Depreciation under Component Approach

Schedule –II of Companies Act, 2013 has introduced a new method of charging depreciation basis the useful life. Schedule –II has become effective from 1^st April, 2014 vide MCA notification no. S.O.902 (E) dated 26^th March, 2014. It prescribes the useful life of individual assets for the purpose depreciation of fixed asset under Part C.  It also defines “useful life” of an asset as the period over which an asset is expected to be available for use by an entity, or the number of production or similar units expected to be obtained from the asset by the entity.

With the introduction of useful life concept, every entity has to review the useful life of all assets.

From the date this Schedule comes into effect, the carrying amount of the asset as on that date—

(a) shall be depreciated over the remaining useful life of the asset as per this Schedule;

(b) after retaining the residual value, shall be recognised in the opening balance of retained earnings where the remaining useful life of an asset is nil.

Principles of Component Approach

The underlying principle behind componentization is simple and logical – all components of a fixed asset that has been acquired will not have the same useful life and additionally, they may depreciate at different rates all through their life. Therefore, it is correct to depreciate each significant component separately over its useful life

Let’s consider the example of an airplane. It may have several engines and a body that have very different useful lives. The engines may need to be replaced several times during the overall life of the airplane. The useful life of the body may be 30 years, whereas the useful life of the engine may be 10 years. The body would be set up as a separate component and depreciated over 30 years, while the engines would be depreciated over 10 years or perhaps based on the number of flight hours (similar to units of production method).

What happens when the engines need to be replaced at the future time? The requirement under Ind AS will be to “derecognize” the engines as they are taken out of operation, by writing off the carrying amount. The replacement engines would be capitalized and depreciated over their useful life of flight hours.