purposes of this part and Schedule II, depreciation also includes the calculation of amortisation. For computing amortisation, the Indian Accounting Standards (Ind AS) are followed. In cases where the Indian Accounting Standards are not applicable, the Companies (Accounting Standards) Rules, 2006 and the accounting standards therein are followed and applied. Exceptions are provided for toll roads in any form of public-private partnership routes (road projects).
Further, Part A specifies that for computing the depreciation in value of assets, the useful lives shall be taken as it is mentioned in Part C of this schedule. It also specifies that the residual value for any asset shall not exceed 5 per cent of the cost of its initial cost. If any company or business chooses to use the information from elsewhere and calculate the useful life of assets or residual value in any other manner, such company or business must disclose such information in their annual financial statement. Such disclosure must be accompanied by technical support and evidence.
Part A also specifies the modes of computing the rate and amount of amortisation for the purpose of toll roads exception under this schedule and the calculation of depreciation for the same. In these cases, the amortisation rate and amortisation amount can be calculated as:
Amortisation rate = (amortisation amount ➗ cost of the intangible asset) ✖100, and
Amortisation amount = cost of intangible asset ✖ (actual revenue of the year ➗ projected revenue from the intangible asset).
Here,
- Cost of intangible assets refer to the cost incurred for the intangible asset as per the accounting standards.
- Actual revenue refers to the revenues (toll charges) generated by the intangible asset in a given financial year.
- Projected revenue refers to the promised or warranted future revenues by the project lender in the financial agreement or closure.
- The whole of the amortised amount shall be taken into consideration over the concession period.
Part B
Part B of Schedule II gives overriding powers to government norms. It states that even though the Companies Act, 2013 specifies useful lives under this schedule and provides a mode for the calculation of depreciation. The government can specify the useful life for certain assets or classes of assets when they feel the need to do so, and every company or business in possession of those assets shall use the government specified useful lives instead of the useful lives specified under Schedule II of the Companies Act, 2013 or any other rules for that matter. Therefore, any Regulatory Authority of the Central Government or established by an Act of Parliament can specify the useful lives or residual value for certain assets, notwithstanding any provision of Schedule II of the Companies Act, 2013 or any other provision.
Part C
The most talked part of Schedule II, Part C, talks about the useful lives of different assets and classes of assets. Part C of the schedule makes a list of the following nature of assets and their specific useful lives:
| Particulars | Useful life |
| Buildings (NESD) | |
| Buildings with RCC frame structure | 60 years |
| Buildings without RCC frame structure | 30 years |
| Factory buildings | 30 years |
| Fence, wells, tube wells | 5 years |
| Others | 3 years |
| II. Bridges, culverts, bunders, etc. (NESD) | These assets are estimated to have a useful life of 30 years. |
| III. Roads (NESD) | |
| Carpeted roads | |
| (i) With RCC | 10 years |
| (ii) Without RCC | 5 years |
| Non-carpeted roads | 3 years |
| IV. Plants and machinery (NESD) | |
| (i) General plant and machinery | |
| Other than continuous process plants | 15 years |
| Continuous process plants | 25 years |
| (ii) Special plant and machinery | |
| Used in motion films | |
| Cinematographic films | 13 years |
| Projecting equipment in film exhibitions | 3 years |
| Used in glass manufacturing | |
| Regenerative glass melting furnaces | 13 years |
| Moulds (NESD) | 8 years |
| Float glass melting furnaces (NESD) | 10 years |
| In mines and quarries | Portable machinery used underground or those used in open cast mining have an estimated useful life of 8 years. |
| In telecommunications | |
| Towers | 18 years |
| Telecom network equipment like transceivers, switch centres and others | 13 years |
| Ducts, cables and optical fibres | 18 years |
| Satellite | 18 years |
| In oil and gas industry | |
| Refineries | 25 years |
| Oil and gas assets (including wells), processing plants and facilities | 25 years |
| Petrochemical plants | 25 years |
| Storage tanks | 25 years |
| Pipelines | 30 years |
| Drilling rigs | 30 years |
| Field operation tools like drilling tools, well-head tanks and others | 8 years |
| Loggers | 8 years |
| In power industry | |
| Thermal/gas/combined cycle power generation plant | 40 years |
