Common Methods for Calculating Depreciation

Every asset a business buys – machinery, furniture, vehicles, computers – loses value as it’s used. Accountants call this loss depreciation, and it has to be recorded systematically in the books every year. But here’s the catch: there isn’t just one way to calculate it. The method you pick changes how much profit a company reports each year, how its balance sheet looks, and even how much tax it pays. Let’s break down the two most widely used methods for providing depreciation and see how each one actually works.

Why the depreciation method matters 🔗

Depreciation is not just an accounting formality. It directly affects reported profit, asset valuation, and tax liability. A company using one method might show higher profits in the early years of an asset’s life, while another method spreads that impact more evenly. Since Indian companies have to comply with the Companies Act, 2013 for financial reporting and the Income Tax Act, 1961 for tax filing, understanding these methods isn’t optional – it’s part of the basic toolkit for any commerce student or working accountant.

The fixed instalment method 🔗

Also known as the straight-line method or original cost method, this is the simplest approach to depreciation. Under this method, the same amount is charged as depreciation every year, calculated on the original cost of the asset rather than its reducing balance. This consistency is exactly why it’s called the fixed instalment method – the instalment, or annual charge, never changes.

How it works 🔗

The formula is straightforward:

Annual Depreciation = (Original Cost − Estimated Residual Value) ÷ Useful Life of the Asset

Say a company buys a machine for ₹5,00,000 with an estimated scrap value of ₹50,000 after 10 years. The annual depreciation would be (5,00,000 − 50,000) ÷ 10 = ₹45,000 every year, without fail, until the asset is written down to its residual value. Under the Companies Act 2013, this is one of the two officially accepted methods for computing depreciation in financial statements.

Where it works best 🔗

This method suits assets that deliver roughly equal benefit throughout their life – think office buildings, furniture, leasehold improvements, and fittings. A building doesn’t suddenly become less useful in year three compared to year eight, so spreading its cost equally makes intuitive sense.

Advantages 🔗

Simplicity: The calculation stays the same every year, making it easy to budget and forecast.

Predictability: Since the charge doesn’t fluctuate, financial planning becomes more stable.

Full write-off: By the end of the asset’s useful life, its book value equals exactly the residual value – no guesswork left.

Easy audit trail: A constant annual figure is simple to verify and compare year on year, which auditors appreciate.

Limitations 🔗

The biggest criticism is that it ignores how assets are actually used. Machinery, vehicles, and electronic equipment tend to be more productive – and lose more value – in their earlier years. Charging the same depreciation every year doesn’t reflect this reality. It also doesn’t account for rising repair costs as an asset ages, which means the combined cost of depreciation plus maintenance actually increases over time, even though the depreciation charge itself stays flat.

The diminishing balance method 🔗

Also called the written down value (WDV) method or reducing balance method, this approach takes a different route. Instead of applying a fixed rate to the original cost, it applies a fixed percentage rate to the asset’s book value at the start of each year – meaning the depreciation amount keeps shrinking as the asset ages.

How it works 🔗

The formula looks like this:

Annual Depreciation = Book Value at Start of Year × Rate of Depreciation (%)

Continuing the earlier example, if the same ₹5,00,000 machine is depreciated at 15% per year using the WDV method, year one’s charge would be ₹75,000, bringing the book value down to ₹4,25,000. Year two’s charge would then be 15% of ₹4,25,000, or ₹63,750 – smaller than the year before, and so on. Because the rate is applied to a shrinking balance, the book value never technically reaches zero; it just keeps approaching it.

Where it works best 🔗

This method fits assets that are more productive and valuable when new, and gradually lose efficiency – machinery, vehicles, computers, and other equipment prone to rapid technological obsolescence. A delivery van, for instance, provides more reliable service in its first few years than in its last, so it makes sense to front-load the depreciation charge accordingly.

Advantages 🔗

Matches usage pattern: Higher depreciation in early years aligns with when the asset is most productive.

Balances total cost: As depreciation charges shrink in later years, they roughly offset the rising repair and maintenance costs of an ageing asset, keeping the combined annual cost more even.

Preferred for tax purposes: This is significant for Indian businesses, because under Section 32 of the Income Tax Act, 1961, depreciation for tax computation is allowed only on the WDV method, applied to a “block of assets” rather than individual items. The straight-line method isn’t accepted for tax filing at all.

Limitations 🔗

The book value never fully reduces to zero mathematically, which can be inconvenient when a company wants to write off an asset completely. It’s also a less intuitive method to calculate, since the depreciation base keeps changing every year, and comparing depreciation charges across years takes more effort than with the fixed instalment method. Additionally, it’s not ideal for long-life assets that don’t lose much value early on, since it can end up misrepresenting how the asset is actually being used.

Fixed instalment vs diminishing balance: a quick comparison 🔗

How Indian regulations shape the choice 🔗

In India, companies actually have to work with two parallel depreciation regimes. For financial reporting under Schedule II of the Companies Act, 2013, businesses can choose either the straight-line method, the WDV method, or in some cases the unit of production method, depending on which best reflects how the asset is consumed. Rates and useful lives are prescribed for different classes of assets, though companies can deviate with proper technical justification.

For tax computation, though, there’s no choice involved. The Income Tax Act mandates the WDV method applied on a block of assets, with depreciation rates that differ from those specified under company law, such as 40% for computers, 15% for plant and machinery, and 10% for furniture in the current rate schedule. This mismatch between accounting depreciation and tax depreciation creates what’s called a timing difference, which is why companies need to account for deferred tax assets and liabilities in their books. It’s also why the WDV rates under company law and income tax law aren’t identical, even though both use the same underlying method for tax purposes.

Choosing the right method in practice 🔗

In real business decisions, the choice usually comes down to the nature of the asset and the objective behind the depreciation policy. If the goal is predictable, simple accounting for an asset that provides steady service – a factory building or office furniture – the fixed instalment method wins on simplicity. If the goal is to match the depreciation charge more closely with how productive an asset actually is over time – think delivery trucks, laptops, or manufacturing equipment prone to becoming outdated – the diminishing balance method is the more realistic choice. And for tax filings in India, the decision is made for you: WDV is the only method the law recognises.

Neither method is inherently “correct.” They’re tools designed for different purposes, and a good accountant picks the one that best represents the economic reality of how an asset is being used, while staying compliant with whichever regulatory framework applies.

What do you think? If you were managing depreciation policy for a company that owns both office buildings and a fleet of delivery vehicles, would you use the same method for both, or does it make more sense to apply different methods to different asset categories? And given that Indian tax law mandates WDV regardless of what a company uses for its financial statements, how do you think this affects a company’s incentive to choose one method over another for reporting purposes?

References

1. https://accountingtool.in/depreciation-as-per-companies-act-2013/
2. https://eduyush.com/en-us/blogs/accounting/straight-line-method-of-depreciation
3. https://www.jiraaf.com/blogs/general/written-down-value
4. https://taxadda.com/depreciation-section-32-income-tax/
5. https://www.manipalcigna.com/blog/depreciation-rate-as-per-income-tax-act
6. https://gstguntur.com/depreciation-rate-chart-as-per-companies-act-2013-with-related-law/