DEPRECIATION UNDER COMPANIES ACT’ 1956

Meaning:

Depreciation is a term used in accounting, economics and finance with reference to the fact that assets with finite lives lose value over time. In other words it is a financial tool for replacing an asset at the end of its useful life. 

Why Provide for Depreciation?  

There are mainly two reasons from financial aspect, those being:

1.  Firstly, the use of any asset erodes its value due to wear and tear or due to the passage of time, or due to obsolescence resulting from a change in technology. The cost of an asset should be written down to reflect its correct value. Since assets like plant and machinery, buildings, and furniture and fixtures are used to generate revenue; the reduction in their values represents a charge, which is debited to the profit and loss account to arrive at the correct profits of the year. 

2.  Secondly, depreciation is non-cash expenditure, i.e., it does not involve an outflow of cash from the business, and therefore results in the accumulation of funds. But since it is debited to the profit and loss account like any other expense, it reduces the taxable profits and, therefore, the burden of tax. It acts as a source of internal financing for replacement of an asset at the end of its useful life. 

Depreciation under Companies Act’ 1956

Depreciation is computed using either the straight-line method (where the amount of depreciation is uniform for all the years) or the written-down value method (where the amount of deprecation is highest in the first year and goes on reducing year after year)

The Rates for Depreciation under Companies Act are specified in Schedule XIV of the Companies Act’ 1956. These rates consist of both Straight line method of depreciation as well as Written down value method of depreciation. 

The rates applicable for each asset is determined from Schedule XIV of the Companies Act and depreciation calculated accordingly.

Click here for a Live Example of Depreciation Calculation as per The Companies Act’ 1956.

Click here for Rates Specified for Depreciation Calculation in Schedule XIV of The Companies Act’ 1956.