| Hydro power generation plant | 40 years |
| Nuclear power generation plant | 40 years |
| Network assets like transmission lines and cables | 40 years |
| Wind power generation plant | 22 years |
| Electric distribution plant | 35 years |
| Gas storage and distribution plant | 30 years |
| Water distribution plant and pipelines | 30 years |
| In the manufacture of steel | |
| Sinter plant | 20 years |
| Blast furnace | 20 years |
| Coke ovens | 20 years |
| Rolling mill in steel plant | 20 years |
| Basic oxygen furnace converter | 25 years |
| In the manufacture of non-ferrous metals | |
| Metal pot line (NESD) | 40 years |
| Bauxite crushing and grinding section (NESD) | 40 years |
| Digestor section (NESD) | 40 years |
| Turbine (NESD) | 40 years |
| Calcination equipment (NESD) | 40 years |
| Copper smelter (NESD) | 40 years |
| Grinder | 40 years |
| Soak pit | 30 years |
| Annealing furnace | 30 years |
| Rolling mills | 30 years |
| Scalping, slitting equipment (NESD) | 30 years |
| Miners, dozers | 25 years |
| Copper refining plant (NESD) | 25 years |
| For medical purposes | |
| Electrical machinery, x-ray apparatus and accessories, diagnostic equipment like cat-scan, ECG monitors, ultrasound machines and others | 13 years |
| Other equipment | 15 years |
| In the pharmaceutical and chemicals industry | |
| Reactors | 20 years |
| Distillation columns | 20 years |
| Drying equipment/centrifuges and decanters | 20 years |
| Storage vessels/tanks | 20 years |
| In civil constructions | |
| Road making equipment | 12 years |
| Heavy lift equipment | 15 to 20 years |
| Tunnelling equipment (NESD) | 10 years |
| Earth moving equipment | 9 years |
| Others (NESD) | 12 years |
| In salt works | 15 years |
| V. Furniture and fittings (NESD) | |
| (i) general furniture and fittings | 10 years |
| (ii) other furniture and fittings (usually used in hotels, restaurants, schools and other educational institutions, libraries, welfare centres, etc., or lent out for functions like marriages, etc.) | 8 years |
| VI. Motor vehicles (NESD) | |
| Motor cycles, scooters and other mopeds | 10 years |
| Motor buses, lorries, cars, taxies (used in businesses or run on hire) | 6 years |
| Motor buses, lorries, cars, taxies (used other than in businesses or run on hire) | 8 years |
| Motor tractors, heavy vehicles and harvesting combines | 8 years |
| Electrically operated vehicles like battery powered vehicles or fuel cell powered vehicles | 8 years |
| VII. Ships (NESD) | |
| Ocean going ships | |
| (i) Bulk carriers and liner vessels | 25 years |
| (ii) Crude tankers, product carriers and chemicals carriers (with or without conventional tank coatings) | 20 years |
| (iii)(a) Chemicals and acid carriers with stainless steel tanks | 25 years |
| (iii)(b) Chemicals and acid carriers with other tanks | 20 years |
| (iv) Gas carriers (liquified) | 30 years |
| (v) Conventional large passenger vessels (also used for cruise) | 30 years |
| (vi) Coastal service ships (all categories) | 30 years |
| (vii) Offshore vessels for supply and support | 20 years |
| (viii) High speed ships and boats like catamarans | 20 years |
| (ix) Drill ships | 25 years |
| (x) Hovercrafts | 15 years |
| (xi) Fishing vessels | 10 years |
| (xii) Ships used for dredging purposes | 14 years |
| Inland water running vehicles | |
| (i) Speed boats | 13 years |
| (ii) Other vessels | 28 years |
| VIII. Aircrafts or helicopters (NESD) | These assets are estimated to have a useful life of 20 years. |
| IX. Railway sidings, locomotives, rolling stocks, tramways and railways used by concerns, excluding railway concerns (NESD) | These assets are estimated to have a useful life of 15 years. |
| X. Ropeway structures (NESD) | These assets are estimated to have a useful life of 15 years. |
| XI. Office equipment (NESD) | These assets are estimated to have a useful life of 5 years. |
| XII. Computers and data processing units (NESD) | |
| (i) Networks and servers | 6 years |
| (ii) Desktops, laptops and other end user devices | 3 years |
| XIII. Laboratory equipment (NESD) | |
| (i) General laboratory equipment | 10 years |
| (ii) Laboratory equipment used in educational institutions | 5 years |
| XIV. Electrical installations and equipment (NESD) | These assets are estimated to have a useful life of 10 years. |
| XV. Hydraulic works, pipelines and sluices (NESD) | These assets are estimated to have a useful life of 15 years. |
All these assets’ useful lives are estimated as a general rule, for ‘one shift’ of use. However, certain assets may be used for extra shifts. NESD refers to “no extra shift depreciation.” Assets which are put under the NESD category do not depreciate in their useful lives when used for extra shifts. Thus, no extra shift depreciation is calculated for those assets when such extra shifts are applicable.
