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DEPRECIATION ACCOUNTING

SUBMITTED BY :

S.NO. ROLL. NO. NAME

1 131 JUDE D’SOUZA

2 160 SERENA PEREIRA

3 149 SYLVIA LEWIS

4 151 SARITA LEWIS

A REPORT SUBMITTED TO THE MET INSTITUTE IN PARTIAL


FULFILLMENT OF THE REQUIREMENT FOR THE AWARD OF MHRDM FOR
THE YEAR 2008-2011.

UNDER THE GUIDANCE OF

PROF. L.N CHOPDE

MET INSTITUTE

BANDRA, MUMBAI

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PREFACE

The main goal of this project is to present the scope and the objective of
depreciation accounting, the different methods employed in the process of
depreciation and to illustrate how to determine depreciation with the assistance
of various cases.

We have also used instances of calculation of depreciation in organizations to


add more practicality to the project.

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ACKNOWLEDGEMENT

We would first and foremost thank our professor Prof. L.N. Chopde for his able
guidance and being our mentor through out the semester and we also wish to
thank all those who have immensely contributed to the project and enhanced our
knowledge and understanding of the subject along the way.

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EXECUTIVE SUMMARY

This project has commenced with the definition of depreciation, extending to the
scope and objective, the determination of depreciation, the method to be
employed for calculating depreciation, determination of useful life,
determination of residual value, queries and responses, balance sheet, schedule
to the balance sheet and instances of calculation of depreciation in one particular
organisation. A neat form of contents follows which acquaints all the readers
with the flow of the project.

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CONTENTS

S.No. Topic Page Nos.

1 Depreciation – Definition, Scope & Objective 6

2 Determination of Depreciation & Depreciation method 7

3 Determination of Useful Life 8

4 Different depreciation method for different class of 11


fixed assets

5 Is Income Tax basis of depreciation acceptable under 12


companies act

6 Depreciation on Idle Assets & on additions/extensions 14 & 15


to an existing asset

7 Depreciation on building for factory and office purpose 16 & 17


& Proportionate depreciation on purchase/sale of assets
during the year

8 Disclosure of Central Government approval for not 19


providing depreciation &

Commentary Depreciation, Recognition, Measurement


and disclosure practices

9 Depreciation Calculation (Working Eg. 1) 22

10 Balance Sheet (Working Eg. 2) 24

11 Schedule annexed to Balance Sheet (Working Eg. 3) 25

12 Hard furnishing (Working Eg. 4) 27

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Depreciation Accounting

Scope & Objective


Depreciation is a measure of the wearing out, consumption or other loss of value
of a depreciable asset arising from use, efflux of time or obsolescence through
technology and market changes. Depreciation includes amortization of assets
whose useful life is predetermined.
Depreciable assets are assets which:
• Are expected to be used during more than one accounting period
• Have a limited useful life; and
• 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.
To qualify as a depreciable asset all three conditions are required to be fulfilled.
Even if a single condition is not fulfilled the same will not qualify as a
depreciable asset. For example, though land would fulfill two of the above
conditions, it does not fulfill the condition of a limited of useful life and therefore
is not a depreciable asset.
Accounting standard – 6 deals with depreciation accounting and applies to all
depreciable assets, except the following items to which special considerations
apply:
• Forests, plantations and similar regenerative natural resources;
• Wasting assets including expenditure on the exploration for and
extraction of minerals, oils, natural gas and similar non-regenerative
resources;
• Expenditure on research and development
• Goodwill
• Live stock
Recognition of Depreciation Charge
The depreciation charge for a period is usually recognized as an expense.
However, in some circumstances, the economic benefits embodied in an asset are

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absorbed by the enterprise in producing other assets rather than giving rise to an
expense. In this case, the depreciation charge comprises part of the cost of the
other asset and is included in its carrying amount. For example, the depreciation
of manufacturing plant and equipment is included in the costs of conversion of
inventories. Similarly, depreciation of property, plant and equipment used for
development activities may be included in the cost of an intangible asset or as a
capital research and development item.

Determination of Depreciation
Assessment of depreciation and the amount to be charged in respect thereof in
an accounting period are usually based on the following three factors:
• Historical cost or other amount substituted for the historical cost of the
depreciable asset when the asset has been revalued.
• Expected useful life of the depreciable asset; and
• Estimated residual value of the depreciable asset.
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. In case the depreciable assets are revalued, the provision for
depreciation is based on the revalued amount on the estimated of the remaining
useful life of such assets. 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. This is based on the concept of historical cost.
Historical cost of a depreciable asset represents its money outlay or its equivalent
in connection with its acquisition, installation and commissioning as well as for
additions to or improvement thereof. The historical cost of a depreciable asset
may undergo subsequent changes arising as a result of increase of decrease in
long term liability on account of exchange fluctuations; price adjustments
changes in duties or similar factors. In case the depreciable assets are revalued,
the provision for depreciation is based on the revalued amount on the estimate of
the remaining useful life of such assets.

