DEPRECIATION

AS 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 allocated so as to charge a fair proportion of the depreciable
amount in each accounting period during the expected useful life of the asset. Depreciation
includes amortisation of assets whose useful life is predetermined.

▪ Depreciable assets are assets which:

(i) are expected to be used during more than one accounting period; and
(ii) have a limited useful life; and Useful life is either (i) the period over which a depreciable asset
is expected to be used by the enterprise; or (ii) the number of
production or similar units expected to be obtained from the use
of the asset by the enterprise.
(iii) are held by an enterprise for use in the production or supply of goods and services, for rental
to others, or for administrative purposes and not for the purpose of sale in the ordinary
course of business.
• Depreciation has a significant effect in determining and presenting
the financial position and results of operations of an enterprise.
Depreciation is charged in each accounting period by reference to the
extent of the depreciable amount, irrespective of an increase in the
market value of the assets.
Depreciable amount of a
depreciable asset is its historical
cost, or other amount substituted
for historical cost in the financial
statements, less the estimated
residual value.
• Depletion: the term ‘depletion’ is associated
with extraction of natural resources like
quarries, mines, etc.
• Amortisation: it means writing off intangible
assets over their useful life.
• Obsolescence: it refers to decline in the
economic value of the asset due to innovation
or improved technique, change in taste or
fashion or inadequacy of existing asset due to
improved demand.
• Assessment of depreciation and the amount to be charged in respect thereof in
an accounting period are usually based on the following three factors:
I. Historical cost or other amount substituted for the historical cost of the
depreciable asset when the asset has been revalued;
II. Expected useful life of the depreciable asset; and
III.Estimated residual value of the depreciable asset.
• Matching Principle requires that the revenue of a given period is matched against the
expenses for the same period.
• This ensures ascertainment of the correct amount of profit or loss.
• If some cost is incurred whose benefits extend for more than one accounting period then it is not
justified to charge the entire costs as expense in the year in which it is incurred.
• Rather such a cost must be spread over the periods in which it provides benefits.
• The rationale of acquisition of fixed asset in a business operation is that these are used in the
earning of revenue.
• It is treated as a charge against the revenue of the corresponding period and must be
deducted before arriving at the net profit.
 DEPRECIATION UNDER COMPANIES ACT 2013
• For the purpose of this schedule, the term depreciation includes amortisation.
• Useful life specified in Part C of the schedule II 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.
• 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.
 DEPRECIATION – HOW TO BE COMPUTED?

• 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% (increase) for that period.

• 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.
 OBJECTIVES OF PROVIDING DEPRECIATION:

1. Ascertain correct profit/loss

2. Show a true and fair view of the financial position.
3. Retain funds out of profit, for replacement
4. Show the assets at their correct value
5. Determine the cost of production
6. Comply with the legal provisions
 RECORDING DEPRECIATION:

• Depreciation can be recorded in the books of account either by :

1. WHEN DEPRECIATION IS CHARGED OR CREDITED TO ASSETS ACCOUNT: crediting the

depreciation to respective asset account

2. WHEN DEPRECIATION IS CREDITED TO PROVISION FOR DEPRECIATION ACCOUNT OR

ACCUMULATED DEPRECIATION ACCOUNT: crediting the depreciation to provision for
depreciation account/ Accumulated Depreciation Account.
WHY??
 RECORDING JOURNAL ENTRY OF
ACCUMULATED DEPRECIATION

when the company sells or disposes of the asset, then this balance of the accumulated
depreciation account will be written off along with the cost of the asset. The entry to
record the same is as follows:
 ACCUMULATED DEPRECIATION
• ADVANTAGES
• The different advantages related to the accumulated depreciation journal entry are as follows:
• It helps in recording all the transactions involving the depreciation of all of the fixed assets of the company thereby
keeping track of the same;
• The accumulated depreciation journal entry credits the accumulated depreciation account every year with the yearly
depreciation figure, the balance of which is shown in the financial statements of the company. This company can get
to know the amount of the total depreciation expense which already has been charged by the company on its assets
since its purchase date;
• DISADVANTAGES
• The different disadvantages related to the accumulated depreciation journal entry are as follows:
• For the companies having a large number of assets, it becomes time-consuming to record every entry related to the
accumulated depreciation.
• As there is the involvement of the humans for recording the accumulated depreciation journal entry, there are
chances of error in it.
 METHODS OF CHARGING DEPRECIATION:
1. STRAIGHT LINE METHOD : it is a method of
providing depreciation under net cost of the
asset (historical cost- realisable value) is written
off equally over the useful life of the asset.
2. WRITTEN DOWN VALUE/ DIMINISHING
BALANCE METHOD : it is a method of providing
depreciation under which a percentage of
depreciation is applied every year on the book
value (i.e. Cost less depreciation)
 EXAMPLE:

STRAIGHT LINE METHOD

 EXAMPLE:

WRITTEN DOWN METHOD Original Cost of Asset = Rs.20,00,000; Depreciation charged @ 10%
QUESTION: (Straight Line Method + Prov. For Dep. A/c.)
SOLUTION:
QUESTION: (SLM + DEP. A/C)
SOLUTION

Contd….
Contd….
NOTES:

3. Calculation of Profit/ Loss on sale of machine: (Rs.)

Value of the machine on 1st April, 2010 32,600
Less: Depreciation for 7 months @ 10% 1902
Book Value on 1st January, 2011 30,698
Less: Depreciation for 10 months @ 10% 2717
Book Value of the machine on the date of sale 27981

