ACCOUNTING FOR FIXED

ASSETS & DEPRECIATION

Introduction
 Revenue expenses/ Operating expenses (OPEX) expense benefit a
particular accounting period – charged to P&L using accrual basis of
accounting
 Capital expenditure (Capex)  expenses benefit for a long period of
time – creation of non-current assets to be charged to P&L using
matching principle
Non-current Assets/ Fixed Assets
 Held with the intention of being used for the purpose of producing or
providing goods/services and is not held for sale in the normal course of
business
 Often comprises a significant portion of the total assets of an enterprise

 Decision to treat an expenditure an asset or an expense, can have a

material effect
 Cost of a non-current/ fixed asset is apportioned over its useful life
Types of Fixed Assets
 Tangible assets
 Assets with physical existence – One can see, touch and feel
 Example: Land, building, plant & machinery, furniture, vehicles, electronic data
processing equipment etc.

 Intangible assets
 Assets without physical existence
 Patent rights, copyrights, software licenses etc.
Types of Fixed Assets
 Fixed assets can also be classified as Acquired assets vs. Self
constructed assets
 Investment property
 Land and building not for use in production or supply of goods, services or for
any administrative use or for sale in the ordinary course of business
 Held to earn rentals or for capital appreciation or both
Property Plant & Equipment
 Tangible assets – Held for use in the production or supply of goods or
services, for rental to others, or for administrative purposes
 Expected to be used during more than one accounting period

 Includes a wide variety of tangible assets viz. land, building, plant &
machinery, furniture and fixtures, vehicles, computers etc.
Recognition of PPE
 Recognized only if it is probable
 Future economic benefits associated with the item will flow to the entity
 Cost of the item can be measured reliably

PPE recognized

Future economic benefits will Cost can be measured

flow to the entity reliably
Initial Cost

 All costs – Necessary to be incurred to bring the asset to its intended use
should be capitalized
 Purchase price and other expenses

 Purchase price – Net of trade discounts and rebates

 Other expenses – Import duties, freight charges, installation and

assembly costs, site preparation, test run etc.
Initial Recognition
 Assets acquired in exchange
 Self constructed assets

 Assets acquired on deferred payment basis

 Interest on borrowings
Initial Recognition

 Assets acquired in exchange

 Fair market value of the asset given up or the fair market value of asset
acquired whichever is more clearly evident
 If the fair value of neither the asset received nor the asset given up is
reliably measurable, the cost is measured at the carrying amount of the asset
given up
 Cash paid as a part payment should also be adjusted to arrive at the cost of
acquisition
Initial Recognition

 Self-constructed assets
 Cost of construction directly incurred for the specific asset and a fair share
of cost incurred on construction activity in general will also form part of the
cost of the asset
 Eliminate  Internal profits, if any
Initial Recognition
 Assets acquired on deferred payment basis
 Capitalize the asset at the cash price equivalent on the recognition date
 Difference between the cash price equivalent and the total payment 
Recognize as interest over the period of credit

 Interest on borrowings
 Capitalize  borrowing cost of the funds taken for acquisition, construction
or production of an asset
Subsequent Expenditure

Subsequent
Expenditure

Cost of replacement, major

Day to day maintenance –
inspection and overhaul –
Charged to the Statement
Capitalize and add to the
of Profit & Loss
carrying amount of the asset
Subsequent Measurement

 Either using Cost model or Revaluation model

 Cost Model
 Asset is carried in the books at its costs less accumulated depreciation and
impairment losses

 Revaluation Model
 Can be used only where the fair value of an asset is reliably measurable
 Revaluations done with sufficient regularity to ensure that the carrying amount
of the assets is close to the fair value at the end of the reporting period
PPE Measurement

Property, Plant and

Equipment

Initial Subsequent
Measurement Measurement

Cost Revaluation
At Cost
Model Model

Cost less Depreciation Revalued amount less subsequent

and Impairment depreciation and impairment
Process of Allocation
 Most of the fixed assets have limited useful life
 Cost of a fixed assets needs to appropriated on a systematic basis over
its useful life – based upon the “Matching Principle”
 Process of allocation/ appropriation  Depreciation/ Amortization/
Depletion
 Different terms:
 Depreciation – Real assets with limited useful life
 Amortization – Intangible assets
 Depletion – Natural resources
Depreciation
 Each part of an item of property, plant and equipment with a cost that is
significant in relation to the total cost of the item – Depreciated separately