Important points about Schedule II
While calculating depreciation as per the provisions of Schedule II of the Act, the following pointers are to be kept in mind:
- For the purpose of this schedule, “factory buildings” does not include ‘offices,’ ‘godowns,’ or ‘staff quarters.’
- At times, it may so happen that an asset is bought and added or sold, discarded, demolished, destroyed, or given away in between a financial year. This means that the asset did not complete a full financial year cycle. In these situations, the depreciation for those assets will be calculated on a pro-rata basis. A pro-rata calculation of depreciation computes the depreciation of any asset on the basis of ‘portions’ or ‘proportions.’ Thus, depreciation for these assets will be calculated from the date on which it was added or till the date on which it was sold/destroyed/demolished/discarded. For instance, company A added a new machine in their factory in the month of October 2020. They use it until May 2023 after which the company decides to sell the machine. In this case, the depreciation will be calculated in a pro rata basis from the month and year it was added up till the month and year it was used. This is different from an usual financial year which begins in the 1st of April of every year and ends on the 31st of March in the next year.
- Disclosure requirements are mandatory while declaring the financial statements of a company or business. A company is mandated to comply with all the disclosure requirements as per the Act and other regulations. When the depreciation is computed and used in obtaining the financial statement, it is mandatory to disclose details about the same in the financial statement made by the company. The financial statement must provide information such as the mode or method of computing depreciation used by the company or business. It shall also disclose the useful lives taken into consideration for any or all of the assets if that information differs from the useful lives as provided by Schedule II of this Act.
- Where Part C specifies the useful life of certain assets, it does so for the whole of that asset. Sometimes assets are combined together to form another asset. These portions or assets that form part of the whole can be significant assets with specific useful lives of their own. When such assets exist with significant useful lives, their useful lives are separately considered for the purposes of calculation of depreciation.
- Depreciation calculated using the useful life of assets as per Schedule II is specific to a single shift use of those assets. Anytime when an asset is used for more than one shift, the depreciation shall be calculated accordingly. For instance, when an asset is used for two shifts (double shift depreciation), the useful life and rate of depreciation of that asset will be increased by 50% for that specific period. Similarly, depreciation will be increased by 100% in case the asset is used for three shifts (triple shift depreciation). The only exception to this general rule is when an asset is specifically classified as “NESD” or the “no extra shift depreciation” category. In this case, the useful life or rate of depreciation will not be increased even when an asset is used for extra shifts.
- For the purposes of this schedule, “continuous process plant” refers to a plant which is designed in a manner for operating 24 hours a day and is also required to do so.
- Schedule II of the Companies Act, 2013 is always read along with Section 123 of this Act.
Calculation of depreciation using Schedule II of Companies Act, 2013
Now that we have understood the necessary parameters and factors for calculating depreciation, it is essential to understand how it is done. The useful lives of assets provided under Schedule II are used to calculate depreciation in the manner and using the methods that we will discuss in this segment of the article. Certain steps are followed in the process of calculation and deduction of depreciation. First, the sum-total of all the money made by the company is calculated. This is known as the gross revenue and is calculated as the total units of products sold multiplied by the price of each unit or the services provided and the price charged for each service.
I.e., Gross revenue = units of products sold ✖ price of each unit, or
Gross revenue = services provided ✖ price of each time of service.
When gross revenue is calculated, the next step is to calculate net revenues. Returns and discounts are deducted from gross revenue to get net revenue. Returns refer to the products returned to the company or services that were cancelled for any reason. Discounts are given by the company at different stages of sales.
