AS 6: Depreciation Accounting

IPCC Paper 1: Accounting Chapter 1 Unit 2 Depreciation - AS 6 CA. Yagnesh Desai

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Introduction

This statement deals with depreciation accounting and applies to all depreciable assets;

Depreciation is allocated so as to charge a fair proportion of depreciable amount in each accounting period during the expected useful life of asset. 2

Applicability

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AS – 10 Fixed Asset

This standard was introduced in 1984

Revised later in the year 1994.

It is applicable to corporates as well all non corporate entities since 1995

This standard is inextricably connected with another standard ? Guess which ?

Scoped Out – Not applicable to

Forests, 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;

Goodwill

Livestock

Land- unless it has limited life 4

Learning Objectives

At What rate should Fixed Assets be depreciated ?

What is the concept of Useful life. ?

Can An Enterprise Change rates of depreciation ?

If yes, How changes are dealt with ? Retrospectively or Prospectively. ? 5

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 obsolescence through technology and market changes.

Depreciation includes amortisation of assets whose useful life is predetermined. Amortisation is phrase used for Intangible Assets.

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Definition – Depreciable Assets

Are assets 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 good and services, for rentals to others, or for administrative purposes & NOT for sale in the ordinary course of business.

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Definitions – Useful Life

Is either the period over which a depreciable asset is expected to be used by the enterprise; or

The number of production or similar units expected to be obtained from the use of the asset by the enterprise 8

Definitions – Depreciable Amount

Of a depreciable asset is its historical cost, or other amount substituted for historical cost in the financial statement, LESS the estimated residual value . 9

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Depreciable Amount

Historical Cost or Other Amount

substituted for HC

Residual Value

Useful Life (Years )

Depreciable Amount

Amount of Depreciation

Usually following three factors help assess Depreciation

Historical Cost

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•Historical Cost includes any money outlay 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.

Historical Cost- When can it Change ? ?

Subsequent Changes may occur

as a result of Long term liability due to:

I. price adjustments, II.changes in duties & similar

factors.

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Useful Life

Useful life of a depreciable asset is estimated 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 major depreciable assets may be required.

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Useful Life

Of a depreciable asset is shorter than the physical life.

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

Depends of the extent of use & physical deterioration-Repairs and maintenance policy

Determination of useful life is a matter of estimation. 14

Useful Life gets reduced by obsolescence

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(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.

Changes in Estimated Useful Life

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If it is considered that the original estimate of useful life of an asset requires any revision.

The unamortised depreciable amount of the asset is charged to revenue over the revised remaining useful life.

Thus , the effect is Prospective and NOT Retrospective

Residual Value

If likely to be insignificant then considered NIL;

If likely to be significant then estimated at the time of acquisition / subsequent revaluation of the asset.

One of the basis of the estimation would be realisable value of similar assets which have reached the end of their lives, and have operated under similar conditions. 17

Method of Depreciation Commonly employed

methods in industry and commercial enterprise

are:

Straight-line method (SLM),

and Reducing Balance

method. 18

A combination of more than one method is sometimes used.

Basis for Selection of Method.

Management selects most appropriate method based 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 for Accumulated Depreciation

Viz. Accumulated Depreciation

This account is contra to Fixed Assets

Meaning to arrive at Net Book Value

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 effectively de-recognised.

Can Depreciation Method be Changed ?

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Change in Method of Depreciation • Method of depreciation once selected is

consistently applied.

• Change from one method to another made only if:

1. Its required by a Statute, or 2. For compliance with an accounting std., 3. Considered that such a change would result

in more appropriate preparation or presentation of the financial statements.

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Change in Accounting Policy OR Change in Estimates

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A Change in Method of Depreciation is treated as a Change in …??

A change in accounting policy , and changes in accounting policy is accounted for retrospectively

How Change in Method is accounted for ? Retrospectively.

There arises either a surplus or deficiency when such recalculation is made.

In case of Surplus: Its credited to the Statement of profit and loss

In case of Deficiency: Its charged to the Statement of profit and loss.

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Depreciation is Re-calculated in accordance with the new method

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 over remaining useful life

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Rate of Depreciation !!!

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The Statute governing an enterprise may provide for Depreciation rates Example: Companies Act 1956 provides for Depreciation rates in Schedule XIV for various assets.

Income tax Act provides rates of Depreciation for the Block of assets .

The Moot Question – Which Rate to apply ?

Rate of Depreciation !!!

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As per management

Rate of Depreciation -SLM

As per Statue

Rate of Depreciation- SLM

Can management apply rate based on its estimate

The Rate of Depreciation 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

Rate of Depreciation !!!

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As per management

Rate of Depreciation -SLM

As per Statue

Rate of Depreciation- SLM

Can management apply rate 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 than the statue. This means higher rate of Depreciation need to be applied This is permissible

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.

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 these components.

• 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 their useful life is shorter than that of the aircraft as a whole.

Component Accounting – Example: Air Craft

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Description

Useful Life

Dep. Rate

Rate at which should have been Dep.

Impact

Landing Gear

5 10% 20% Under Depreciated

Frame 20 10% 5% Over Depreciated

Engine 10 10% 10% Adequately Depreciated

Depreciation and Disposal

• In case of Disposal / Destruction/ Demolition/ or when assets are discarded :

Any Material Net Surplus or Deficiency are

disclosed

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Presentation in Financial Statement – Balance Sheet

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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 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 each class of assets,

Historical cost or other amount substituted for Historical cost of each class of depreciable assets;

Additional disclosures Note: 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 Assets Note: 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.

Thank You

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