Accounting for Depreciation on Fixed Assets

Every machine that runs in a factory, every building that houses an office, and every delivery van that clocks up kilometres loses value with time. Companies cannot pretend otherwise in their books. Accounting for depreciation is how a business systematically records this wear and tear, so that both the Profit and Loss Account and the Balance Sheet show a realistic picture of what the company owns and what it actually earned during the year. For commerce students, this topic sits at the intersection of two financial statements, and understanding it properly makes final accounts far less intimidating.

Why fixed assets need depreciation 🔗

A fixed asset like machinery is bought to generate revenue over several years, not just in the year of purchase. If its entire cost were charged as an expense in year one, that year’s profit would look artificially low, while every following year would look artificially high because the asset would still be earning revenue without any matching cost. Depreciation solves this by spreading the cost of the asset over its useful life, so that each accounting period bears a fair share of the expense. This is really an application of the matching principle in accounting, where costs are matched against the revenue they help generate.

Depreciation is also not the same as a fall in market value. A company keeps depreciating an asset according to a fixed method even if the asset’s resale price in the market moves up or down for unrelated reasons. It is a systematic allocation of cost, not a valuation exercise.

Which fixed assets actually get depreciated 🔗

Buildings, plant and machinery, furniture, vehicles, and office equipment are all depreciated because they have a limited, determinable useful life. Land is the one common exception. Since land generally does not wear out or become obsolete the way a machine does, it is usually not depreciated, though the buildings standing on that land certainly are. This distinction matters in exam answers and in real financial statements alike, since clubbing land and buildings together as one depreciable block is a common mistake.

How depreciation is recorded in the books 🔗

There are two broad ways of recording depreciation. In the older method, depreciation is credited directly to the asset account, so the asset’s book value keeps falling on the face of the account itself. Most companies today use the second method: Provision for Depreciation Account. Here, the original cost of the asset stays untouched in the Asset Account, and the yearly depreciation is credited to a separate Provision for Depreciation Account (also called Accumulated Depreciation Account). This second method is preferred because it lets a company show both the original cost and the total depreciation charged so far, side by side, which is exactly what regulators expect to see in financial statements.

Straight line method versus written down value method 🔗

Under the Straight Line Method (SLM), an equal amount of depreciation is charged every year over the asset’s useful life. Under the Written Down Value (WDV) method, a fixed percentage is applied each year to the asset’s reducing balance, so the depreciation charge is higher in early years and tapers off later. Indian companies are free to choose either method, but under the Companies Act, 2013, the rate or amount must be derived from the useful life prescribed in Schedule II, rather than picked arbitrarily. Schedule II sets out indicative useful lives for various classes of assets, and companies must justify any deviation from these with technical evidence.

Charging depreciation to the Profit and Loss Account 🔗

Whichever method is used, depreciation for the year is charged as an expense in the Profit and Loss Account, reducing the reported net profit. This is a non-cash expense: no money actually leaves the business when depreciation is recorded, but the accounting entry still lowers profit because it reflects the asset being consumed over time. This is also why depreciation gets added back when preparing a cash flow statement using the indirect method, since it never involved an actual cash outflow in that period.

Companies must provide depreciation every year regardless of whether they made a profit or a loss. Skipping depreciation in a bad year to inflate reported profits would misstate the financial position and is not permitted under statutory reporting requirements.

Showing depreciation in the Balance Sheet: the Net Block 🔗

Under Schedule III of the Companies Act, 2013, which prescribes the balance sheet format, fixed assets are not shown at one single figure. Instead, the notes to accounts disclose three linked numbers for each class of asset:

The Balance Sheet itself typically shows only the net block figure for each asset class, while the full breakup of gross block, additions, deletions, and accumulated depreciation appears in the notes to accounts. This gives a reader of the financial statements both a quick summary figure and, if they dig into the notes, the complete movement during the year.

A worked example 🔗

Suppose a company owns machinery with an original cost of ₹10,00,000 at the start of the year. During the year, it buys new machinery worth ₹2,00,000 and sells old machinery with an original cost of ₹1,00,000. Depreciation for the year works out to ₹1,50,000, and accumulated depreciation brought forward (net of the depreciation on the machinery sold) stood at ₹3,00,000.

This net block of ₹6,50,000 is what appears against machinery in the Balance Sheet, while the movement schedule sits in the notes for anyone who wants the full detail.

Keeping detailed fixed asset records 🔗

None of the figures above can be produced accurately without a proper fixed asset register, maintained asset by asset or in reasonable groups. A well-maintained register typically records the date of purchase, original cost, location, useful life, rate of depreciation, additions, disposals, and accumulated depreciation for every asset. This is not just good practice; it is a statutory requirement. Companies must maintain records that let auditors trace exactly how each year’s depreciation was arrived at, and disclose in their financial statements the method of depreciation used along with the useful life adopted, especially where it differs from what Schedule II recommends.

Where a significant part of an asset, such as an aircraft engine within an aircraft, has a materially different useful life from the rest of the asset, that part is depreciated separately under the component accounting approach. This level of granularity is exactly why detailed asset-wise records matter, rather than treating an entire class of assets as one lump figure.

Aligning with accounting standards 🔗

Companies following Indian Accounting Standards apply Ind AS 16, which governs the recognition, measurement, and depreciation of property, plant and equipment. It requires that the residual value and useful life of an asset be reviewed at least at each financial year-end, and any change be accounted for prospectively as a change in accounting estimate, not by restating past years. Companies not yet on Ind AS continue to follow AS 6 and AS 10 alongside Schedule II. Either way, the underlying idea stays the same: depreciation must be charged consistently, disclosed transparently, and applied uniformly for similar assets, so that financial statements remain comparable year on year and across companies.

Getting the useful life estimate wrong has real consequences. When Schedule II replaced the older Schedule XIV rates in 2014, many companies had to recompute depreciation on assets like buildings that were previously depreciated over a much longer assumed life, adjusting the transition impact through retained earnings. This is a good reminder that depreciation policy is not a one-time decision; it needs periodic review as regulations and asset conditions change.

What do you think? If a company deliberately underestimates the useful life of its machinery to charge higher depreciation and reduce its reported profit, what could be its motive, and how might auditors catch this? And when a fixed asset is fully depreciated but still physically in use, should its value in the Balance Sheet stay at zero forever?

References

1. https://tallysolutions.com/business-guides/depreciation-rate-companies-act-2013/
2. https://www.incometaxindia.gov.in/w/schedule-iii
3. https://bcajonline.org/journal/from-published-accounts-85/
4. https://sbsandco.com/schedule-ii-to-companies-act-2013/
5. https://resource.cdn.icai.org/67208bos54111-cp7u2.pdf
6. https://neerajbhagat.com/wp-content/uploads/2024/03/Depreciation-2013-Act.pdf