Depreciation Method
There are several methods of allocating depreciation over the useful life of the
assets. Those most commonly employed in industrial and commercial enterprises
are the straightline method and the reducing balance method. The straightline
method of depreciation is appropriated when the use of the asset is expected to
be relatively even over its estimated useful life or there is not discernible pattern
of decline in service potential. However, if the expected productivity or revenue-

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earning power of the asset is relatively greater during the earlier years of its life,
or where maintenance charges tend to increase during later years, the written-
down value method is more appropriate.
The management of a business selects the most appropriate method(s) based on
various important factors eg.
• Type of asset
• The nature of the use of such asset and
• Circumstances prevailing in the business.
A combination of more than one method is sometimes used. In respect of
depreciable assets, which do not have material value, depreciation is often
allocated fully in the accounting period in which they are acquired. The method
used for an asset is selected based on the expected pattern of economic benefits
and is consistently applied form period to period unless there is a change in the
expected pattern of economic benefits from that asset.
The straightline method and the reducing balance method are two acceptable
methods under the Companies Act.

Depreciation to be determined for each component of an asset


Under IAS 26 it is expressly provided that depreciation should be determined
and charged separately for each significant part of an item of plant, property and
equipment. AS 10 requires in certain circumstances significant components to be
identified and recognized separately, for example, in the case of an air-craft, the
body of the air-craft and its engine are recognized as separate assets, since they
have different useful lives. Therefore, in such cases depreciation for these two
identified components of the same asset would be computed separately. The two
components would have different useful lives and residual value and the
depreciation method to be applied on these two components need not be the
same.

Determination of Useful Life


As the economic benefits embodied in the asset are consumed by the enterprise,
the carrying amount of the asset is reduced to reflect this consumption, normally
by charging an expense for depreciation. A depreciation charge is made even if
the value of the asset exceeds its carrying amount. The economic benefits
embodied in an item of property, plant and equipment are consumed by the
enterprise principally through the use of the asset. However, other factors such
as technical obsolescence and wear and tear while an asset remains idle often

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result in the diminution of the economic benefits that might have been expected
to be available from the asset.

Useful life is either

1. The period over which a depreciable asset is expected to be used by the


enterprise; or
2. The number of production or similar units expected to be obtained form
the use of the asset by the enterprise.

The useful life of a depreciable asset is shorter than its physical life and is:
1. Pre-determined by legal or contractual limits, such as the expiry dates of
related leases
2. Directly governed by extraction or consumption
3. Dependant on the extent of use and physical deterioration on account of
wear and tear which again depends on operational factors, such as, the
number of shifts for which the asset is to be used, repair and maintenance
policy of the enterprise etc; and
4. Reduced by obsolescence arising from such factors as:
a) Technological changes
b) Improvement in production methods
c) Change in market demand for the product or service output of the
asset; or
d) Legal or other restrictions

Determination of the useful life of a depreciable asset is a matter of estimation


and is normally based on various factors including experience with similar types
of assets. Such estimation is more difficult for an asset using new technology or
used in the production of a new product or in the provision of a new service but
is nevertheless required on some reasonable basis.
The useful life of an asset is defined in terms of the asset‘s expected utility to the
enterprise. The asset management policy of an enterprise may involve the
disposal of assets after a specified time or after consumption of a certain
proportion of the economic benefits embodied in the asset. Therefore, the useful
life of an asset may be shorter than its economic life. The estimation of the useful

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life of an item of property, plant and equipment is a matter of judgment based
on the experience of the enterprise with similar assets.

Review of Useful Life


The quantum of depreciation to be provided in an accounting period involves
the exercise of judgment by management in the light of technical, commercial,
accounting and legal requirements and accordingly may need periodical review.
The useful life of an item of property, plant and equipment should be reviewed
periodically and, if expectations are significantly different from previous
estimates, the unamortized depreciable amount should be charged over the
revised remaining useful life. During the life of an asset it may become apparent
that the estimate of the useful life is inappropriate. For example, the useful life
may be extended by subsequent expenditure on the asset which improves the
condition of the asset beyond its originally assessed standard of performance.
Alternatively, technological changes or changes in the market for the products
may reduce the useful life of the asset. For example, due to certain changes in the
design of the finished product, a company may intend to discontinue using the
moulds much before the expiry of their useful life.
AS-6 requires a periodic review of the useful lives of fixed assets. If such a review
results in the revision of the useful life, depreciation is to be charged over the
remaining useful life. The repair and maintenance policy of the enterprise may
also affect the useful life of an asset. The policy may result in an extension of the
useful life of the asset or an increase in its residual value. However, the adoption
of such a policy does not negate the need to charge depreciation. It is important
that the above reassessment of useful life does not result in depreciation lower
than that required under Schedule XIV, as that would result in contravention of
Section 205 (2) of the Companies Act.

