Depreciation is an accounting method of allocating the cost of a tangible asset over its useful life. In this tutorial, we’ll explore how to calculate depreciation under the Companies Act and the Income Tax Act. We’ll also discuss the procedure for calculating deferred tax related to fixed assets.
Depreciation Under Companies Act
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The depreciation under the Companies Act is calculated based on the useful life of the assets, as stated in Schedule II of the Companies Act, 2013.
Here’s a simplified step-by-step process:
- Identify the Asset: Determine the fixed asset that you will depreciate.
- Determine the Cost: Ascertain the historical cost of the asset, including purchase price, import duties, transportation, and installation.
- Assess the Useful Life: Refer to Schedule II for the prescribed useful life of the asset class.
- Select the Method: Choose a depreciation method (Straight line method or Written down value method) as per your company policy.
- Calculate Depreciation: Apply the method to the cost of the asset over its useful life.
Example Table of Rates and Useful Life as per Companies Act:
| Asset Type | Useful Life (Years) | Depreciation Rate (SLM) | Depreciation Rate (WDV) |
|---|---|---|---|
| Buildings | 30 | 3.34% | 5.28% |
| Furniture | 10 | 9.50% | 18.10% |
| Machinery | 15 | 6.33% | 13.91% |
| Computers | 3 | 31.67% | 63.16% |
Note: SLM stands for Straight Line Method, and WDV stands for Written Down Value Method.
Depreciation Under Income Tax Act
The Income Tax Act allows businesses to claim depreciation on their assets to reduce their taxable income using the Written Down Value (WDV) method.
Steps for calculation under Income Tax Act:
- Categorize the Asset: Identify the block of asset as per Income Tax rules.
- Determine the WDV: Find out the Written Down Value at the beginning of the year.
- Apply the Rates: Use the rates provided by the Income Tax Act for different asset types.
- Compute Depreciation: Calculate the depreciation for the year based on the applicable rate.
Example Table of Rates as per Income Tax Act:
| Asset Block | Depreciation Rate |
|---|---|
| Building | 10% |
| Furniture and Fittings | 10% |
| Machinery and Plant (General) | 15% |
| Computers and Software | 40% |
Calculating Deferred Tax
Deferred tax is calculated on temporary differences between the book value of assets as per accounting records and their value for tax purposes.
Here’s how to calculate deferred tax:
- Identify Temporary Differences: Determine the temporary differences that arise due to differences in depreciation methods or rates as per accounting standards and tax laws.
- Calculate Timing Differences: Assess the timing difference for the period by subtracting the tax base of the asset from its carrying amount.
- Apply the Tax Rate: Apply the current tax rate to the timing difference to find the deferred tax.
- Deferred Tax Asset or Liability: If the carrying amount is greater than the tax base, it results in a deferred tax asset. Conversely, if the tax base is greater, it leads to a deferred tax liability.
Example Calculation:
| Particulars | Carrying Amount | Tax Base | Temporary Difference | Tax Rate | Deferred Tax |
|---|---|---|---|---|---|
| Machinery (as per books) | 100,000 | 80,000 | 20,000 | 30% | 6,000 |
In this example, a deferred tax liability of Rs. 6,000 will be recognized on the balance sheet because the carrying amount is more than the tax base.
Remember that rules and rates are subject to change, and different types of assets may have specific requirements. It’s important to refer to the latest schedules and rates provided under the Companies Act and Income Tax Act respectively, and to consult with a tax professional for accurate depreciation and deferred tax calculations.
