How To Calculate Depreciation As Per Companies Act

For assets purchased on or after 1st April 2014, depreciation is applicable on such assets as per the companies act 2013. Here’s the basic idea of depreciation and calculating depreciation as per the companies act.

Understanding depreciation


Depreciation in the financial language is a measure of loss of value of an asset arising from the use of the asset, passage of time, or obsolescence either through the market or technical changes. In simpler terms, depreciation incorporates the decrease of the asset’s value resulting from its use, the passage of time, or modifications of any sort.


For example, a car purchased in 2020 for Rs. 5,00,000 now has a value of Rs. 3,50,000 after a year. The loss of 1,50,000 is the depreciation applicable to the car. This depreciation can result from anything, like the car’s use, the passage of time, or a change in ownership or components of the car.


In every accounting period, depreciation gets charged in a fair proportion of the depreciable amount during the expected useful life of the asset. We can treat depreciation as an expense, as everything losses value over time. Depreciation charged on the assets of an entity or a company can get recorded as an expense in the Profit & Loss Account in the books of accounts.


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Depreciable assets


A company or an entity can compensate for the value lost on the depreciable assets by charging depreciation as an expense in the Profit & Loss account.


The assets used for the business that depreciates over time are called depreciable assets. Hence, the value of a depreciable asset is considered a business expense over the asset’s useful life.


Most of the tangible assets can be depreciated and recorded in the profit and loss account of the company or an entity—for example, machinery, vehicle, furniture, fixtures, equipment, computers, etc. Intangible assets can also be depreciated and recorded as expenses in the profit and loss accounts—for example, computer software, patents, copyrights, etc.


Why is depreciation charged?


Depreciation does not represent an accurate cash flow; hence it can be a complicated topic for many to understand and record in the books of accounts. Depreciation is charged to get the exact knowledge of how well a company has performed in a given reporting period.


It gets charged against the company’s revenue generated using an asset depreciated over time to get the net revenue earned. It is called the matching principle in financial terms. 


There is an insubstantial connection between revenue generation and a specific asset. This matching concept has a considerable difficulty, making it complex to calculate and record depreciation for the accounting year. 


There is no specific way to link a specific fixed asset to specific revenue, as all the company assets should get treated as a single system that generates profit.


The business concern will end depreciating the business asset in the following situations:


  • If the business asset reached the end of its useful life or

  • The business concern dispose of the asset


The Process to Calculate Depreciation As Per Companies Act 


Depreciation can get calculated as per companies act following the below-mentioned steps:

  1. Finding out the useful life of the asset as per the new schedule

  2. Calculating already expired useful life of the asset

  3. Difference between steps 1 and 2

  4. Taking residual life at 5% of the historical cost as per management estimate

  5. The formula of calculating depreciation is - Depreciable amount = Historical cost/revalued value – residual value (calculated in step 4)

  6. If the Straight Line Method gets followed, then (amount of depreciation per annum = depreciable amount / Remaining useful life)

  7. If the Written Down Value Method gets followed, we need to determine the depreciation rate by using the below-mentioned formula: 


(1-(s/c)^(1/n))*100 where S = Salvage Value, C= Carrying Amount as on 01-04-14, N= Difference of useful life as per new and old schedule


Types of depreciation


Companies act 2013 prescribes two methods for calculating depreciation. The methods are:

  • Straight-line method and

  • Written down value method


To conclude –


If there would be no system of charging depreciation at all, companies would write off all the business assets as an expense at the time of purchase, resulting in considerable losses in the months when the transaction occurred. Hence, it is crucial to calculate depreciation as per the companies act 2013 to get a perfect picture of its profit and losses.

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