11. Depreciation Finalization — Companies Act vs IT Act

Depreciation is one of the most misunderstood yet most litigated year-end adjustments.While depreciation does not involve cash outflow, it has a direct and recurring impact on profit, tax liability, and credibility of financial statements.
This guide explains how to finalise depreciation correctly, why two different depreciation computations are required, and how to manage the differences without confusion or risk.

1. Introduction — Why Depreciation Finalisation Is Critical

Many SMEs assume depreciation is a “system-generated” figure that needs no review.In reality, depreciation errors are a frequent cause of audit adjustments and tax disallowances.
Depreciation impacts:
  • Profit & Loss account
  • Balance Sheet (WDV of assets)
  • Income-tax computation
  • MAT / AMT (where applicable)
  • Future years’ tax positions
A depreciation mistake made once continues to affect every future year until corrected.

2. Objective

To ensure that at year-end:
  • Depreciation is computed correctly under applicable law
  • Separate depreciation workings exist for books and tax
  • Differences are identified and reconciled
  • Supporting documentation is audit-ready
  • No excess or ineligible depreciation is claimed

3. Why Two Depreciations Exist

A fundamental principle to understand:
Depreciation as per Companies Act ≠ Depreciation as per Income-tax Act
They serve different purposes and follow different rules.

4. Depreciation as per Companies Act (Book Depreciation)

Purpose
  • To reflect true consumption of asset value
  • To present a true and fair view of financial statements
Key Features
  • Governed by Schedule II of Companies Act, 2013
  • Based on useful life of assets
  • Residual value considered
  • Method: SLM or WDV (as per policy)
  • Requires management judgment
Focus
Economic reality, not tax benefit.

5. Depreciation as per Income-tax Act (Tax Depreciation)

Purpose
  • To determine allowable deduction for tax computation
Key Features
  • Governed by Section 32 of Income-tax Act
  • Asset-wise depreciation replaced by block of assets
  • Fixed statutory rates
  • Half-year rule for additions
  • No residual value concept
Focus
Standardised tax computation, not asset life.

6. CABTA Framework — “The 7-Step Depreciation Finalisation Process”

Step 1 — Finalise Fixed Asset Base

Ensure:
  • Opening WDV matches prior year audited closing
  • All additions and deletions are finalised
  • CWIP is correctly segregated
Depreciation cannot be finalised unless asset base is correct.

Step 2 — Compute Depreciation as per Companies Act

For each asset:
  • Apply useful life
  • Apply method (SLM / WDV)
  • Consider residual value
  • Ensure consistency with accounting policy
This depreciation goes to P&L and Balance Sheet.

Step 3 — Compute Depreciation as per Income-tax Act

For each block:
  • Apply statutory rate
  • Apply half-year/full-year rule
  • Adjust for asset sales
This depreciation is used only for tax computation.

Step 4 — Identify Differences (Book vs Tax)

Common causes:
  • Different rates
  • Different methods
  • Timing differences
  • CWIP treatment
Prepare a depreciation difference statement.
Untracked depreciation differences create confusion during tax audit and assessment.

Step 5 — Pass Correct Accounting Entries

Only Companies Act depreciation is booked in accounts:
Depreciation A/c Dr
To Accumulated Depreciation A/c
Income-tax depreciation is never booked in books.

Step 6 — Prepare Deferred Tax / Adjustment Notes (If Applicable)

For companies subject to:
  • Deferred tax accounting
  • MAT / AMT
Depreciation difference has downstream impact.

Step 7 — Documentation & Audit Support

Maintain:
  • FAR
  • Book depreciation working
  • Tax depreciation working
  • Reconciliation statement
Auditors and tax officers demand both workings.

7. Common Depreciation Errors in SMEs

  • Booking income-tax depreciation in books
  • Applying tax rates for book depreciation
  • Missing half-year rule
  • Depreciating CWIP
  • No reconciliation between book and tax depreciation
  • Inconsistent depreciation policy
These errors lead to repeated audit adjustments and tax disallowances.

8. Audit & Tax Scrutiny Focus Areas

Auditors examine:
  • Consistency of depreciation policy
  • FAR linkage
  • Reasonableness of useful life
Tax authorities examine:
  • Eligibility of assets
  • Excess depreciation claims
  • Put-to-use condition

9. Case Example — Avoiding Excess Depreciation Disallowance

Issue:Client applied tax depreciation rates in books, overstating expense.
CABTA Action:
  • Recomputed book depreciation
  • Corrected FAR
  • Reconciled tax depreciation separately
Outcome:
  • Clean audit
  • No depreciation disallowance
  • Correct profit reporting

10. Tools & Templates (Application Layer)

  • Book Depreciation Working Sheet
  • Tax Depreciation (Block-wise) Sheet
  • Depreciation Reconciliation Statement
  • FAR Review Checklist
  • Depreciation Policy Note

11. CABTA Insight

“Depreciation is not an estimate — it is a legally controlled computation.”

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