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AS 6: DepreciationAccounting

IPCC Paper 1: Accounting Chapter 1 Unit 2

Depreciation - AS 6

CA. Yagnesh Desai

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Introduction

This statement deals with depreciationaccounting and applies to all

depreciable assets;

Depreciation is allocated so as to

charge a fair proportion of depreciableamount in each accounting periodduring the expected useful life of asset. 2

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Applicability

3

AS 10 Fixed Asset

This standard was introduced in 1984

Revised later in the year 1994.

It is applicable to corporates as well all noncorporate entities since 1995

This standard is inextricably connected withanother standard ? Guess which ?

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Scoped Out Not

applicable toForests, Plantations and similar regenerative natural resources

Wasting Assets including-

Mineral rights, Expenditure on the Exploration for and Extraction of Minerals,

Oil, Natural Gas and similar non-regenerative resources.

Expenditure on Research & Development;

GoodwillLivestock

Land- unless it has limited life 4

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Learning Objectives

At What rate should Fixed Assets bedepreciated ?

What is the concept of Useful life. ?

Can An Enterprise Change rates of

depreciation ?

If yes, How changes are dealt with ?Retrospectively or Prospectively. ?

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What is Depreciation ?

Para 3. Depreciation is a measure of the wearing out,consumption or other loss of value of a depreciable asset

arising from use, effluxtion of time or obsolescencethrough technology and market changes.

Depreciation includes amortisation of assets whoseuseful life is predetermined. Amortisation is phrase usedfor Intangible Assets.

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Definition Depreciable

Assets

Are assets expected to be used during morethan one accounting period;

Have a limited useful life; and

Are held by an enterprise for use in the productionor supply of good and services, for rentals to others,or for administrative purposes & NOT for sale in theordinary course of business.

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Definitions Useful Life

Is either the period over which adepreciable asset is expected

to be used by the enterprise; or

The number of production orsimilar units expected to beobtained from the use of theasset by the enterprise 8

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Definitions

Depreciable Amount

Of a depreciable asset isits historical cost, or

other amount substitutedfor historical cost in the

financial statement,LESS the estimatedresidual value . 9

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10

Depreciable

Amount

Historical Costor OtherAmount

substituted forHC

Residual

Value

Useful Life(Years )

DepreciableAmount

Amount ofDepreciation

Usually following three factors help assess

Depreciation

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Historical Cost

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Historical Cost includes any moneyoutlay or equivalent in connection with:

1.Acquisition,

2.Installation,

3.Commissioning,

4.Additions and

5.Improvement

In other words Initial Cost at which a

asset is recognized and measured.

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Historical Cost- When

can it Change ? ?

Subsequent Changes may occur

as a result of Long term liabilitydue to:

I. price adjustments,

II.changes in duties & similar

factors.12

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Useful Life

Useful life of a depreciable asset isestimated based on following factors:

Expected Physical wear and tear;

Obsolescence;

Legal or other limits on the use of the asset.

Periodic review of the useful life of majordepreciable assets may be required.

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Useful Life

Of a depreciable asset is shorter than thephysical life.

Some times pre-determined by legal orcontractual limits. Assets under Finance Lease.

Depends of the extent of use & physicaldeterioration-Repairs and maintenance policy

Determination of useful life is a matter ofestimation.

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Useful Life gets reduced by

obsolescence

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(a)technological

changes;

(b)improvement

in productionmethods;

(c) change in

market demandfor the product

or serviceoutput of the

asset; or

(d) legal orother

restrictions.

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Changes in Estimated Useful

Life

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If it is considered that the originalestimate of useful life of an assetrequires any revision.

The unamortised depreciable amount ofthe asset is charged to revenue overthe revised remaining useful life.

Thus , the effect is Prospective andNOT Retrospective

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Residual Value

If likely to be insignificantthen considered NIL;

If likely to be significantthen estimated at the time ofacquisition / subsequent revaluation of the asset.

One of the basis of the estimationwould be realisablevalue of similar assets which have reached the end oftheir lives, and have operated under similar conditions.

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Method of Depreciation

Commonly employedmethods in industry andcommercial enterprise

are:

Straight-linemethod (SLM),

andReducing Balancemethod.

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A combination of more than one method is

sometimes used.

B i f S l ti f

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Basis for Selection of

Method.Management selects most appropriate methodbased on important factors such as:

1. Type of Asset,

2. The nature and use of asset, and

3. Circumstances prevailing in the business.

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Basic Accounting Entry

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An allowance account is created forAccumulated Depreciation

Viz. Accumulated Depreciation

This account is contra to Fixed Assets

Meaning to arrive at Net Book Value

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Materiality

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Depreciation fully allocated in same

accounting period when the asset does

not have a material value. !!!