I.e., Net revenue = gross revenue – returns – discounts.
Therefore, net revenue is the total revenue generated by the company before deducting business expenses like depreciation, amortisation, taxes, interests and other expenses. This is the EBITDA of the company. Depreciation and amortisation are deducted from this value to obtain the EBIT of the company. Hereafter, taxes and interests are paid, any pending loans or EMIs are paid, and all other expenses are paid off. The amount which is obtained after the payment of all these expenses is the net profits or loss of the company. If after making the deductions, the remainder is a positive value, the company has made profits in that financial year. If this value is on the negative side, then the company has incurred losses in that particular year.
I.e., EBIT = EBITDA – (depreciation + amortisation), and
Net profit/burn = EBIT – (interests + taxes).
Method of calculating depreciation
There are commonly used methods of calculating depreciation, such as the straight line method (SLM), the written down value (WDV) method, the units of production (UOP) method, the sum of the years’ digits depreciation method, and the double declining balance method. Each of these methods uses different variables like the cost of an asset, the scrap value, the useful life, the book value of assets, etc. To learn more about these methods of calculating depreciation, kindly visit Depreciation as per Companies Act, 2013 – iPleaders.
The Companies Act, 2013 prescribes the calculation of depreciation using the ‘useful life assets. This can be used in calculation using the straight line method or the written down value method as well. The newly framed “Units of Production” (UOP) method takes into consideration the ‘units’ of an asset used or produced for determining depreciation instead of using their useful life as a period of time. The units of production method uses the number of units produced over a period of time to determine depreciation. As used in the other two methods, the useful life of assets as mentioned in Schedule II of the Companies Act, 2013 to calculate depreciation is considered. This method is used to calculate the depreciation in value of an asset over a period of time which is known as its ‘useful life.’
Straight line method (SLM)
The straight line method calculates depreciation as,
Depreciation = (cost of an asset – salvage value) ➗ useful life of that asset.
Here,
- The cost of an asset is the price at which the asset was purchased.
- Salvage value refers to the value of the asset at the end of its useful life.
- Useful life refers to the useful life of any particular asset as mentioned under the Schedule II of the Act.
Written down value (WDV) method
Written down value method calculates depreciation as,
Depreciation = (cost of an asset – salvage value) ✖ rate of depreciation.
Here,
Rate of depreciation = [ 1 – (salvage value ➗ initial cost of the asset) ^ 1/n ] ✖ 100
- The cost of an asset is the price at which the asset was purchased.
- Salvage value refers to the value of the asset at the end of its useful life.
- Useful life (n) refers to the useful life of any particular asset as mentioned under the Schedule II of the Act.
Double declining balance method
Depreciation is calculated using this method as,
Depreciation = 2 ✖ SLDV ✖ BV.
Here,
- SLDV or straight line depreciation value refers to the depreciation amount obtained using the straight line method.
- BV refers to the book value of an asset at the beginning of a financial year.
Sum of years’ digit depreciation method
The sum of years’ digit method can be used to calculate depreciation as,
Depreciation = (number of useful years ➗ sum of useful years) ✖ depreciable amount.
Here, the sum of useful years is obtained by totalling the number of useful years. For instance, if the total useful life is 4 years, the sum of useful years will be 4 + 3 + 2 + 1 = 10.
Units of production (UOP) method
This method uses the data of the total productive capacity of an asset to calculate depreciation. Using the units of production method, depreciation is calculated as,
Depreciation = depreciable value ✖ (units produced during the year of use ➗ estimated total production).
Here, depreciable value = initial value of an asset – salvage value of the asset.
Conclusion
Computing depreciation can be tricky but it is also crucial. A company or business can choose any method for calculating depreciation. The Companies Act, 2013 recommends calculating depreciation using the useful life of assets as provided under the Schedule II of the Act. However, a company can choose any other means of data on the useful lives of assets for calculating depreciation as long as they disclose it in their annual financial statements. A company owns many assets in different classes and categories. These can be tangible assets like furniture and fittings, or intangible assets like trademarks, patents, etc. They can also be immovable properties like land and building or movables like cars, machinery, etc. Irrespective of their classes and categories, all these assets lose monetary value over a period of time known as their useful lives and thus, depreciation is calculated for each asset individually. These depreciation values are then clubbed together. This clubbed value is then deducted from the revenue statements of the company, which helps in determining the profit or loss statements.
