Now-a-days, a huge amount is spent for acquiring modern machines. For the purpose of such acquisition, the management must have to take some concrete decision.
Thus, the policy must include the following:
(1) To select the appropriate method of depreciation.
(2) To review of the current provision for depreciation whether there is any under provision for depreciation or over provision for depreciation.
(3) To evaluate the existing policy of depreciation from the stand point of tax consideration:
(4) To constitute a committee for “Depreciation Policy”.
(5) To ascertain the proper amount of depreciation and its recording procedure.
(6) To disclose the policy of depreciation in the published annual report for the benefit of shareholders, outsiders etc.
The depreciation policy to be followed in an organisation is decided at the top level. Depreciation policy, in fact, relates to the choice of the method of depreciation and its suitability for the organisation. Various methods can be evaluated in the light of many factors, such as, effect of obsolescence, repairs and maintenance, future operating efficiency of the asset in use, service cost of the asset, etc.
Objectives of Depreciation Policy
The management has to consider the following objectives while framing a proper depreciation policy:
(a) To recover the cost of fixed assets before its effective life.
(b) Creating funds to replace the asset in future.
(c) To take advantages of tax benefit.
(d) To determine the correct profit.
(e) Following a uniform rate of return.
(f) Sometimes to create a source of fund for working capital.
Requirement of Companies Act 1956
Sec. 205 (2) of the Companies Act deals with the provision of depreciation. The Companies Act 1988 has delinked depreciation under the Companies Act from that under the Income Tax Act. The Act now provides the rates of depreciation in schedule XIV to the Act. Every company has the following alternatives with respect to provision for depreciation.
(a) Provide depreciation on the written down value at the rates specified in Schedule XIV to the Act, at the end of the each financial year.
(b) Provide depreciation by dividing 95% of the original cost of each depreciable asset by the specified period in respect of such asset.
(c) Any other method with the prior consent from the Central Government which would ensure writing off at 95% of the original cost during specified period.
(d) For assets for which schedule XIV does not provide rates on basis approved by Central Government by any general or special order published in official Gazette.
Schedule XIV provides separate rates of depreciation for WDV basis and Straight Line basis. Rates are also specified for single shift, double shift and three shifts. Companies Act also stipulates that in the event an asset is sold, discarded, demolished or destroyed before the new provision of depreciation, the difference between the book value and sale proceeds of the asset must be written off in the financial year in which the asset is sold, discarded, demolished or destroyed.