Depreciation - Ind AS - Indian Accounting Standards - Companies Law

Depreciation Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. Each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item shall be depreciated separately. A significant part of an item of property, plant and equipment may have a useful life and a depreciation method that are the same as the useful life and the depreciation method of another significant part of that same item. Such parts may be grouped in determining the depreciation charge. Recognition of depreciation - The depreciation charge for each period shall be recognised in profit or loss unless it is included in the carrying amount of another asset. The depreciation charge for a period is usually recognised in profit or loss. However, sometimes, the future economic benefits embodied in an asset are absorbed in producing other assets. In this case, the depreciation charge constitutes 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 (see Ind AS 2 ). Similarly, depreciation of property, plant and equipment used for development activities may be included in the cost of an intangible asset recognised in accordance with Ind AS 38 , Intangible Assets. Depreciation amount is determined on the following three factors: Historical Cost/Revalued amount Expected useful life of the depreciable asset; and Estimated residual value of the depreciable asset. Residual Value It is an estimated amount, which can be recovered from the asset at the end of the useful life. Initially, the estimation is made by the entity s management at the time of acquisition/installation. If estimated residual value is insignificant (immaterial) Normally considered as NIL. The residual value and the useful life of an asset shall be reviewed at least at each financial year-end and, if expectations differ from previous estimates, the change(s) shall be accounted for as a change in an accounting estimate in accordance with Ind AS 8, Accounting Policies, Changes in Accounting Estimates and Errors. Useful life of an Asset - The future economic benefits embodied in an asset are consumed by an entity principally through its use. However, other factors, such as technical or commercial obsolescence and wear and tear while an asset remains idle, often result in the diminution of the economic benefits that might have been obtained from the asset. Consequently, all the following factors are considered in determining the useful life of an asset: expected usage of the asset. Usage is assessed by reference to the asset s expected capacity or physical output. expected physical wear and tear, which depends on operational factors such as the number of shifts for which the asset is to be used and the repair and maintenance programme, and the care and maintenance of the asset while idle. technical or commercial obsolescence arising from changes or improvements in production, or from a change in the market demand for the product or service output of the asset. Expected future reductions in the selling price of an item that was produced using an asset could indicate the expectation of technical or commercial obsolescence of the asset, which, in turn, might reflect a reduction of the future economic benefits embodied in the asset. legal or similar limits on the use of the asset, such as the expiry dates of related leases. Irrespective of difficulty in assessment, it should be estimated on a reasonable basis. Depreciation Method- The depreciation method used shall reflect the pattern in which the asset s future economic benefits are expected to be consumed by the entity. The depreciation method applied to an asset shall be REVIEWED at least at each financial year-end and, if there has been a significant change in the expected pattern of consumption of the future economic benefits embodied in the asset, the method shall be changed to reflect the changed pattern. Such a change shall be accounted for as a change in an accounting estimate in accordance with Ind AS 8. A variety of depreciation methods can be used to allocate the depreciable amount of an asset on a systematic basis over its useful life. These methods include :- the straight-line method - Straight-line depreciation results in a constant charge over the useful life if the asset s residual value does not change. the diminishing balance method - The diminishing balance method results in a decreasing charge over the useful life, and the units of production method - The units of production method results in a charge based on the expected use or output. The entity selects the method that most closely reflects the expected pattern of consumption of the future economic benefits embodied in the asset. That method is applied consistently from period to period unless there is a change in the expected pattern of consumption of those future economic benefits. A depreciation method that is based on revenue that is generated by an activity that includes the use of an asset is not appropriate. The revenue generated by an activity that includes the use of an asset generally reflects factors other than the consumption of the economic benefits of the asset. For example, revenue is affected by other inputs and processes, selling activities and changes in sales volumes and prices. The price component of revenue may be affected by inflation, which has no bearing upon the way in which an asset is consumed. The standard does not prescribe any specific method to be followed by the entity. While selecting the depreciation method, the management should consider true fair view, Prudence, Substances over form and materiality.