Determination of Residual Value


“Determination of residual value of an asset is normally a difficult matter. If
such value is considered as insignificant, it is normally regarded as nil. On the
contrary, if the residual value is likely to be significant, it is estimated at the time
of acquisition/installation or at the time of subsequent revaluation of the asset.
One of the bases for determining the residual value would be the realizable value
of similar asset, which have reached he end of their useful lives and have
operated under conditions similar to those in which the asset will be used”.

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Different Depreciation Method for Different Class of Fixed Assets
The management of a business selects the most appropriate method(s) based on
various important factors e.g.
1. Type of asset
2. The nature of the use of such asset and
3. Circumstances prevailing in the business.
A combination of more than one method is sometimes used. The method used
for such an asset is selected based on the expected pattern of economic benefits
and is consistently applied from period to period unless there is a change in the
expected pattern of economic benefits from that asset. For eg. A motor vehicle
may provide higher economic benefits in the initial years as compared to a
building which may provide uniform economics benefits over several years.
Therefore, some enterprises may choose to apply the WDV method in the case of
a motor vehicle and SLM method in the case of buildings.

Different Depreciation Method for Different Class of Fixed Assets


The management of a business selects the most appropriate method(s) based on
various important factors e.g.
1. Type of asset
2. The nature of the use of such asset and
3. Circumstances prevailing in the business.
A combination of more than one method is sometimes used. It is therefore
possible that plant and machinery be depreciated on WDV basis and all other
assets on SLM basis. Sometimes, different methods of depreciation for the same
class of assets used in different plants of the company can be applied if the
management considers it appropriate to do so after taking into account
important factors such as the type of assets, the nature of the use of such asset
and circumstances prevailing in the business. For example, if an enterprise is in
the business of letting out vehicles on hire it may depreciate the hired vehicles at
a higher rate than compared to the vehicles which are used by its employees for
office purposes. These situations are however expected to be rare. Therefore
normally an uniform deprecation rate and method is applied for the same class
of fixed assets.

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Is Income-tax Basis of Depreciation Acceptable under companies Act?

Query
Whether adoption of block concept of charging depreciation in accounts, as per
the Income-tax Act, is justified in the case of a company? If so, whether the
concept of true and fair view of accounts is affected when the profit on sale of
assets is not credited to profit and loss account but to the concerned block of
assets?

Response
After Schedule XIV coming into force, rates higher than those under that
Schedule can only be adopted on the basis of a bonafide determination of the
commercial life of an asset, which is a technical matter. Also, in such a case,
proper disclosure has to be made. Therefore, a company can follow rates
prescribed under the Income-tax Act/Rules only if these rates represent bona fide
commercial depreciation and are higher than Schedule XIV rates. Also Note No.4
to Schedule XIV to the Companies Act, 1956 requires “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 that 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. Therefore for purposes of companies Act, it is not
appropriate to determine depreciation, after crediting profit on sale of assets
against the concerned block of assets. In fact profit on sale of assets needs
separate recognition and disclosure under the Companies Act.

Minimum Depreciation
The statue governing an enterprise may provide the basis for computation of the
depreciation. For example, the Companies Act, 1956 lays down the rates of
depreciation in respect of various assets. Where the management’s estimate of
the useful life of an asset of the enterprise is shorter than that envisaged under
the provisions of the relevant statute, the depreciation provision is appropriately
computed by applying a higher rate. If the management’s estimate of the useful
life of the asset is longer than that envisaged by the statute, depreciation rate
lower than that envisaged under the stature, depreciation rate lower than that
envisaged by the statute can be applied only in accordance with requirements of
the statute. In a large number of cases, the rates of depreciation under Schedule

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XIV of the Companies Act are low, and therefore enterprises that have an
appreciation for good corporate governance and accounting practices, use much
higher rates than the prescribed under the Schedule. For example, Infosys uses
much higher rates than that prescribed under Schedule XIV on computers owned
by them. It is important for financial statements to be true and fair that
management estimate the useful lives of assets and determines depreciation at
higher rates if the useful lives are lower than the one set out in Schedule XIV.

Rates higher than Schedule XIV should be used provided such rates are based on
sound commercial and technical considerations. For example, higher
depreciation rates are used where technological obsolescence is prevalent, eg.
Computers. In such a case, the auditor should broadly satisfy himself that the
rates are determined in an appropriate manner. Since the determination of
commercial life of an asset is a technical matter, the decision of the Board of
Directors is normally accepted by the auditor unless he has reason to believe that
such decision is grossly incorrect.

Query

The company had set up a factory on coastal land. In view of the corrosive
climate, the machine life was reducing faster and, therefore, it wanted to charge a
higher rate of depreciation than those prescribed under Schedule XIV.

