Depreciation is one of the most important accounting concepts for SMEs because it impacts profitability, tax liability, financial reporting, loan eligibility, and audit compliance.
This guide explains depreciation in a simple, structured, and practical way.
Depreciation represents the systematic allocation of the cost of a fixed asset over its useful life.It reflects the consumption, wear-and-tear, or usage of the asset.
Depreciation affects:
- Profitability
- Tax computation
- Balance sheet valuation
- Audit compliance
- Investor reporting
- Loan assessments
Incorrect depreciation leads to:
- Tax disallowances
- Overstated or understated profits
- Misleading financial statements
- Audit remarks and notices
• Assets lose value over time — depreciation reflects this economic reality.• It is a non-cash expense but impacts tax and profit.• Different laws (Companies Act vs Income Tax) have different rules.• Depreciation begins only when the asset is put to use.
To provide a clear, practical understanding of depreciation methods, rates, rules, and compliance requirements for SMEs and startups.
Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life.
Depreciation ensures:
- Cost of asset is matched with revenue generated
- Books reflect correct asset value
- Profit is neither overstated nor understated
Two primary methods are widely used:
Depreciation = (Cost – Residual Value) ÷ Useful Life
Expense is uniform each year.
• Buildings• Furniture• Computers (for internal MIS)• Office equipment
Depreciation = Opening WDV × Rate%
Higher expense in early years; reduces over time.
• Machinery• Manufacturing equipment• Vehicles• Assets subject to rapid wear/tear
Higher initially, reduces each year
• Follows • Allows SLM or WDV• Requires component accounting• Residual value usually 5%• Useful life must be disclosed
Useful life of computers = 3 yearsUseful life of furniture = 10 years
• Follows • Only is allowed• Prescribed rates (not useful life)• Depreciation based on rate × WDV• Half-rate if asset used <180 days in the year
• Computers – 40%• Plant & Machinery – 15%• Furniture – 10%• Motor Car – 15%
Key points:• Depreciation based on useful life• Component-wise depreciation• Review useful life annually• Change in estimate applied prospectively
Depreciation allowed only when asset is:
• Installed• Ready for use• Actually put to use (for Income Tax)
Even one day of use qualifies for full depreciation under Companies Act.
If asset is used for <180 days in the year → allowed.
Significant parts of an asset with different useful lives must be depreciated separately.
Example:• Factory building – 30-year life• Roofing sheet – 10-year life
• Allowed, but must be justified• Prospective treatment under AS 10• Retrospective adjustment may apply under Ind AS
If assets are revalued:• Depreciation adjusts to new value• Revaluation reserve must be disclosed• Revaluation should be based on valuation report
A practical system for ensuring depreciation accuracy:
Track additions, deletions, location, cost components.
Follow:• Companies Act for statutory audit• Income Tax Act for tax computation• Align internal MIS based on business need
Ensure only eligible costs are capitalized (refer Capitalization Rules).
Post regularly to avoid year-end backlog.
Check:• WDV reconciliation• Asset verification• Disposal accounting• Depreciation working papers
Engineering firm Incorrect depreciation rates and misclassification led to audit qualification and higher tax liability.
• Corrected asset classification• Prepared dual depreciation schedule (Companies Act + Income Tax)• Updated Fixed Asset Register• Recomputed WDV accurately
• Clean audit report• Correct tax liability• Accurate asset valuation
• Dual Depreciation Calculator (Companies Act + Income Tax)• Fixed Asset Register Template• Depreciation Policy Document• Capitalization Checklist• Disposal & Write-Off SOP
(Available on request.)