Depreciation Rules and Asset Management under Indian GAAP: An Explainer

Indian depreciation rules bring together Ind AS 16 property, plant, and equipment (PPE) and AS 10 accounting with Schedule II of Companies Act, 2013, requirements. They address component-level depreciation and deferred tax impact on asset valuation to help companies make sound financial decisions.

Accounting depreciation in India is governed by two key regulatory frameworks – the Companies Act, 2013 (Schedule II) and the Indian accounting framework, which includes Indian GAAP and the Indian Accounting Standards (Ind AS).

Schedule II of the Companies Act, 2013, replaced the fixed-rate system prescribed under the 1956 Act with a useful life-based approach. This change allows companies to estimate the useful life of assets based on their operational conditions and usage patterns. The Schedule also stipulates that the residual value of an asset should generally not exceed 5 percent of its original cost, unless a different value is justified with appropriate technical evidence.

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India’s accounting standards further align with this shift. The withdrawal of AS 6 (Depreciation Accounting) and its integration into AS 10 (Property, Plant and Equipment) streamlined the treatment of depreciation under Indian GAAP. For companies following Ind AS, Ind AS 16 (Property, Plant and Equipment) now provides comprehensive guidance on depreciation methods, asset recognition, and measurement principles.

Recognition, useful life, and residual value

Factors determining useful life

An asset’s useful life estimation should not be arbitrary, rather it depicts the real consumption pattern and its economic benefits. Both AS 10 and Ind AS 16 require that useful lives be determined by considering the following factors:

• Physical wear and tear of an asset based on usage frequency and intensity;
• Technological obsolescence, particularly relevant for assets in rapidly evolving sectors such as information technology or electronics;
• Legal or contractual limits, which may restrict an asset’s productive life; and
• Maintenance programs, which can extend its life.

Companies can review the estimates of useful life and residual value annually and any changes made here would be treated as changes in accounting estimates under Ind AS 8.

Residual value assessment

Residual value refers to the estimated amount that a company expects to realize from the sale of an asset at the end of its useful life. While Schedule II of the Companies Act, 2013 generally caps residual value at 5 percent of the asset’s original cost, companies may adopt a higher value if supported by technical justification and appropriately disclosed in their financial statements.

Depreciation methods and component accounting

Commonly used depreciation methods

Indian GAAP allows companies to select depreciation methods that best reflect the pattern of benefit consumption. They can choose from the following methods:

• Straight-line method (SLM): Allocates cost evenly over useful life using the formula: (cost – residual value) ÷ useful life.
• Written down value (WDV): Applies a fixed rate to the book value each year which means higher depreciation during the early years of use.
• Units of production method: Links depreciation to output or usage using the formula: [(cost – residual value) ÷ estimated total output] x actual output.

The chosen method should align with the assets’ economic usage and be disclosed in the financial statements.

Since Ind AS 16 came into effect, changes in depreciation methods are treated as changes in accounting estimates and applied prospectively, unlike the previous AS 6 requirement for retrospective application.

Component accounting

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Under Ind AS 16, entities must apply component accounting, which requires major parts of an asset with differing useful lives to be depreciated separately. For instance, in the case of an aircraft, the engine, body, and interior fittings may each follow distinct depreciation schedules to reflect their individual wear and replacement cycles.

To implement component accounting effectively:

• Identify major components that represent significant cost portions of the asset;
• Assign appropriate useful lives to each identified component; and
• Track costs, depreciation, and accumulated depreciation separately in the financial records.

This approach ensures a more accurate reflection of asset consumption and compliance with Ind AS 16 requirements.

Revaluation model and impairment

Fair value measurement

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Entities can opt for the revaluation model, under which assets are measured at fair value minus accumulated depreciation and impairment losses. Revaluation gains then get recorded in equity through other income, except when it is for reversing previously recognized losses. And depreciation after revaluation is calculated on the revalued amount over the remaining useful life.

Ind AS 16 permits, but does not require, the transfer of excess depreciation (arising from revaluation) from the revaluation reserve to retained earnings.

Integration of impairment testing

Annual impairment testing is required for assets with indefinite lives and goodwill. Ind AS 36 gives the leeway for impairment testing to ensure that an asset’s carrying amount does not exceed its recoverable amount, since it is defined as the higher of:

• Fair value minus costs of disposal, and
• Value in use, determined by discounted future cash flows.

If the carrying amount exceeds the recoverable amount, the difference is recognized as an impairment loss in the profit and loss statement. Future depreciation is then recalculated on the revised carrying amount.