Response

The statute governing an enterprise may provide that basis for computation of
the depreciation. For example, the Companies Act, 1956, lays down the rates of
depreciation in respect of various assets. In accordance with AS-6, ‘Depreciation
Accounting’, where the management’s estimate of the useful life of an asset of
the enterprise is shorter than that envisaged under the provisions of the relevant
statute, the depreciation provision is appropriately computed by applying a
higher rate. If the management’s estimate of the useful life of the asset is longer
than that envisaged under the statute, depreciation rate is lower than that
envisaged by the statute can be applied only in accordance with requirements of
the statue. It is important for financial statements to be true and fair that
management estimate the useful lies of assets and determines depreciation at
higher rates if the useful lives are lower than the one set out in schedule XIV.

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Rates higher than schedule XIV should be used provided such rates are based on
sound commercial and technical considerations. For example, a facory building
situated in a coastal are may be subject to higher depreciation due to corrosion.
In such a case, the auditor should broadly satisfy himself that the rates are
determined in an appropriate manner. Since the determination of commercial life
of an asset is a technical matter, the decision of Board of Directors is normally
accepted by the auditor unless he has reason to believe that such decision is
grossly incorrect. The department of company affairs has also clarified that the
rates contained in Schedule XIV should be viewed as the minimum rates, and,
therefore, the company cannot charge depreciation at rates lower than specified
in the schedule in relation to the assets. However, if on the basis of a technical
evaluation higher rates of depreciation are justified, which may be true in this
case, the higher rates should be applied. Where rates other than Schedule XIV
rates are applied, appropriate disclosure in the notes to the accounts would be
required.

Depreciation on Idle Assets

Section 205(2) of the Companies Act, 1956, does not deal with the manner of
provision for depreciation on assets remaining idle owing to labour trouble etc.
However, since depreciation also arises out of efflux of time, it would be
necessary for the purpose of Section 205 to provide for depreciation even in
respect of assets which are not in use during any financial year, if it plans to
declare any dividend. It may be possible due to assets lying idle the remaining
usable life is extended, in which case a reassessment of useful life can be made.
On this basis the unamortized depreciable amount should be charged over the
revised remaining useful life, which would result in a lower annual charge of
depreciation in the future years. However, as cautioned above, depreciation
amount should not be lower than that determined under Schedule XIV for the
purposes of Section 205(2) of the CompaniesAct. Full depreciation is provided
for even if the asset is kept in the best working condition or its market price has
gone up since depreciation is also a factor of efflux of time.

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A point to be noted that there is a difference between an idle asset that is
installed and an idle asset that is not installed. An asset that is installed but is
not being used requires depreciation to be provided on it because depreciation is
also caused by efflux of time. No depreciation is required on an asset that is lying
idle but waiting installation. However, in such cases one will have to determine
whether it is impaired. Further, if the asset is not going to be used, one must
determine if the asset can be classified as an asset held for sale or disposal and
value it at lower of cost and net realizable value.

Depreciation On Additions/Extension To An Existing Asset

Any addition or extension to an existing asset which is of a capital nature and


which becomes an integral part of the existing asset is depreciated over
remaining useful life of that asset. As a practical measure, however, depreciation
is sometimes provided on such addition or extension at the rate, which is
applied, to an existing asset. Any addition or extension which retains a separate
identity and is capable of being used after the existing asset is disposed of, is
depreciated independently on the basis of an estimate of its own useful life.
Where the historical cost of a depreciable asset may undergo subsequent changes
arising as a result of increase or decrease in long term liability on account of
exchange fluctuations, price adjustments, changes in duties or similar factors the
depreciation on the revised unamortised depreciable amount is provided
prospectively over the residual useful life of the asset. For example, lets say the
useful life of an asset of Rs.6,00,000 is 5 years. In the second year when the net
value of the asset was Rs.4,80,000 an additional amount of Rs.20000 is capitalised
on account of foreign exchange difference. The revised unamortised amount of
Rs.5,00,000 would be depreciated over the remaining useful life of 4 years.
Therefore, depreciation each year for the next 4 years would be Rs.1,25,000.

If the company was using the written down value method the computation gets
slightly complicated. In the above case the straight line depreciation rate is 20%
which translates to roughly 60% on the reducing balance method. Now if the
straight line method it works out to 25%, which under WDV would work out to
roughly 75%. Thus depreciation on the original amount would be provided at
60% and on the addition at 75%. To make the computations easier, a weighted
average can be worked out.

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Query

The company procured ocean going dredgers which were cleared by the customs
without levy of custom duty in the year 2000. However in 2003 the custom
authorities alleged willful misstatement and suppression of facts. The company
disputed the allegations but believes that the liability will fructify. Therefore, the
amount of customs duty sought to be levied on the respective dredgers has been
capitalised and a provision for customs duty was made in the books. We check
the method on how to charge depreciation on the addition to fixed asset in 2003
caused by capitalisation of the customs duty.

