Schedule 2 of Companies Act 2013 provides a model for calculating depreciation. Depreciation means the reduction in the value of a company’s assets over time due to wear and tear, obsolescence, or other factors. Schedule 2 of Companies Act 2013 mentions the useful life of assets, which means how long an asset will last and whether it will be functional and useful for the company. This helps companies in calculating how much value and assets they lose in one year, which is an important factor of financial reporting.
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Schedule 2 of Companies Act 2013: Overview
Part A of Schedule 2 of Companies Act 2013 explains that depreciation is the systematic allocation of an asset’s depreciable amount over its useful life, which refers to the period the asset is expected to be usable or productive. It also clarifies that depreciation includes amortization. For certain companies following prescribed accounting standards, the useful life and residual value of assets should align with those mentioned in Part C unless deviations are justified and disclosed. Other companies must adhere to the prescribed useful life and residual value limits.
Part B states that if a Regulatory Authority or the Central Government specifies the useful life or residual value of an asset, those values must be used, even if they differ from the schedule.
Part C lists the useful lives of various tangible assets, which must be used in depreciation calculations, subject to the conditions outlined in Parts A and B.Few such things as plants and machinery, vehicles, furniture, and computers, and their respective useful lives. The schedule gives an assumption about how long these assets will last before they are no longer useful. Some of the examples are as follows:
Computers: 3 years
Motor vehicles: 8 years
Buildings (not temporary structures): 60 years
The notes provide additional guidelines on depreciation under Schedule 2 of the Companies Act, 2013:
1. Factory buildings do not include offices, storage, or staff quarters.
2. Depreciation on assets bought or disposed of during a financial year is calculated pro rata based on the time of acquisition or disposal.
3. Companies must disclose:
The depreciation methods used.
The useful life of assets if it differs from the schedule.
4. If a part of an asset has a significantly different useful life from the whole asset, its useful life must be determined separately.
5. The depreciable amount is the asset’s cost minus residual value, which should generally be no more than 5% of the asset's original cost.
6. Depreciation for assets used in double or triple shifts increases by 50% and 100%, respectively, except for assets marked NESD (No Extra Shift Depreciation).
7. Existing assets will be depreciated according to the schedule. If an asset’s useful life has ended, its remaining value is adjusted in the retained earnings.
8. A continuous process plant operates 24 hours a day and is designed for continuous operation.
These points provide a clear understanding of how depreciation is calculated and reported under different conditions.
What is depreciation?
As defined above, the term depreciation refers to the process of allocating the cost of a tangible asset [e.g., machinery, computers, buildings, etc.] over its useful life. For example, a company buys 10 computers worth 10 lac rupees [₹10,00,000], but after ten years, that machine will be worth much less due to wear and tear [in other words, due to depreciation].
Formulas to Calculate Depreciation as per Schedule 2 of Companies Act
After knowing the useful life of an asset, we can calculate the yearly value of that asset. There are two basic formulas to calculate it.
Straight Line Method (SLM) where the asset loses an equal amount of value every year. If you buy a machine for₹10 lakhs with a useful life of 10 years, you would depreciate₹1 lakh per year.
Written Down Value Method (WDV) where the asset loses more value in the early years. Using this method, the depreciation amount reduces each year as the value of the asset diminishes.
Also, Learn about Deductions under Section 80C of Income Tax Act, 1961.
Analytical Use of Schedule 2 of Companies Act
It is important to understand the concept of depreciation for every company as it effects financial statements, tax liabilities, and investment decisions.
1. Effect on financial statement
It effects the company's financial statements in the sense that it effects how profits of the company are shown.
For example;
A company buys a machine for 10 lacs. Normally, the machine is expected to last 10 years, so the company would reduce its value by ₹1 lakh each year. But if the company decides to reduce the machine’s value faster, let’s say by ₹2 lakhs per year, this means the company will show lower profits because more of the machine’s cost is counted as an expense.
2. Effects on Tax
Depreciation can help companies lower the taxable amount because depreciation is treated as a business expense. For example, let’s say a company earns ₹10 lakhs in a year. If they can claim₹2 lakhs as depreciation for their equipment, they only need to pay taxes on₹8 lakhs instead of the full₹10 lakhs.
3. Advance planning of capital use
Depreciation schedules work as a guideline for companies in deciding when to replace assets. For example, if a company knows that a machine will be fully depreciated in 5 years, they can plan ahead to make a new purchase in year 6.
Recent Amendment in Schedule 2 of Companies Act 2013
The Companies Amendment Act, 2021, and the guidelines of 2023 have made certain changes due to advancements in technology and business practices. These amendments provide flexibility to the companies in choosing the useful life for the assets and how appreciation should be calculated.
Companies now have a choice in opting for their useful life of assets. They do not need to strictly follow the period mentioned in the schedule. However, the condition is that they justify the deviation with technical assessments or industry-specific reasons.
Now companies are not required to calculate the depreciation of an entire asset as one unit. They can choose to calculate depreciation by dividing the asset into different components. It helps, especially when different components of a machine have different useful lives.
Companies are required to ensure that the calculations under Schedule 2 align with the applicable accounting standards [Ind AS or AS] , providing consistency across financial reporting.
Learn about more Income Tax Rules.
Illustration for the application of Schedule 2 of Companies Act 2013
To bring this concept to life, let’s consider two examples of how companies might apply Schedule 2 of Companies Act 2013:
Example 1: Depreciating a Computer
A small business buys a computer for ₹50,000 in 2024. According to Schedule 2, the useful life of a computer is 3 years. Using the Straight Line Method (SLM), the company would depreciate the computer by ₹16,666 each year for 3 years. After 3 years, the computer’s book value will be zero.
Example 2: Depreciating Machinery
A manufacturing company purchases machinery for ₹20 lakhs in 2024. The useful life of the machinery, according to Schedule 2, is 10 years. Using the Written Down Value Method (WDV), the company could depreciate the machinery by 20% in the first year and then by a reduced amount each subsequent year as the machine’s value decreases.
Summing Up
In a nutshell, Schedule 2 of the Companies Act 2013 provides a blueprint for how a company should calculate the depreciation of their assets. This ensures transparency in the financial reporting. The recent amendment has provided more flexibility to the companies in calculating depreciation. These provisions help businesses maintain accurate financial records and manage their tax liabilities efficiently.
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Schedule 2 of Companies Act 2013: FAQs
Q1. What is Schedule II of the Companies Act, 2013?
Schedule II provides the basis for calculating depreciation of tangible assets by specifying their useful lives and residual values.
Q2. What replaced Schedule XIV of the Companies Act, 1956?
Schedule II under the Companies Act, 2013 replaced Schedule XIV and introduced a useful life-based approach instead of rigid depreciation rates.
Q3. When did Schedule II come into effect?
Schedule II became effective from April 1, 2014.
Q4. What is meant by “useful life” in Schedule II?
Useful life refers to the period over which an asset is expected to be used by the company, as per Schedule II or as assessed by the management.
Q5. Is the useful life specified in Schedule II mandatory?
It is generally mandatory, but companies can use a different useful life if justified by technical advice and disclosed in financial statements.
Q6. What is the standard residual value allowed?
Schedule II prescribes a residual value not exceeding 5% of the original cost of the asset.
