Depreciation under the Companies Act: useful lives in Schedule II

You are closing the books for the year. The fixed asset register is open. Some assets were bought during the year, one laptop was scrapped, and a machine has been running two shifts. The question in front of you is simple: how much depreciation do you charge, and on what basis?

For a company, the Companies Act 2013 answers this itself. Depreciation is not left to habit or to what the last accountant did. This article walks through what the Act says, so that your depreciation note can stand up at audit.

Why the Act cares about depreciation

Depreciation is not only an accounting entry. It decides how much profit you show, and profit decides whether you may pay a dividend.

A company cannot declare or pay a dividend for a financial year except out of profits "arrived at after providing for depreciation in accordance with the provisions of sub-section (2)" (s.123(1)(a), Companies Act 2013). And that sub-section says: "depreciation shall be provided in accordance with the provisions of Schedule II" (s.123(2), Companies Act 2013).

There is a second link. No company may declare dividend unless "carried over previous losses and depreciation not provided in previous year or years are set off against profit of the company for the current year" (a proviso to s.123(1), Companies Act 2013). So if depreciation was skipped in an earlier year, it has to be made good before a dividend can be paid.

In short: get depreciation wrong, and the profit figure behind a dividend can be wrong too.

What Schedule II is

The Schedule has been amended since the Act came into force, including by notifications of 31 March 2014 (G.S.R. 237(E)), 29 August 2014 (G.S.R. 627(E)) and 17 November 2016 (G.S.R. 1075(E)). The wording below is the Schedule as it now reads, as amended (Schedule II, Companies Act 2013).

Schedule II is titled "Useful lives to compute depreciation" and refers back to section 123. It has three parts (Schedule II, Companies Act 2013):

• Part A gives the general rules: what depreciation is, the residual value cap, and how intangible assets are handled.
• Part B deals with assets whose life or residual value is notified by a regulator.
• Part C is the table of useful lives for tangible assets, with notes.

Key terms in plain words

Part A, paragraph 1 defines the ideas you need (Schedule II, Companies Act 2013):

• Depreciation is "the systematic allocation of the depreciable amount of an asset over its useful life".
• Depreciable amount is the cost of the asset (or other amount substituted for cost), less its residual value.
• Useful life is the period over which the asset is expected to be available for use by the company, or the number of production or similar units expected to be obtained from it.
• Residual value is what you expect the asset to be worth at the end of its life. It is the part you do not depreciate.

Paragraph 2 adds that, for the purposes of the Schedule, the term depreciation includes amortisation. For intangibles, the position is set out below.

The two core rules: useful life and 5% residual value

Part A, paragraph 3(i) is the heart of the Schedule (Schedule II, Companies Act 2013). It says two things:

• The useful life of an asset "shall not ordinarily be different" from the useful life given in Part C.
• The residual value "shall not be more than five per cent. of the original cost of the asset".

So for a machine costing ₹10 lakh, the residual value you assume should not exceed ₹50,000. The amount to be depreciated over the useful life would then be at least ₹9.5 lakh.

When you may use a different life or residual value

The word "ordinarily" matters. The proviso allows you to use a different useful life, or a residual value above 5%, but only on conditions (proviso to para 3(i), Part A, Schedule II, Companies Act 2013):

• The financial statements must disclose the difference.
• You must give a justification for it.
• The justification must be "duly supported by technical advice".

A bare management view that "this machine will last longer" is therefore not enough. Keep the technical note, such as an engineer's report or a manufacturer's statement, in your records.

Some useful lives from Part C

Part C, paragraph 5 lists useful lives for tangible assets "subject to Parts A and B". A few of the common ones, as written in the Schedule (Part C, Schedule II, Companies Act 2013):

The Schedule also has special lives for specific kinds of plant, such as telecommunications, oil and gas, mining, glass and civil construction, as well as ships, aircraft, railway sidings and ropeways. If your company is in one of these lines, read the relevant entry in Part C itself and do not rely on a general table.

Note 1 to Part C clarifies that "factory buildings" does not include offices, godowns and staff quarters. So an office building does not get the factory building life.

Part B: lives fixed by a regulator

Part B, paragraph 4 says that where a Regulatory Authority constituted under an Act of Parliament, or the Central Government, has notified a useful life or residual value for a specific asset for accounting purposes, that life or value "shall be applied" in calculating depreciation for that asset "irrespective of the requirements of this Schedule" (Part B, Schedule II, Companies Act 2013).

If your company is in a regulated sector, check whether your regulator has notified anything for your assets before you apply Part C.

Intangible assets

Intangibles are not run through the Part C table. Part A, paragraph 3(ii) says that for intangible assets the relevant Indian Accounting Standards (Ind AS) apply. A company not required to follow Ind AS must follow the relevant Accounting Standards under the Companies (Accounting Standards) Rules, 2006 (Part A, para 3(ii), Schedule II, Companies Act 2013).