Response

As per AS-6, where the historical cost of a depreciable asset has undergone a
change due to increase or decrease in long term liability on account of exchange
fluctuations, price adjustments, changes in duties or similar factors, the
depreciation on the revised depreciable amount should be provided
prospectively over the useful life of the asset. In the given case, the nature of
change in historical cost of the fixed asset is different i.e. it is not a situation of a
change in the duty as such, but it is a case of an asset escaping payment of duty.
Accordingly, the depreciation should be worked out on restrospective basis i.e.
the depreciation in respect of the past years since the acquisition of the dredgers
should be charged in the profit and loss account of the current year and should
be disclosed as a prior period item.

Depreciation On Building Used For Factory And Office Purposes

Query

Snowbright Ltd. , a newspaper company owns a building. The basement of the


building is used for printing, whereas the rest of the building is used for office
purposes. As per Schedule XIV, SLM depreciation on office buildings is 1.63%
and factory buildings is 3.34%. For calculating depreciation, can Snowbright
apply 1.63% for office portion and 3.34% for basement? Assume two scenarios –
useful life of a building is (a) 25 years (b) 75 years.

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Response

As per as-6, “depreciation accounting”, depreciation is based on the useful life of


an asset. If based on an assessment of the useful life, depreciation is higher than
the statutory rates, higher depreciation should be applied. If based on the useful
life assessment depreciation is lower than the statutory rate, minimum
depreciation based on the statutory rate should be followed. In the given case,
the building is used for office s well as factory purposes; however, the entire
building can only have one useful life.

In the scenario where the useful life is 25 years, the entire building is depreciated
on SLM basis over 25 years. In the scenario where the useful life is 75 years, the
minimum statutory depreciation should be provided the following alternatives
may be permissible:

(a) 3.34% SLM depreciation is provided on the entire building since one building
can only have one rate of depreciation or one useful life and therefore the higher
rate is applied

(b) 1.63% can be applied on office portion and 3.34% can be applied on factory
portion- this could be justified on the grounds that it should achieve proper
allocation of deprecation to future years based on Schedule XIV requirement.

The view in (a) is the preferred view and the one in (b) is an alternative view.

Proportionate Depreciation On Purchase / Sale Of Assets During The Year

Note no. 4 in Schedule XIV to the Companies Act, 1956, prescribes 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”. A company may group additions and
disposals in appropriate time period (s), eg. 15 days or a month, for the purpose
of charging pro rata depreciation in respect of additions and disposals of its
assets keeping in view the materiality of the amounts involved”.

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Depreciation should be provided when the asset is installed even though not in
use (but is ready for use) for the whole or part of any financial year, due to
reasons like strike, lock-out, shortage of raw materials etc. However, if the asset
is not installed and is thus not ready for being put to use, depreciation should
not be provided on them. If a company has purchased certain equipments which
are in capital WIP, since civil work has been delayed for a long period, the
company should not provide depreciation on the equipments.

Disclosure

The following information should be disclosed in the financial statements:

(1) The historical cost or other amount substituted for historical cost of each
class of depreciable assets
(2) Total depreciation for the period for each class of assets
(3) The related accumulated depreciation

The following information should also be disclosed it eh financial statements


along with the disclosure of other accounting policies

(1) Depreciation methods used


(2) Depreciation rates or the useful lives of the assets if they are different from
the principal rates specified in the statue governing the enterprise.

If any depreciable asset is disposed of, discarded, demolished or destroyed, the


net surplus or deficiency, if material should be disclosed separately.

A change in the method of depreciation is treated as a change in accounting


policy and is disclosed accordingly.

In case the depreciable assets are revalued, the provision for depreciation is
based on the revalued amount on the estimate of the remaining useful life of
such assets. In case the revaluation has material effect on the amount of
depreciation, the same is disclosed separately in the year in which revaluation is
carried out.

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Disclosure Of Central Government Approval For Not Providing Depreciation

An example of this can be found in the 2001 – 02 financial statements of century


textiles and industries Ltd. – “arrears of depreciation for the accounting years
1999 – 2000 and 2000 – 2001 remaining to be provided in respect of the three
divisions, namely, Maihar cement unit – ii, century pulp & paper and century
denim, pursuant to the approval of the central government under section 2005 (2)
(c) of the companies act, 1956 as at 31st march, 2002 aggregates Rs. 115.42 crore
(previous year rs. 130.13 crore)”.