 Various parts having same useful life and depreciation method – May be
grouped together for calculating depreciation
Determinants of Depreciation

 Amount of depreciation depends upon

 Cost of acquisition
 Expected useful life
 Estimated residual value/ salvage value
 Method of depreciation
Determinants of Depreciation
 Cost of acquisition
 Comprises purchase price and any attributable cost of bringing the asset to its
working condition for its intended use
 Capitalize borrowing cost up to the point the asset is ready for its intended use
 Import duties, taxes, delivery and handling costs, site preparations, transport
insurance, installation cost, professional fees, start up, commissioning and test
runs etc.
 Administrative costs are generally excluded
Determinants of Depreciation
 Expected useful life
 Expected useful life is matter of managerial judgment
 Often shorter than the physical life as management prefer to dispose the
asset before it becomes obsolete
 Past experience with similar type of assets comes handy – When no past
experience, things are tough
 Legal / Contractual requirements
 Technological changes – Obsolescence
 Natural resource  Guiding parameters: Assessment of embedded
quantity and rate of extraction
Determinants of Depreciation
 Estimated residual value
 Amount expected to be realized on disposal
 Past experience comes handy
 If considered insignificant – taken as Nil
 Depreciable value = Cost of acquisition – Estimated residual value
Depreciation Methods
 Method of allocating the cost of assets over its useful life:
 Straight Line Method (SLM)
 Written Down Value Method (WDV)
 Sum-of-Year Digits Method (SOYD)
 Unit of Production Method

 Management is free to use any method

 Method chosen must be applied consistently from period to period –

following Consistency principle
Straight Line Method

 Depreciable amount is amortized equally over the useful life of the asset
 Depreciation = (Cost – Residual value)/ Useful life
 Depreciation charge in each period remains same over the useful life of
the asset
 Simple to operate and understand
Accelerated Method –
Written Down Value Method (WDV)
 Other names – Diminishing Value Method, Reducing Balance Method
 Underlying assumption – Asset provides higher economic benefit in the initial years
so higher depreciation in the earlier years and vice-versa
 Depreciation is calculated by applying a rate to the net book value in the beginning
of the year
Accelerated Method –
Sum-of-Year Digit Method (SOYD)
 SOYD = n(n+1)/2

 Depreciation for 1st year = n/Sum of Years Digits

 Depreciation for 2nd year = n-1/Sum of Years Digits

 Accelerated methods are conservative as they higher depreciation is

written in the initial years
Units-of-Production Method

 Life of an asset is defined not in terms of number of years but in terms of

number of units it is expected to produce during its life time
 Depreciation per unit = Cost of the asset/ total no. of units produced

 Depreciation amount = Depreciation per unit × Amount produced in a year

Depreciation as per Companies’ Act 2013
 Provides useful life and residual value for various categories of assets
for calculating depreciation
 Useful life of an asset shall not be longer than the useful life prescribed
in the schedule
 Residual value shall not be more than 5% of the original cost of the
asset
 If the company uses different values, a justification should be given

 Useful life mentioned is as per the single shift, if double shift increase
depreciation by 50% and if triple shift increase by 100% for the period
for which the asset is used
Depreciation as per Income Tax Act, 1961
 Only WDV method of depreciation is allowed
 WDV method – Postpones the tax liability by charging higher
depreciation in the earlier years
 Bifurcating year into 0-180 days and 181-365 days  If assets is used for
<180 in a year, half year depreciation is charged else full year
Principles for Recording Fixed Assets

 Normally recorded following `Cost Principle’

 Cost of acquired asset – All costs that are necessary to be incurred to bring
the assets to its intended use are capitalized, while subsequent costs are
treated as operating expenses.
 Assets acquired in exchange – Cost of acquisition will be either the fair
value of either the asset given up or the fair market value of the asset
acquired, whichever is more evident.
 Cost of self constructed asset – Cost of constructing the asset after
eliminating the Internal profits.
Principles for Recording Fixed Assets
 Capitalization of interest – If the funds are borrowed for acquiring the
asset, interest incurred till the asset is ready for its intended use will be
capitalized as cost of the asset. Any income earned due to temporarily
investing the funds should be deducted from interest for capitalization.
Subsequent interest should be charged to the P&L account.
 Subsequent expenditures – Regular expenditure – to run the machine
properly e.g. Repairs, maintenance etc.; Major expenditure – to increase
the future benefits from the existing asset e.g. Improvement
Accounting for Depreciation