The Schedule gives a special revenue-based amortisation method only for toll road intangibles created under build-operate-transfer type arrangements in road projects. Most companies will never use it.

Pro-rata charge for additions and disposals

This is where year-end errors creep in. Note 2 to Part C says that where, during a financial year, an asset is added, or is sold, discarded, demolished or destroyed, depreciation "shall be calculated on a pro rata basis" (Note 2, Part C, Schedule II, Companies Act 2013):

• For an addition, from the date of addition.
• For a disposal, up to the date the asset was sold, discarded, demolished or destroyed.

Example: a laptop is bought on 1 October. You charge depreciation for the days from 1 October to the year end, not a full year and not a half-year by rule of thumb. If the laptop is scrapped on 31 January, depreciation runs only up to that date.

Keep the date of put-to-use and the date of disposal in the asset register. Without them, the pro-rata calculation cannot be checked.

Significant parts: component accounting

Useful lives in Part C are "for whole of the asset". Note 4(a) adds that where the cost of a part of the asset is significant to the total cost and its useful life differs from that of the rest of the asset, "useful life of that significant part shall be determined separately" (Note 4(a), Part C, Schedule II, Companies Act 2013).

Note 4(b) says this was voluntary for the financial year commencing on or after 1 April 2014 and mandatory for financial statements for financial years commencing on or after 1 April 2015 (Note 4(b), Part C, Schedule II, Companies Act 2013). So today it is simply part of the rules.

Example: a building has a lift that costs a large share of the total and wears out sooner than the structure. Under Note 4(a), the lift is given its own life and is depreciated separately.

Extra shift depreciation

The lives in Part C are based on single-shift working. Note 6 says that, except for assets marked NESD ("no extra shift depreciation") in Part C, if an asset is used for any time in the year for a double shift, depreciation "will increase by 50%" for that period. For a triple shift, depreciation "shall be calculated on the basis of 100% for that period" (Note 6, Part C, Schedule II, Companies Act 2013).

Many categories carry the NESD mark, for example office equipment, furniture and fittings, motor vehicles and computers. Check the mark against the exact line in Part C before adding any extra shift charge.

Disclosures

Note 3 to Part C requires the accounts to disclose (Note 3, Part C, Schedule II, Companies Act 2013):

• the depreciation methods used; and
• the useful lives of the assets for computing depreciation, if they are different from the life specified in the Schedule.

This sits alongside the justification disclosure in the proviso to Part A, paragraph 3(i). Together they mean an auditor or reader of your accounts can see where you departed from the Schedule and why.

What not to do

• Do not skip depreciation in a loss year. The Act ties dividend to depreciation having been provided, and a proviso to s.123(1) requires depreciation not provided in earlier years to be set off before dividend (s.123(1), Companies Act 2013).
• Do not charge a full year on a mid-year addition or disposal. Note 2 requires pro-rata.
• Do not set residual value above 5% without a note. If you do, disclose it and back it with technical advice (Part A, para 3(i) proviso, Schedule II).
• Do not use one life for a whole asset with a major part that wears out faster. Apply Note 4(a).
• Do not assume extra shift depreciation applies to every asset. Check for the NESD mark in Part C.

What to do now

Have a CA review your facts before you act or file.

FAQs

Q1. Is depreciation under the Companies Act optional?
No. Dividend can be paid only out of profits arrived at after providing depreciation in accordance with Schedule II (s.123(1)(a) and s.123(2), Companies Act 2013).

Q2. Can we use a useful life shorter or longer than Part C?
Ordinarily no. If you do, the financial statements must disclose the difference and give a justification supported by technical advice (Part A, para 3(i) and its proviso, Schedule II, Companies Act 2013).

Q3. What is the maximum residual value?
Not more than five per cent of the original cost of the asset. A higher figure needs disclosure, justification and technical advice (Part A, para 3(i) and its proviso, Schedule II).

Q4. How is depreciation charged for an asset bought during the year?
On a pro-rata basis from the date of addition. The same applies up to the date of sale, discarding, demolition or destruction (Note 2, Part C, Schedule II, Companies Act 2013).

Q5. Does Schedule II apply to intangible assets such as software?
Part A, paragraph 3(ii) points to the Indian Accounting Standards, or, for companies not required to follow Ind AS, the Accounting Standards under the Companies (Accounting Standards) Rules, 2006, for intangible assets (Schedule II, Companies Act 2013). Part C's table covers tangible assets.

Q6. What if an asset has a significant part with a different life?
Determine that part's useful life separately (Note 4(a), Part C, Schedule II, Companies Act 2013).

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See Also

• We declared a dividend but have not paid it: what the 30-day rule means
• Board's Report Under Section 134: Contents, Signing and Penalty
• Shareholders did not adopt the accounts: what the company still files with the ROC