Commentary On Depreciation Recognition, Measurement And Disclosure


Practices

The authors observation in respect of depreciation practices based on an


independent review of financial statements are set out below:

1. AS – 6 and Schedule XIV requires depreciation to be provided either


under the straight – line method or the written down value method;
however, a few enterprises have applied other methods such as the unit of
production method which is not appropriate. Further in those situations
it is not clear whether the unit of production charge is equal to or higher
than the Schedule XIV charge.
2. Most enterprises have followed the minimum depreciation rates set out in
Schedule XIV rather than applying the greater of Schedule XIV rate and
the rate determined based on managements estimate of useful life of the
asset in accordance with AS 6. However many enterprises have
considered accelerated depreciation in respect of computers.
3. Continuous process plants are subject to single shift depreciation, whereas
in the case of non-continuous plant multiple shift depreciation is required
to be provided. It is generally been observed that there is very little
disclosure on how a continuous process plant has been defined by an
enterprise, wherever it is applicable.
4. Many enterprises have not disclosed the depreciation policy in respect of
additions / deletions during the year, which needs to be disclosed if the
amounts involved are significant.

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5. Many enterprises have not defined if they have a separate policy for low
value items and the threshold amount that defines what a low value item
is.
6. Most enterprises have disclosed differences in depreciation rates as set out
under Schedule XIV and those applied in the preparation of the financial
statements. This disclosure is required by Schedule XIV.
7. Changes in depreciation method and rates applied are common and
without due regard to (i) the useful life of the asset (ii) the most
appropriate depreciation method (iii) justification for change in the
method.
8. Changes in depreciation basis has been achieved by using several options,
eg.
a. Change in economic useful life (or depreciation rate)
b. Change in depreciation method
c. Change in classification of the item being depreciated
d. Change in classification of plant from continuous to non –
continuous and vice – versa
e. Change in determining extra shift charge – for eg. By determining
extra – shift at performance unit level rather than for the company
as a whole has reduced depreciation impact.
9. A few enterprises have applied innovative accounting – for eg., the
additional burden on change in method of depreciation has bee recouped
from general reserve – such a practice ensures that additional burden of
depreciation does not reduce profits and EPS, though for MATt purpose
the recouping out of general reserves will be ignored. Further, by
increasing the depreciation in the financial books there is a reduction in
deferred tax liability the credit for which is directly taken to the profit and
loss account. For MAT purposes this credit is ignored. In other words,
MAT profit have been kept minimum and book profits have been
maximised.
10. Some enterprises have applied different depreciation rates for the same
class of assets depending on when the asset was capitalized, for example,
pre 2000 10% and post 2000 15%. Whilst this approach seems to have
gained acceptance in the Indian industry, it may be non – compliant with

DEPRECIATION ACCOUNTING -20/33-


as 6. Under AS 6, depreciation is provided at greater of schedule xiv rates
and rates estimated by management based on the assets economic useful
life. It is impossible to conceive that the same asset would have different
economic useful life depending on when they were capitalised. Hence in
the authors view, depreciating the same class of asset using two different
depreciation rates depending on a cut – off of capitalisation is not
permissible.
11. Some enterprises have not provided for depreciation pursuant to a central
government order under section 205 (2) (c) of the companies act; a fact
adequately disclosed in the financial statements.
12. Some enterprises have provided depreciation on investment properties
whereas other’s have not. Under section 205 and 350 read with Schedule
XIV of the Indian companies act, no distinction is made between fixed
assets and investment properties and hence depreciation would be
required on all assets owned by the company irrespective of how they
have been disclosed in the financial statements. As to whether it would be
necessary to provide for depreciation in respect of immoveable property
which has been acquired as an investment for the purpose of earning
supplementary income and not for the use of the company, the
department of company affairs has opined that as such immovable
properties unless they are acquired for resale represent fixed assets, it
would be obligatory to provide depreciation thereon. (Circular no (10) –
CL – VI/61, dated 27-9-1961). Even under AS 6, depreciation would be
required to be provided on investment properties.
13. In one instance the following policy was disclosed – ‘no depreciation has
been charged on the assets, which have not been put to use during the
period’. The point here is that depreciation should commence when the
asset is ready for its intended use rather than when the enterprise is ready
to use the asset. Therefore the above policy may not be in strict
compliance with AS 6. However if the assets were not installed and not
ready for its intended used, but were lying idle, then depreciation should
not be provide.
14. There were few interesting examples, where the depreciation rate applied
for a class of asset was lower than that set out under Schedule XIV but on

DEPRECIATION ACCOUNTING -21/33-


an overall basis the aggregate depreciation was higher than Schedule XIV
depreciation. This in the authors view is non-compliance with Schedule
XIV, since compliance should be determined with respect to each class of
assets and not the entire fixed assets of the company.

Depreciation Calculation

(Working Example I)

A working of Depreciation followed at Future Capital Real Estate.