Understanding the disclosure and transparency requirements

Disclosure obligations

Ind AS 16 sets out comprehensive disclosure requirements for each major class of assets. Companies are required to provide details on:

• The measurement basis used for determining the carrying amount of assets;
• The depreciation methods applied, along with the rates or useful lives used;
• The gross carrying amount and accumulated depreciation (including impairment losses) at the beginning and end of each reporting period; and
• A reconciliation of carrying amounts, reflecting additions, disposals, depreciation, impairment, and revaluations during the period.

Disclosures on estimate changes

Whenever a company revises its useful life, residual value, or depreciation method, it must disclose the following:

• The nature of the change;
• The financial impact on the current and future reporting periods; and
• Attached technical assessments and other supporting documents that justify the revision.

Asset management and capitalization principles

Capital versus revenue expenditure

Later expenditure on assets should be classified correctly as capital or revenue. The difference depends on whether the cost improves the asset’s future economic benefits. Capital expenditure are costs that extend useful life, improve efficiency, or add new function. Revenue expenditure relates to regular maintenance or repair that restores, but does not improve asset performance.

Also ensure that when components are replaced, the carrying amount of the replaced part must be derecognized, and the new component capitalized if it meets recognition criteria.

Machinery spares and component treatment

Spare parts that meet the definition of PPE are capitalized even if purchased separately from the main equipment. They can be capitalized if they are expected to be used for more than one accounting period and serve directly in production or service delivery process.

Minor or frequently replaced spares that do not meet these criteria are treated as inventory and expensed when consumed.

When major components such as turbines, engines, or compressors are replaced:

• The carrying value of the replaced component is derecognized from the asset register;
• The new component is recognized at cost and depreciated over its own useful life; and
• Any difference between the derecognized value and the new component’s cost is recorded as a gain or loss in profit & loss statement.

It is applicable in all industries with large capital assets like energy and aviation.

Depreciation ceasing events and its disposal

Depreciation ceasing events

Depreciation ceases under two conditions, when an asset is classified as held for sale under Ind AS 105 or when it is derecognized after disposal, replacement, or impairment.

An asset is considered “held for sale” only when:

• It is available for immediate sale in its present condition;
• A sale is highly probable within 12 months; and
• Management has committed to a disposal plan.

Once classified as held for sale, the asset is measured at the lower of carrying amount and fair value less costs to sell, and depreciation is discontinued.

Disposal and derecognition accounting

When an asset is sold or retired, both its gross cost and accumulated depreciation are removed/derecognized from the financial records. The difference between net disposal proceeds and carrying amount is recognized as gain or loss in the profit and loss statement. Such gains or losses are treated as non-operating income to preserve the distinction between recurring business operations and one-off capital transactions.

Tax and accounting depreciation differences

Block of assets under Income Tax Act

The Income Tax (IT) Act, 1961 uses a block of assets system. It differs from the individual asset-based accounting system under GAAP. In block system, assets of similar nature and use are grouped together to apply a uniform rate on the WDV.

Source: Income Tax Act, 1961                                                               

Deferred tax recognition

In situations when depreciation under accounting standards differs from tax depreciation, there can be temporary differences (differences that can be reversed later). Temporary differences should be recognized as Deferred Tax Assets (DTA) or Deferred Tax Liabilities (DTL) under Ind AS 12.

• A DTA arises when book depreciation exceeds tax depreciation, which means lower future taxable income.
• A DTL arises when tax depreciation exceeds book depreciation, which means there is a future tax obligation.

For example, accelerated depreciation under tax law in early years creates a DTL, which reverses accounting depreciation catches up over time. Therefore, having a proper deferred tax recognition can help your business have an accurate representation of future tax effects.

Risk mitigation strategies

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Companies can reduce depreciation-related risks by:

• Hiring audit professionals for review of asset valuation and useful life assumptions.
• Establishing company-wide policies for depreciation methods and revaluation.
• Keeping proper documents which have all the technical justifications; and
• Reviewing depreciation changes periodically to identify any systemic issues.

A proper control and audit framework gives companies’ financial reporting credibility and reassures investors that the numbers reflect real assets.

Key takeaways

Indian GAAP ensures that companies keep an eye on every addition, movement, or write-off and they become visible in the book in real time. Companies that carry out regular physical checks can ensure that assets in the book actually exist and remain in usable condition, and then decisions on replacement or disposal can pass through managerial review. Organizations can make better choices on when to invest, how to plan finances and when to maintain, when data and records are moving in tandem.

Also Read: GST 2.0: How India’s New HSN and SAC Code Structure Transforms Tax Compliance for Businesses

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