We began this article with a simpler example of a mobile (tangible asset, movable asset) to understand the concept of depreciation. Now that we have understood the concept in detail and learned computing depreciation using the data provided in Schedule II, let us conclude with a rather complex example. As we already know, depreciation is also calculated for intangible assets and immovable assets. These calculations can be tricky. Let us take an example of a building which is an immovable asset and understand the depreciation of this asset using all the knowledge we have gained so far. A company, business or an individual can own a building for different purposes. This building will depreciate in value over a period of time. As per the data provided under Schedule II, the useful life of a building is 60 years. We also have to take into consideration the land on which the building exists. For calculating the depreciation of this building, we take two factors into consideration – the useful life of the building and the number of years after it is constructed. This number of years after construction is divided by the useful life of the building. This is the depreciable amount which is deducted from the initial cost of acquiring the building to calculate depreciation and residual value. Finally, the price of the land is added to this value to obtain the actual price of the asset at the end of its useful life.
Let us understand it with an example. Let us assume you own a building and plan to sell it after 10 years of possession. Let us calculate depreciation for the same:
- First, the price of land at the time of purchase was 40 lakh INR.
- Further, the cost of constructing the building was 20 lakh INR.
- Thus, the appreciated value of the property after construction is 60 lakh INR.
- Useful life as per Schedule II is 60 years. Thus, the depreciable value is years after construction divided by the useful life, i.e., 10 years / 60 years = 1/6
- This value is deducted from the amount used in constructing the building, i.e., 20,00,000 – (1/6 of 20,00,000) = 20,00,000 – 3,33,333 = 16,66,667 INR.
- Finally, the appreciated value of the property is added to this depreciated value to obtain the price of the property at the end of 10 years, i.e., 16,66,667 + 60,00,000 = 76,66,667 INR.
Therefore, the market value of the property at the end of its desired life in the case of this immovable property is 76.67 lakh INR. This example was crucial because of the complexities involved in the case of immovable properties like land and buildings. Even though in usual cases, the value of any asset depreciates over a period of time, additional costs are added in the case of land and buildings (the appreciated value due to the constructions made in this case) which can increase the overall market value over a period of time. A bit off the context, but this is also why traditionalists believe that real estate is one of the best forms of investment as even with market factors and fluctuations, the investment gives rewarding profits after a period of time.
Frequently Asked Questions (FAQs)
Is it mandatory to follow Schedule II of the Companies Act, 2013 for all companies?
No, companies are not mandated to follow Schedule II for the useful lives of assets to calculate depreciation. However, when they use data from elsewhere, they need to disclose the same in their annual financial statement supported by technical evidence for doing so.
What are the exceptional situations where one can use regulations other than Schedule II?
A company can decide not to use the data provided under Schedule II in the following cases:
- In the case when a Regulatory Authority established under any Act of Parliament or the Central Government specifically prescribes different useful lives for any asset or classes of assets.
- In the case of intangible assets where Ind AS are followed.
- Where a company decides to use other data and discloses the same in its financial statements.
Do you need to wait for a new financial year to begin calculating depreciation for an asset?
No, one does not need to wait for a new financial year to begin to start calculating depreciation for any asset. When any asset is added or removed in the middle of a financial year, the depreciation for such asset shall be calculated on a pro-rata basis from the date it was added or till the date it was used.
What is a standard rule for the estimation of residual value?
The standard rule and general provision is that the residual value of any asset should not be higher than 5 per cent of the initial cost of that asset. However, if and when companies decide to increase this value, they must disclose the same in their annual financial statement.
References
- https://blog.ipleaders.in/depreciation-as-per-companies-act-2013/
- https://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf
- https://corporatefinanceinstitute.com/resources/accounting/types-depreciation-methods/
- https://www.caclubindia.com/articles/overview-of-schedule-ii-of-companies-act-2013-24631.asp
- https://wirc-icai.org/wirc-reference-manual/part5/schedule-ii-rate-of-depreciation-the-companies-act-2013.html
- https://www.mca.gov.in/content/mca/global/en/acts-rules/ebooks/accounting-standards.html
- https://www.mca.gov.in/Ministry/notification/notification_comp_Acct.html
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