(The real estate arm of Future Capital Holding)

Original Cost 30-Apr-05 2,039,844


Depreciation Upto 31.3.08 565,428
WDV as on 31.3.08 31-Mar-08 1,474,416

If Sale date 31-Aug-08


Depn from April 08 to Aug 08
Days 154
Rate of Depreciation 9.50%
Depn Amount for April 08 to
Aug 08 81,761

Total Depreciation as on 31.8.08 647,189

Original Cost 2,039,844


Depreciation upto 31.8.08 647,189
WDV as on 31.8.08 1,392,655
Sales consideration 101,992
Loss 1,290,662

DEPRECIATION ACCOUNTING -22/33-


The above table presents the depreciation calculation for an ‘x’ asset followed at
Future Capital Real Estate – the real estate arm of Future Capital Holding.
Depreciation is followed at Straightline Method

Elucidation

The Original Cost of the asset is


(date of purchase of asset is 30-April-2005) Rs. 2,039,844

Depreciation upto 31.3.2008 (A) Rs. 5,65,428


(Includes depreciation for 3 years starting May 05 onwards - 05-06, 06-07 & 07-
08)

Written down value as on 31-March-2008 Rs. 1,474,416

If the sale date is 31-Aug-2008


Then depreciation from April 2008 to August 2008
For 154 days @ 9.50% (B) Rs. 81,761

Total Depreciation (A) + (B) Rs. 647189

Original Cost Rs. 2,039,844


Depreciation upto date of sale Rs. 647189
WDV as on 31-Aug-2008 Rs. 1,392,655
Sales consideration Rs. 101,992
Loss Rs. 1,290,662

DEPRECIATION ACCOUNTING -23/33-


(Example 2)

Balance Sheet of Future Capital Holdings Ltd.

DEPRECIATION ACCOUNTING -24/33-


Schedule Annexed to and forming part of Consolidated Balance Sheet

(Example 3)

Fixed Assets and Depreciation

Tangible Assets
Fixed Assets are stated at cost less accumulated depreciation and impairment
losses, if any. Cost comprises the purchase price and any other directly
attributable costs of bringing the asset to its working condition for its intended
use.

DEPRECIATION ACCOUNTING -25/33-


Leasehold improvements are depreciated on straight line basis over primary
period of lease agreements.

Intangible Assets

Intangible assets include goodwill, domain names, trademarks, copyrights and


computer software, which are acquired, are capitalized and amortized on a
straight line basis over the estimated useful lives ranging from 5-10 years.

Expenditure related to and incurred on commissioning of new branch is


capitalized as cost of improvement/cost of network development of the branch
and recognized as intangible assets.

Depreciation

Depreciation is provided using Straight Line Method as per the useful lives of
the assets estimated by the management or at the rates prescribed under
Schedule XIV of the Companies Act, 1956, whichever is higher.

Tangible assets and intangible assets costing Rs. 5,000 or less individually are
fully depreciated/amortized in the year of purchase.

DEPRECIATION ACCOUNTING -26/33-


(Example 4)

At Future Capital Real Estate, employees can avail of a benefit termed as ‘Hard
Furnishing’, details on the policy are stated as under:

HARD FURNISHING POLICY

1. Objective

• The objective of this policy is to enable the employees to acquire capital


item for their personal use.

2. Applicability

• All the confirmed employees in Band 3, 4 & 5 with effect from 1st July
2005 (Revised on 1st July 2006).

3. Guidelines

• The Hard Furnishing entitlement is for a period of three years.


• The three years block period commences from the date of purchase.
• The employee may avail of his/her entitlement in either one part, by
taking items up to the maximum ceiling at one time, or break it into two
parts, by taking items at two different times. However, the employee may
NOT avail of it in more than two parts.
• In case the employee has not claimed his / her full entitlement up at the
end of the block period of three years, the remaining amount will lapse
and cannot be carried forward to the next block of three years.
• On completion of the block of three years, the employee will be eligible to
claim a fresh entitlement, as per the policy, at the start of the next block.
This will apply only in case the employee has availed his entitlement from
the date of eligibility, i.e., confirmation. If the employee avails on a later
date, the block starts from the date he claims his entitlement.
• In case of a promotion, if the entitlement increases, the employee may
avail of the incremental difference.

DEPRECIATION ACCOUNTING -27/33-


4. Entitlement

The entitlement under this policy would vary as follows:

Value (Rs.)
Position
(for block of 3 years)

Head 3,00,000/-

Chief 2,25,000/-

Sr. Manager 1,50,000/-

Manager 1,20,000/-

Manager 90,000/-

Asst. Manager 60,000/-

No option available for encashing this benefit.

4. Process of Availing Entitlement

• The employee is required to fill the Hard Furnishing Form. It is to be


approved by the HOD and sent to HR. After Head HR approval, it is
sent to Finance.
• In order to receive the actual payments for the items purchased the
employee needs to attach the respective Performa Invoice(s) and VAT
numbers of the dealer in the name of FUTURE CAPITAL REAL
ESTATE
• The cheque(s) will be made in the name of the Registered dealer /
agent by the Finance Department. All payments will be made through
cheque only.
• The employee has to submit the original bill from the dealer within
one month of receiving the cheque or else the amount availed will be
shown as an advance in the employee's account.
• If an employee has availed of this benefit and if s/he resigns during the
block of three years, he would have to buy the items compulsorily at
written down value.

