With new Companies Act 2013 round the corner and vigorous environment of analysis going on as to its impact on financial statements of the company,here is the analysis of one of the most vital elements, a non cash expenditure that impacts profitability and tax outgo of companies. Yes! Depreciation is being talked about here. Although several changes are there in the new Companies Act in respect of this topic but here is the major one.
Government has kept in mind a flaw in previous Companies Act 1956 that several assets do not have useful life as prescribed in the old schedule like, 14 years for some office equipments. As a rectified measure, Schedule II of new Companies Act 2013,which came into effect on April 1 this year, has prescribed useful lives,that are more realistic and practical, for companies to depreciate their assets.Not only that but companies have been given liberty too to exceed the limit of useful life prescribed in the new companies act, thereby enabling them to use higher useful life as long as reasonable justification for the same is provided and same shall have to be disclosed in the notes to accounts.
Depreciation = Cost of Asset – Residual life
Residual life of an asset cannot be more than 5% of the cost of the asset.
On general insight, changes in the depreciation under new act will have a negative impact on the profitability of the company as the new act provides shorter useful life, meaning higher depreciation and depreciation being an expense will reduce the profit. However, companies can reduce the negative impact of such rate if it can show justification for using higher useful life as provided by the new act. Example: Useful life of plant and equipment has come down from 21 years to 15 years. Companies, normally manufacturing companies, in case estimate higher useful life of plant can charge depreciation on such higher period if they can provide justification, fairly, of their estimate.
Beauty of the new act is that flexibility provided in it can help to neutralise the negative impact caused by reducing the useful life of asset in right cases.
However, some industries will witness positive effect of the change prescribed in the new Companies Act. Power generation and distribution companies can now take into account 40 years as useful life as opposed to 21 years as was prescribed by old act while non ferrous industries too can have 30-40 useful life for their equipments. Heavy industries like oil and gas refinery, power companies are among other industries that will taste the positive changes of the act.
Although new act tries to overcome the limitations of old act, there are still some challenges for the government that are required to be met. Rates of depreciation as per new rules are still not in alignment with the rates prescribed by the Income Tax Act 1961, as depreciation under Companies Act is calculated on the basis of useful life of an asset. Companies will have to put extra effort in preparing financial statements keeping in mind both the laws. Alignment in the rates of the two laws could have eased the pressure on the companies and companies could have used that saved effort in more productive activities.
With new act trying to fix the minor loopholes and flaws of the previous act, its real impact will be seen and experienced once it gets implemented at large scale. It has to be seen how effectively companies play to reduce the negative impact and gain from the positives of the act.
Invite enlightenment and correction from learned readers, of any error that may have crept unwillingly. :)
Tags Corporate Law