Depreciation as per the Companies Act

At ADCA, one of the common questions we receive from business owners and finance teams is how depreciation should be calculated under the Companies Act, 2013. Depreciation has a direct impact on profits, asset values, and statutory compliance. Under the Companies Act, depreciation is governed by Schedule II, which prescribes the useful life of various assets. In this guide, we explain depreciation as per the Companies Act in simple terms, along with depreciation rates, methods, and practical examples.

What is Depreciation?

Depreciation is the gradual reduction in the value of a fixed asset over time due to wear and tear, usage, or obsolescence.

For example, a company may purchase a car, computer, or furniture for business use. These assets provide benefits over several years, not just in the year of purchase. Instead of charging the full cost in one year, the expense is spread over the asset’s useful life.

Depreciation helps businesses:

• Present a true and fair view of financial statements.

• Match asset cost with revenue generated.

• Determine accurate profits

• Plan future asset replacements.

Depreciation as per the Companies Act, 2013

Depreciation under the Companies Act, 2013, is governed by Schedule II. Unlike the earlier system, which prescribed fixed depreciation rates, the current framework is based on the useful life of assets.

This means companies estimate how long an asset is expected to be used and charge depreciation accordingly.

Key points:

• Schedule II specifies the useful life for different assets

• Residual value is generally limited to 5% of the original cost.

• Companies may use different useful lives if supported by technical justification.

• Depreciation must be charged mandatorily in financial statements.

This approach provides greater flexibility and ensures more realistic accounting.

Key Rules for Depreciation

Depreciation is Based on Useful Life

The depreciation rate under the Companies Act is determined by the asset’s useful life rather than a fixed percentage.

Residual Value is Limited to 5%

Residual value is the expected value of the asset at the end of its useful life. Under Schedule II, it is normally capped at 5% of the original cost.

Different Useful Life is Allowed

Companies may adopt a different useful life if they have technical evidence to support the estimate.

Pro-Rata Depreciation

If an asset is acquired during the year, depreciation is charged only for the period it is used.

Component Accounting

Significant parts of an asset with different useful lives may be depreciated separately.

At ADCA, we help companies apply these rules correctly and maintain compliance in statutory financial statements.

Methods of Depreciation Under the Companies Act

Straight Line Method (SLM)

Under SLM, the same amount of depreciation is charged each year over the asset's useful life.

Written Down Value Method (WDV)

Under WDV, depreciation is higher in the initial years and gradually reduces over time.

Both methods are allowed under the Companies Act. Companies should apply the chosen method consistently.

Depreciation Rates as per Companies Act (Schedule II)

The Companies Act does not prescribe fixed rates directly. Instead, rates are derived from useful life.

Common Asset-Specific References

• Depreciation on furniture as per the Companies Act: Useful life of 10 years

• Depreciation on car as per Companies Act: Useful life of 8 to 10 years, depending on usage

• Companies Act depreciation rates: Derived from Schedule II useful life

These are indicative values, and companies may adopt different estimates if properly justified.

Example of Depreciation Calculation

Suppose a company purchases machinery for ?1,00,000.

• Cost of asset: ?1,00,000

• Residual value (5%): ?5,000

• Useful life: 5 years

Step 1: Calculate Depreciable Value

?1,00,000 – ?5,000 = ?95,000

Step 2: Annual Depreciation (SLM)

?95,000 ÷ 5 = ?19,000 per year

This means the company will charge depreciation of ?19,000 each year.

Difference Between Companies Act and Income Tax Act Depreciation

This distinction is important because companies often maintain separate depreciation calculations for books and tax purposes.

Why Depreciation is Important for Companies

Depreciation is more than an accounting entry. It:

• Reflects the actual value of assets

• Ensures compliance with the Companies Act

• Impacts reported profits

• Helps with valuation and financial analysis

• Supports long-term capital planning

Accurate depreciation also improves audit readiness and financial reporting quality.

Common Mistakes to Avoid

Businesses often make the following mistakes:

• Using Income Tax rates instead of the Schedule II useful life

• Ignoring residual value

• Not charging pro-rata depreciation.

• Failing to review the useful life periodically

• Missing component accounting where required

Professional review helps avoid these issues and ensures compliance.

Quick Summary

Depreciation as per the Companies Act is governed by Schedule II and is based on the useful life of assets. Companies can use SLM or WDV, provided they are applied consistently. Proper depreciation ensures accurate financial reporting and legal compliance.

Conclusion

Depreciation under the Companies Act, 2013, is based on the useful life of assets rather than fixed rates. Schedule II provides the framework, while companies must apply appropriate methods, such as SLM or WDV, to reflect the true value of assets.

Understanding depreciation rates as per the Companies Act is essential for preparing accurate financial statements and complying with statutory requirements. At ADCA, we help businesses determine the correct depreciation treatment, review asset classifications, and ensure compliance with Schedule II and audit standards.

FAQs

What is depreciation as per the Companies Act?

It is the systematic allocation of an asset’s cost over its useful life as prescribed under Schedule II of the Companies Act, 2013.

What is Schedule II in the Companies Act?

Schedule II specifies the useful-life and residual-value guidelines for depreciable assets.

Which method is used for depreciation under the Companies Act?

Companies may use the Straight Line Method (SLM) or Written Down Value Method (WDV).

Can companies change the useful life of assets?

Yes, if supported by technical justification and proper disclosure.

What is the difference between the Companies Act and Income Tax depreciation?

Companies Act depreciation is used for financial reporting, while Income Tax depreciation is used for tax computation.

What is residual value in depreciation?

Residual value is the estimated value of the asset at the end of its useful life, usually capped at 5% of the original cost.