This in other words , remaining net

book value is fully charged as

Depreciation. The asset is effectivelyde-recognised.

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Can Depreciation

Method beChanged ?

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Change in Accounting

Policy OR Change inEstimates

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A Change in Method of Depreciation is

treated as a Change in ??

A change in accounting policy , and changesin accounting policy is accounted for

retrospectively

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How Change in Method is

accounted for ? Retrospectively.

There arises either a surplus ordeficiency when such recalculationis made.

In case of Surplus: Its credited tothe Statement of profit and loss

In case of Deficiency: Its chargedto the Statement of profit and loss. 25

Depreciation is Re-calculated in accordance withthe new method

Ch i th f t

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Change in other factors

1. Change in Historical Cost Depreciation is calculated prospectively over Residual

useful life

2. Revision in Useful life Unamortised depreciation charged over REVISED

remaining useful life

3. Addition or extension in the asset

- Calculate depreciation at the same rate overremaining useful life

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Rate of Depreciation !!!

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The Statute governing an enterprise may providefor Depreciation rates

Example:

Companies Act 1956 provides for Depreciation rates inSchedule XIV for various assets.

Income tax Act provides rates of Depreciation for the Block

of assets .

The Moot Question Which Rate to apply ?

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Rate of Depreciation !!!

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As per

managem

ent

Rate of

Depreciati

on -SLM

As per

Statue

Rate of

Depreciati

on- SLM

Can

managem

ent apply

rate based

on its

estimate

The Rate

of

Depreciati

on will be

20 Years 05% 10 Years 10% No 10%

Useful Life as per management s estimate is higher

than the statue

This means lower rate of Depreciation need to

be applied

This is NOT Permissible

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Rate of Depreciation !!!

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As per

managem

ent

Rate of

Depreciati

on -SLM

As per

Statue

Rate of

Depreciati

on- SLM

Can

managem

ent applyrate based

on its

estimate

The Rate

of

Depreciation will be

10 Years 10 % 20 Years 5 % Yes 10%

Useful Life as per management s estimate is shorter thanthe statue.

This means higher rate of Depreciation need to be applied

This is permissible

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Conclusion

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Enterprise can not depreciate asset at rate

lower than the one prescribed under the

Companies Act,1956

To put in other words

The rates of depreciation may ideally be as

per useful life but not lower than the rates

prescribed under the Companies Act 1956.

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Component Accounting

Optional NOT compulsory to

implement

Airline companies follow this method

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Extract para 8.3 of AS

10

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8.3.In certain circumstances, the accounting for an

item of fixed asset may be improved if the total

expenditure thereon is allocated to its component

parts, provided they are in practice separable, and

estimates are made of the useful lives of thesecomponents.

For example, rather than treat an aircraft and its

engines as one unit, it may be better to treat the

engines as a separate unit if it is likely that theiruseful life is shorter than that of the aircraft as a

whole.

C t A ti

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Component Accounting

Example: Air Craft

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Description UsefulLife

Dep.Rate

Rate atwhich

should have

been Dep.

Impact

LandingGear

5 10% 20% UnderDepreciated

Frame 20 10% 5% Over

Depreciated

Engine 10 10% 10% AdequatelyDepreciated

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Depreciation and

Disposal

In case of Disposal / Destruction/ Demolition/

or when assets are discarded :

Any MaterialNet Surplus or Deficiency are

disclosed

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Presentation in Financial

Statement Balance Sheet

35

Reduced from the Gross Book Value

Description Amount

Fixed Assets Gross Book

Value

25,00,000

Less : Accumulated

Depreciation

5,00,000

Net Book Value 20,00,000

Presentation in Financial

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Presentation in Financial

Statement Statement of Profit &

Loss

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Depreciation Expenses is

presented on the debit side of the

Statement of Profit & Loss

Debit Profit & Loss Account / Depreciation Exp.

Credit Accumulated Depreciated

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Disclosures

The related accumulated depreciation.

Total depreciation for the period of eachclassof assets,

Historical cost or other amount substitutedfor Historical cost of each classofdepreciable assets;

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Additional disclosuresNote: Audio for this slide will be updated shortly

Following information should also be disclosed along

with disclosures of other accounting policies:

Depreciation methods used, and

Depreciation rates or useful lives of the assets

(if they are different from the principal rates specified in the

statute governing the enterprise e.g: Companies Act, 1956)

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Disclosures Revalued AssetsNote: Audio for this slide will be updated shortly

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If 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 a 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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Thank You

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