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. 

List of Accounting Standards

Number	Name of the standard
AS 1	Disclosure of Accounting Policies
AS 2	Valuation of Inventories
AS 3	Cash Flow Statements
AS 4	Contingencies and Events Occuring after the Balance Sheet Date
AS 5	Net Profit or Loss for the period,Prior Period Items and Changes in Accounting Policies
AS 6	Depreciation Accounting ( Deleted w.e.f April 01,2016)
AS 7	Construction Contracts
AS 9	Revenue Recognition
AS 10	Property, Plant and Equipment
AS 11	The Effects of Changes in Foreign Exchange Rates
AS 12	Accounting for Government Grants
AS 13	Accounting for Investments
AS 14	Accounting for Amalgamations
AS 15	Employee Benefits
AS 16	Borrowing Costs
AS 17	Segment Reporting
AS 18	Related Party Disclosures
AS 19	Leases
AS 20	Earnings Per Share
AS 21	Consolidated Financial Statements
AS 22	Accounting for Taxes on Income.
AS 23	Accounting for Investments in Associates in Consolidated Financial Statements
AS 24	Discontinuing Operations
AS 25	Interim Financial Reporting
AS 26	Intangible Assets
AS 27	Financial Reporting of Interests in Joint Ventures
AS 28	Impairment of Assets
AS 29	Provisions,Contingent` Liabilities and Contingent Assets

Changes in AS 10 and AS 6_ Accounting for fixed assets and AS 6 -Depreciation accounting

AS 10 – Accounting for fixed assets and AS 6 -Depreciation accounting

The notification has changed the name of AS 10 to “Property, Plant and Equipment” from “accounting for fixed assets”. AS 6 “depreciation accounting’ has been omitted and all the provision related to depreciation has been merged into AS 10 only. Now, AS 10 (Revised) will contain provisions relating to deprecation methods, Useful life etc… Some of the major changes are as follows:

Definition of fixed asset

As per existing definition, fixed asset is an asset held with the intention of being used for the purpose of producing or providing goods or services and is not held for sale in the normal course of business. 

As per the revised definition, Property, plant and equipment are tangible items that (a) are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and (b) are expected to be used during more than a period of twelve months

Now, if expected usage period of more than one year has been added in the definition.

Component Accounting

Existing accounting standard provides that component approach can be applied only when it’s practical to do so, which basically means that its applicability is not mandatory at all. The Companies Act 2013 also contains requirements for the componentisation. The requirement shall be voluntary in respect of F.Y. 2014-15 and mandatory from financial years commencing on or after the April 01, 2015. Now, the component accounting has also been introduced in the revised AS 10 in sync with the Ind AS 16 and Schedule II to Companies Act, 2013.

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.

Revaluation of assets

Under the existing standard, an entity cannot adopt revaluation model as its accounting policy. The entity can select assets for revelation on a systematic basis and there was stipulated time frame within which the entity must revalue the assets.

As per the revised standard, an entity should choose either the cost model or the revaluation model as its accounting policy and should apply that policy to an entire class of property, plant and equipment. Further, revaluations should be made with sufficient regularity to ensure that the carrying amount does not differ materially fair value at the balance sheet date. If an item of property, plant and equipment is revalued, the entire class of property, plant and equipment to which that asset belongs should be revalued.

Deferred payments (beyond normal credit terms)

If payment of any item of PPE is deferred beyond normal credit terms, the difference between the cash price equivalent and the total payment is recognised as interest expense over the period of credit and the asset is recorded at cash price equivalent.

For example: Entity A, purchased asset X for Rs 500,000. The normal credit period was one month. However, the supplier has agreed to settle the payment after 2 years. The entity need to record the asset at the cash price equivalent which is around Rs 400,000 and the amount of  Rs 100,000 will be recorded as interest cost over the credit period.

Review of Useful life, Residual Value and Depreciation Method

Under the existing standard, there was no timeframe within with an entity has to review the residual value, the useful life and depreciation method should be reviewed at least at each financial year-end and, if expectations differ from previous estimates, the change(s) should be accounted for as a change in an accounting estimate.

Change in Depreciation Method

Under the existing standard, when the method of depreciation is changed, new depreciation method is applied from the date of the asset coming into use (i.e. retrospectively). The deficiency or surplus arising from retrospective re-computation of depreciation as per the new method is adjusted in the year of change. Such a change is treated as a change in accounting policy and according disclosed in the financial statements.

Under the revised standard, Change of depreciation method will be treated as change in estimates and will be applied prospectively.

Financials Statements required by Companies falling under phase 1

• Opening Ind AS Balance sheet as at 1 April 2015.
• Equity reconciliation between Ind AS and Indian GAAP on 1 April 2015 & 31 March 2016.
• Income Reconciliation between Ind AS and Indian GAAP for the year ending 31 March 2016.
• Ind AS financial statements as at and for the year ending 31 March 2016 for comparative.
• Ind AS financial statements as at and for year ending 31 March 2017.

  Ind AS financial statements includes following deliverables:

• Balance Sheet
• Statement of profit and loss
• Statement of changes in equity
• Statement of cash flows
• Notes including significant accounting policies and other     explanatory information to the accounts.

Difference between Ind AS 7 and AS 3

Under AS 3, Bank overdraft is considered as financing activities whereas under Ind AS 7, bank overdraft is included as cash and cash equivalents if they form part of an entity’s cash management.

Under AS 3, cash flows from extraordinary items are disclosed separately and it can be from operating, investing or financing activities whereas under Ind AS 7, the concept of extraordinary does not exist. The cash flow statement does not reflect any items of cash flow as extraordinary.

Under AS 3, there is no specific guidance available for cash flows related to changes in ownership interest whereas, under Ind AS 7 cash flows related to changes in ownership interest without loss of control is classified as financing activities.

Difference between Ind AS 2 and AS 2

• Measurement requirements of Ind AS 2 does not apply to inventories held by commodity broker –traders who measure their inventory at fair value less costs to sell whereas no similar exemption is available under AS 2.

• Difference between the purchase price of inventories for normal credit terms and amount paid for deferred settlement terms is recognized as interest expense. Whereas, there is no specific guidance available under existing AS 2 on inventories purchased on deferred settlement terms.

•  Entity is required to use the same cost formulae for all inventories having similar nature and use to the entity whereas under AS 2, it is not expressly mandated to use the same cost formulae for all inventories that have a similar nature and use to the entity.

• Reversal of written down of inventory is possible under Ind AS , if circumstances that leads to the reversal no longer exist or net realisable value increases as a result of changes in economic circumstances. Under existing AS, no specific guidance exists for reversal. 

Difference between Ind AS 1 and AS 1

• Profit or loss attributable to non-controlling interests and equity holders of the parent are disclosed in the statement of profit or loss as allocations of profit or loss and total comprehensive income for the period against the current practice of showing profit or loss attributable to minority interests as deduction from the profit or loss for the period as an item of income or expense.

• A statement of changes in equity is currently not presented. Movements in share capital, retained earnings and other reserves are to be presented in the notes to accounts.

• Presentation of any items of income or expense as extraordinary is prohibited.

• Under Ind AS, disclosure is required of key sources of estimation uncertainty at the end of the reporting period, that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year.

• Ind AS requires disclosure of critical judgments made by management in applying accounting policies

• Under Ind AS, comparative figures are presented for one year. When a change in accounting policy has been applied retrospectively or items of financial statements have been restated/ reclassified, a balance sheet is required as at the beginning of the earliest period presented.