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Application of Time Value of Money concept to the calculation of WDV Depreciation method

Depreciation as per written down value method (WDV) has been under the spotlight after the introduction of the Companies Act, 2013. Schedule II of the act mandates to provide depreciation as per useful life of assets using either straight line method or written down value method. This article is on Application of Time Value of Money Concept to the calculation of Depreciation under WDV method. Let’s start with example;

Example 1

Company A has procured a plant and machinery on 1 September 2018 and put into use on 1 October 2018. Cost of machinery is Rs.50 lacs and useful life is 8 years. Company follows financial year. As per normal practice, when asset is acquired during the year, first year depreciation is calculated based number of days asset is used during the year. In the given case, depreciation for first year will be Rs. 7,78,611 (Rs.50,00,000*31.23%*182/365).

Technically, this is under booking of depreciation. Depreciation for the first year will be Rs.8,53,749. This amount has been derived using time value of money concept, present value formula and charts. In simple term, it is daily reducing WDV depreciation or Compounding WDV Depreciation.

Why this happened so?

In normal WDV Depreciation calculation, depreciation is calculated first annually then it is allocated based on number of days asset used during the year. This allocation becomes straight lined. Let’s take one more example,

Example 2

A computer costing Rs.1 lac has been procured on 1st October 2018. Now, say 60% is rate of WDV. Estimate Residual value Rs.6,400. Useful life is 3 years.

Depreciation = Rs.1,00,000* 60%* 6/12 = Rs.30,000 which makes per month allocation Rs.5,000

During the year, allocation of depreciation becomes straight lined rather than reducing balance.

Under Daily reducing WDV depreciation, depreciation during initial month is high. Below chart explains the same;

Month on Month Comparison

Depreciation under daily reducing method is high in initial years which has an impact of saving MAT Tax liability. Further, at the end of the useful life, under normal depreciation, WDV does not equate to residual value. See below year wise comparison;

Year on Year Comparison

Issues under Normal WDV Depreciation Calculation

Impact of using Daily reducing WDV Depreciation/Compounding WDV Depreciation

We have evaluated current practice of Normal depreciation on some of taxation, auditing software available in market. We have taken opinion from practicing Chartered Accountants on current WDV depreciation method.

Myself CA Vishal Mulchandani, I came across to this daily reducing method of depreciation while developing perpetual depreciation calculator. In my opinion, application of time value of money concept to the WDV Depreciation calculation makes more logical and accurate.

Feedback, suggestions are welcome.

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