DEPRECIATION ACCOUNTING -28/33-


5. Selection of Hard Furnishing

• The employee may select hard furnishing items of his / her choice;
however, the items should purely be capital items as defined under the
Income Tax Act.

The typical items included are sofas, furniture, personal computer,


fans, air conditioners, refrigerators, washing machine, microwave,
oven, cooking range, water purifier, dish washer, mixer / grinders, TV,
VCR, music systems, inverters etc.

6. Purchase Of Items

• The items will be purchased by the company on the employee’s


request and will be assets in the company’s name.
• At the end of three years, it is mandatory for the employee to buy off
the asset from the company. As per the policy this will be at 5% of the
original cost at which the company bought them.
• In case, employee resigns from the company before three years from
the date of the purchase of assets, then the employee is required to
purchase the assets from the company at the cost, reduced by
depreciation calculated at the rate of 31.67% per annum.

7. Repair And Maintenance Of Assets

• Repair and maintenance of goods purchased under this scheme will be


the employee’s responsibility entirely. The employee is expected to
take good care of the assets and keep them in good working condition.
In case the employee wishes to insure these items, it will be at his
personal cost.

8. Income Tax

• The hard furnishing items will be given as assets to the employee for
his/her use and treated as perquisites under income Tax Act. The
taxable value of this perquisite will be calculated as mentioned in the
below attached document.

DEPRECIATION ACCOUNTING -29/33-


Annexure (2) – Items & Perquisite Value for Hard Furnishing (Few egs.)

Perquisite Value at the


Item Category Yearly Perquisite Value time of sale of Assets to
the Employee (After 3
years)

Computers Computers & Nil 7.50% of the cost of assets


Laptops

Laptop Computers & Nil 7.50% of the cost of assets


Laptops

Camera Electronics 10% of the cost of assets 7.50% of the cost of assets

The above perquisite value will be added to the employee’s annual taxable income.

Attached is the full & final settlement statement of one of the ex-employees who
has left us within three years of purchase of the asset. The amount of
depreciation is mentioned and the working given:

FULL & FINAL SETTLEMENT

Date of
Employee no : xxx Joining: 17-Jul-07
Date of
Employee Name : xxx Resignation: 01-Aug-08
Date of
Designation xxx Leaving 31-Oct-08
Department: xxx
Band: xxx
A) Amount Due to Employee Amount Rs Amount Rs

Salary Payable for the Month


1 ( 31 days )

Basic 87,500 87,500

HRA 52,500 52,500


Conveyance -

DEPRECIATION ACCOUNTING -30/33-


Adhoc 98,725 98,725
Total 238,725

2 Food coupon (Comments) 1,300 1,300

3 Exgratia (Comments) -

4 LTA 38,819 38,819

5 Medical Reimbursement (NonTaxable) 1,250 1,250

6 Leave Encashment (12days) 96,010 96,010

7 Petrol & Car maintenance 232,911 232,911

8 Driver's Salary 100,928 100,928


9 Other
Total Amount Due to Employee (A) Total 709,944
Less
B) Amount Due From Employee
1 Salary Recovery - -

2 Hard furnishing 41,102 41,102


3 Company Car Recovery
4 Food Coupon Recovery
5 Other Recovery
Total Amount Due From Employee (B) Total 41,102
C) Less Deductions

1 Provident Fund 87,500 10,500 10,500


2 Provident Fund on Leave Encashment

3 Profession Tax 200 200

4 Income Tax 22,326 22,326


5 Other Misc
Deductions (C ) Total 33,026
TOTAL DUES PAYABLE(RECEIVABLE) (A-B-C) 635,816
PREPARED BY CHECKED & APPROVED BY

xxxxx xxxxxx

DEPRECIATION ACCOUNTING -31/33-


Working of Depreciation calculated on assets purchased

Asset I Total Block

Asset Purchase Date 28-May-08 Cost of the Asset 47,584


Rate of Depreciation(HR
Date of Leaving 31-Oct-08 Policy) 31.67%

Number of days 157.00 Depreciation(HR) 6,482

Asset Purchased All Hard Furnishings Transfer Value(To Employee) 41,102


Cost of the Asset 47,584
Rate of Depreciation(HR Policy) 31.67%
Depreciation(HR) 6,482
Transfer Value(To Employee) 41,102

DEPRECIATION ACCOUNTING -32/33-


BIBLIOGRAPHY

• Indian Accounting Standards


• The finance team of Future Capital Real Estate and Future Capital
Holdings

DEPRECIATION ACCOUNTING -33/33-

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