 At the time
 Purchase of assets
 Charging of depreciation
 Disposing of asset
Special Situations
 Revision in useful life or residual value
 Change to be carried out prospectively
 Carrying amount of the related asset is adjusted in the period of the change
 Effect of change is applied prospectively by including it the profit or loss
in the period of change and future periods
Special Situations
 Change in Method of Depreciation
 Only if required by a law/ accounting standard or if it is considered that it
would result in more appropriate presentation
 Change in method is applied prospectively
Special Situations
 De-recognition of assets
 Derecognized either on disposal or when no further economic benefits are
expected from its use or disposal
 Carrying amount  Eliminated from the financial statements
 Gain or loss arising on de-recognition  recognized in the profit or loss
when the item is derecognized
 Gain or loss  Difference between the net disposal proceeds and the
carrying amount of the item
Special Situations
 Small value items

 Assets taken on lease

 Asset is financed out of government grant – fully or partially

 Deduct the capital grant from the value of the asset
 Show the grant as deferred income

 Assets acquired in foreign exchange

Impairment of assets
 Carrying amount – Book value of an asset
 Value in use – Net present value (NPV) of a cash flow or other benefits that an
asset generates for a specific owner under a specific use
 Recoverable amount – Higher of net selling price or its value in use

 If carrying amount > recoverable amount in is said to be impaired

 What should be done  Carrying amount of the asset should be reduced to its
recoverable amount and the difference should be charged to statement of P&L as
impairment cost
Intangible Assets

 A identifiable non-monetary assets, without physical existence

 Computer software, patents, copyrights, mortgage servicing rights, licenses etc.
 Recognized only if
 it is identifiable,
 the entity has control over it,

 the entity would derive future economic benefits,

 cost of the asset can be measured reliably.

 Intangible asset is usually amortized using SLM method over its useful
life
Measurement of Intangible Assets

 Initial Measurement – At cost

 Cost includes purchase price, including import duties and non-
refundable purchase taxes, after deducting trade discounts and rebates
and all expenses necessary to make the asset ready for its intended use.
 Asset acquired in business combination (e.g. merger & amalgamation),
initial measurement shall be at the fair value on the acquisition date
Measurement of Intangible Assets

 Subsequent Measurement – Either cost model or revaluation

model
 Cost model - carried at its cost less accumulated amortization and
accumulated impairment loss, if any
 Revaluation model - carried at a revalued amount (fair value) less
amortization and impairment loss subsequent to revaluation
Amortization on Intangible Assets
 Estimated Useful life
 Assets with infinite life will not be amortized – Goodwill, trademarks, and perpetual
franchises; they are checked for impairment yearly.
 Residual Value
 Normally assumed to be zero
 Amortization Method
 Based upon the pattern in which the economic benefits from the assets are expected
to be derived by the entity.
 If however, such pattern cannot be determined reliably, the assets will be amortized
using Straight Line Method.
Measurement of Intangible Assets

Intangible
Assets

Subsequent
Initial Measurement
Measurement

At Cost Cost Model Revaluation Model

Finite Life Revalued amount less

Cost less Infinite Life
subsequent
amortization and Test for
amortization and
impairment
Impairment impairment
Intangible Assets – Types
 Brand
 Goodwill
 Research and development
 Website costs
Brand

 Internally generated brands are not recognized

 Advertising expenditure to build the brand and improve the image 
Treat them as revenue expense not to be capitalized
Goodwill
 Internally/ self generated goodwill is not recognized as intangible asset
 Acquired goodwill are recorded at the cost of acquisition  Recorded
only when it is acquired (paid for it); Whenever a business is acquired for
a price which is in excess of the value of the net assets of the business
taken over, the excess should be termed as goodwill
Research and Development
 Research phase – Not sure about the outcome  Expensed in the year
when incurred
 Development phase – Commercial development of findings of research
phase so now possible to identify an economic asset with probable
future economic benefit  Capitalize them
 Software development expenses – Same rules as R&D
 Expenses incurred at preliminary project stage  Expense
 Expenses incurred in the development stage  Capitalize
Web Site

 Planning stage – Undertaking feasibility study, defining objectives,

evaluating alternatives, selecting preferences  Treat research
expenses
 Development stage – Capitalize it
Thank You!