Less: Sale proceeds 27400

Loss on sale of Machine 581
QUESTION: (DIMINISHING BAL. + PROV. FOR DEP. A/C)
SOLUTION:

Contd….
QUESTION:
SOLUTION:

Contd….
Contd….
QUESTION:
SOLUTION:
QUESTION:
 SOLUTION :
VALUE OF MACHINERY ACCOUNT AS ON JANUARY1, 2013= ₹ 38,500
DEPRECIATION AS PER INCOME TAX – SECTION 32
 WHAT ARE THE RELEVANT PROVISIONS OF THE
INCOME TAX ACT RELATED TO DEPRECIATION
• THE FOLLOWING PROVISIONS OF THE INCOME TAX ACT, 1961 OVERALL GOVERNS THE
ALLOWANCE OF ‘DEPRECIATION’ AS PER INCOME TAX:

• (I) SECTION 2(11): WHICH DEFINES THE ‘BLOCK OF ASSETS’

• (II) SECTION 32: WHICH DEALS WITH DEPRECIATION ALLOWANCE
• (III) SECTION 32(1)(IIA): WHICH DEALS WITH ADDITIONAL DEPRECIATION IS CERTAIN
CASES
• (IV) SECTION 43(1): DEFINES THE ACTUAL COST OF AN ASSET
• (V) SECTION 43(6): RELATED TO COMPUTATION OF WRITTEN DOWN VALUE
• (VI) SECTION 50: RELATES TO THE COMPUTATION OF DEEMED CAPITAL GAINS ON
TRANSFER OF DEPRECIABLE ASSETS
• (VII) RULE 5 OF INCOME TAX RULES, 1962 READ WITH APPENDIX-1
 DEPRECIATION IN THE YEAR IN WHICH ASSET IS
PURCHASED

• DEPRECATION IS ALLOWED ONLY IF THE ASSET IS PUT TO USE IN THE YEAR OF PURCHASE.
• DEGREE OF UTILISATION OF ASSETS WILL NOT BE CONSIDERED WHILE DETERMINING WHETHER
THE ASSET IS PUT TO USE OR NOT. FOR EXAMPLE IF THE ASSET IS USED FOR TRIAL RUN THEN IT
IS CONSIDERED THE ASSET IS PUT TO USE.
• IF ASSET IS PUT TO USE FOR LESS THAN 180 DAYS THEN AMOUNT EQUAL TO 50% OF THE
AMOUNT CALCULATED USING NORMAL DEPRECIATING RATES IS ALLOWED AS DEPRECIATION.
I.E ASSET PUT TO USE ON OR BEFORE 3RD OCT OF THE YEAR (4TH OCT IN CASE OF LEAP YEAR)
THEN 100% DEPRECIATION IS ALLOWED, OTHERWISE 50%.
• DEPRECATION WILL BE ALLOWED ON THE BASIS OF BLOCK OF ASSET METHOD.
 DEPRECIATION IN SUBSEQUENT YEARS

• IF ASSET IS NOT PUT TO USE IN THE YEAR OF PURCHASE OR PUT TO USE FOR LESS THAN 180
DAYS EVEN THEN FULL DEPRECIATION IS ALLOWED IN THE SUBSEQUENT YEARS IF THE BELOW
CONDITION SATISFIES.
• DEPRECIATION IS ALLOWED ON WHOLE BLOCK OF ASSET EVEN IF ONLY A SINGLE ASSET IN THAT
BLOCK IS USED DURING THE YEAR AT ANY POINT OF TIME.
• IF THE AMOUNT OF WDV COMES AT A NEGATIVE AMOUNT THEN NO DEPRECIATION IS ALLOWED AND
THE AMOUNT WILL BE CONSIDERED AS CAPITAL GAIN AND THE CLOSING WDV WILL BE ZERO.
• IF SUCH AMOUNT IS POSITIVE AND NO ASSET EXISTS IN THE BLOCK THEN SUCH AMOUNT WILL BE
TREATED AS SHORT TERM CAPITAL LOSS AND NO DEPRECIATION IS ALLLOWED.
• THE CAPITAL GAIN/LOSS FROM DEPRECIABLE ASSETS IS ALWAYS TREATED AS SHORT
TERM IRRESPECTIVE OF THE FACT THAT ASSET IS HELD FOR MORE THAN 3 YEARS OR NOT.
• IF THERE IS A LOSS UNDER BUSINESS AND PROFESSION AND THE REASON FOR SUCH LOSS IS
DEPRECIATION, THEN IT IS CALLED UNABSORBED DEPRECATION AND IT SHALL BE ALLOWED TO BE
CARRIED FORWARD.
• UNABSORBED DEPRECIATION CAN BE CARRIED FORWARD FOR INDEFINITE NUMBER OF YEARS.
• UNABSORBED DEPRECIATION CAN BE SET OFF FROM ANY HEAD OF INCOME OTHER THAN SALARY
AND CAPITAL GAIN IN ANY YEAR.
• THE ASSESSE SHOULD SET OFF BROUGHT FORWARD LOSSES IN THE FOLLOWING MANNER: –
• FIRST OF ALL CURRENT YEAR DEPRECIATION WILL BE ADJUSTED.
• THEN BROUGHT FORWARD BUSINESS LOSSES WILL BE SET OFF (SPECULATIVE OR NON-SPECULATIVE)
• THEN UNABSORBED DEPRECIATION WILL BE SET-OFF AGAINST BUSINESS INCOME.