Depreciation: Complete Guide for CA Students (SLM, WDV, Schedule II & Ind-AS 16)

Depreciation is the systematic allocation of the depreciable amount of a tangible asset over its useful life. It reflects the reduction in value due to wear and tear, usage, obsolescence, or effluxion of time. For CA Foundation students, mastering depreciation is the cornerstone of preparing accurate Final Accounts, ensuring the 'True and Fair' view of the Balance Sheet.

In India, depreciation follows Ind-AS 16 (or AS 10) for financial reporting and Schedule II of the Companies Act, 2013 for useful lives, while tax depreciation is governed by the Income Tax Act.

Quick Answer for Featured Snippets:
Depreciation is not a process of valuation but a process of cost allocation. The two primary methods are Straight Line Method (SLM), where depreciation is constant, and Written Down Value (WDV), where depreciation decreases over time. Both methods allocate the same total depreciable amount over the asset's life.

What is Depreciation? Definition, Causes & Importance

Depreciation (as per Schedule II & Ind-AS 16):
"Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life."

$\text{Depreciable amount} = \text{Cost of asset} - \text{Residual (salvage) value}.$
$\text{Useful life} = \text{Period over which asset is expected to be available for use}.$

Main Causes:

• Physical wear and tear from usage
• Obsolescence (technological or market changes)
• Effluxion of time (passage of time)
• Depletion (exhaustion of natural resources)

Why It Matters (Matching Principle & More):

• Matching Principle: Matches the cost of the asset against the revenue it generates (accrual basis).
• True and Fair View: Ensures assets are not overstated on the Balance Sheet (Carrying Amount = Cost - Accumulated Depreciation).
• Tax Impact: Provides a tax-deductible expense, reducing taxable income.
• Replacement Planning: Helps businesses understand when capital expenditure will be required.

Non-depreciable assets: Land (generally appreciates), Goodwill (amortized), Inventories (not depreciated).

Key Concepts & Terminology

• Cost of Asset: Purchase price + Import duties + Non-refundable taxes + Directly attributable costs to bring the asset to its working condition (Ind-AS 16).
• Residual / Salvage Value: The estimated amount that an entity would currently obtain from disposing of the asset, after deducting estimated costs of disposal.
• Carrying Amount / Book Value: The amount at which an asset is recognized after deducting accumulated depreciation.
• Accumulated Depreciation: The total amount of depreciation expense recognized in the income statement since the asset was put into service.
• Useful Life: The period over which an asset is expected to be available for use. This must be reviewed at least annually.

Overview of Depreciation Methods

Companies must choose a method that reflects the pattern in which the asset’s future economic benefits are expected to be consumed (Ind-AS 16).

Key Insight: SLM and WDV produce the same total depreciation over the asset’s life but different annual amounts and book values each year.

Straight Line Method (SLM) – Detailed

Most common & simplest method. Equal depreciation expense every year.

Formula (KaTeX):
$\text{Annual Depreciation} = \frac{\text{Cost of Asset} - \text{Residual Value}}{\text{Useful Life (years)}}$

Journal Entry:
Dr. Depreciation Expense A/c
Cr. Accumulated Depreciation A/c

Example:
Plant & Machinery Cost = ₹5,00,000
Residual Value = ₹50,000
Useful Life = 5 years
$\text{Annual Depreciation} = \frac{5,00,000 - 50,000}{5} = ₹90,000$

Pros: Simple, easy budgeting & comparison.
Cons: Does not reflect higher early-year usage/obsolescence.
CA Exam Tip: Always check if the asset was purchased mid-year. If purchased on 1st Oct, charge only 6 months of depreciation.

Written Down Value (WDV) / Diminishing Balance Method

Accelerated method – Higher depreciation in early years. This is the dominant method under Indian tax law.

How Rate is Determined under Schedule II (India-specific):
$\r = 1 - \left( \frac{\text{Residual Value}}{\text{Cost}} \right)^{\frac{1}{\text{Useful Life}}}$

Pros: Matches higher early productivity; better for assets losing value quickly (vehicles, computers).
Cons: Complex calculations; lower profits in early years.

Units of Production (Output) Method

Depreciation based on actual usage/output rather than time.

Formula:
$\text{Depreciation per unit} = \frac{\\text{Cost} - \text{Residual}}{\\text{Total Estimated Units}}$
$\text{Period Depreciation} = \text{Depreciation per unit} \times \text{Actual units used}$

Indian Regulatory Framework

1. Ind-AS 16 / AS 10 (Property, Plant & Equipment)

• Method must reflect the pattern of consumption of benefits.
• Review useful life and residual value at least annually.
• Changes in estimates are applied prospectively.

2. Companies Act 2013 – Schedule II

• Prescribes useful lives for various assets (e.g., Buildings: 60 years, Furniture: 10 years).
• Residual value should not exceed 5% of original cost.

3. Income Tax Act, 1961

• Uses the 'Block of Assets' concept.
• Primarily follows the WDV method.
• Creates temporary differences between book and tax depreciation, leading to Deferred Tax.

Practice Questions

Short Form Questions

Q1. Distinguish between Depreciation and Amortization.
Model Answer: Depreciation applies to tangible assets (Machinery, Buildings), while Amortization applies to intangible assets (Patents, Copyrights).

Q2. A machine costing ₹2,00,000 has a residual value of ₹20,000 and a life of 4 years. Calculate annual depreciation using SLM.
Model Answer: $\text{Depreciation} = \frac{2,00,000 - 20,000}{4} = ₹45,000$.

Case Study: SLM vs WDV Impact

Scenario: A vehicle is bought for ₹10,00,000 on 1st April 2023. Residual value is ₹1,00,000. Life is 5 years. Compare Year 1 impact using SLM and WDV (Rate 30%).

Solution:

• SLM Year 1: $\frac{10,00,000 - 1,00,000}{5} = ₹1,80,000$
• WDV Year 1: $10,00,000 \times 30\% = ₹3,00,000$
• Conclusion: WDV results in a lower profit in Year 1 due to higher depreciation expense.

Common Mistakes & CA Exam Tips

• Mistake: Using the tax rate for book depreciation. Always check if the question asks for "as per Companies Act" or "as per Income Tax Act".
• Mistake: Forgetting to prorate for mid-year purchases.
• Tip: In WDV, the last year's depreciation is often adjusted to ensure the final book value exactly matches the residual value.

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