As the financial year draws to a close, businesses must make informed decisions to optimize financial statements, enhance tax efficiency, and strengthen investor confidence. A proactive approach today ensures smoother compliance and better financial positioning tomorrow.
Depreciation is not merely an accounting exercise—it is a crucial financial planning tool influencing profitability, taxation, business valuation, and investor perception. As companies prepare their financial statements for year-end, reassessing depreciation methods can be a strategic move. However, transitioning from the Straight-Line Method (SLM) to the Written Down Value (WDV) method requires careful analysis of financial, tax, and compliance implications.
This professional guide provides a detailed framework to navigate this transition, covering accounting treatment, tax impact, investor considerations, compliance obligations under Ind AS, the Income Tax Act, and SEBI regulations, along with capitalization policies and risk management strategies.
Case Study: ABC Engineering Ltd.
ABC Engineering Ltd., a mid-sized industrial manufacturer, has been following the Straight-Line Method (SLM) for depreciating its plant and machinery. Effective 1st April 2024, the company decides to shift to the Written Down Value (WDV) method, citing better alignment with asset utilization and cash flow management.
The company had acquired an asset on 1st April 2021 at a total cost of Rs. 85,00,000, with a useful life of 10 years and a residual value of nil. Under the SLM method, an annual depreciation charge of Rs. 8,50,000 was applied, resulting in an accumulated depreciation of Rs. 25,50,000 by 31st March 2024. The WDV depreciation rate has now been reassessed at 30% per annum for the remaining life of the asset.
Key Considerations for Changing Depreciation Method
Accounting Policy vs. Accounting Estimate: Understanding the Classification
Under Ind AS 8 (Accounting Estimates and Errors), changes in depreciation methods are classified as changes in accounting estimates rather than accounting policies. Ind AS 16 (Property, Plant & Equipment), Para 61, reinforces that such a shift is a reassessment of how an asset’s economic benefits are derived rather than a fundamental policy change.
Since the transition reflects a reassessment of asset usage, the change should be applied prospectively from 1st April 2024 rather than retrospectively.
Prospective vs. Retrospective Adjustment: What is Allowed?
Regulations mandate that changes in depreciation methods be applied prospectively. Ind AS 8, Para 36, clearly states that adjustments must not affect prior financial statements. Therefore, WDV depreciation will be applied from 1st April 2024, and the impact will be disclosed accordingly.
Correct Accounting Treatment for Transition from SLM to WDV
To implement the change, the company must first determine the net book value of the asset as of 1st April 2024. With a cost of Rs. 85,00,000 and accumulated depreciation of Rs. 25,50,000, the net book value is Rs. 59,50,000.
Applying the WDV method at 30% per annum, depreciation for FY 2024-25 will be Rs. 17,85,000. The journal entry to record this depreciation is:
Dr. Depreciation Expense Rs. 17,85,000
Cr. Accumulated Depreciation Rs. 17,85,000
(To record depreciation under WDV method for FY 2024-25)
Taxation and Capitalization Policy Considerations
Under Section 32 of the Income Tax Act, the WDV method is the prescribed depreciation approach for tax purposes. Aligning tax and book depreciation can simplify calculations and reduce deferred tax liabilities. Higher initial-year depreciation also results in lower taxable income, improving short-term cash flows.
Companies should frame capitalization policies to determine when asset expenditures should be capitalized versus expensed, impacting EBITDA, cash flows, and compliance with financial covenants.
Impact on Business Valuation, IPO, and Financial Statements
Changing depreciation methods affects key financial metrics. While higher depreciation lowers book profits and earnings per share (EPS), it enhances cash flow. Transparent disclosure is critical, particularly for companies planning an IPO, as SEBI (LODR) Regulations require detailed explanations of material accounting changes in financial reports.
Under Companies Act, 2013 (Schedule III), companies must disclose the rationale behind the change in depreciation method in the explanatory notes of their financial statements. For IPO-bound companies, detailed justifications should also be included in the Draft Red Herring Prospectus (DRHP).
Risk Management & Audit Considerations
Audit approval is a crucial step in this transition. Auditors will scrutinize the justification for changing methods, ensuring compliance with Ind AS 16 and tax laws. Companies should also document the change in board resolutions and investor communications to mitigate potential concerns.
Additionally, proactive communication with investors through earnings calls and disclosures will help manage market perception and maintain trust.
Conclusion & Strategic Recommendations
ABC Engineering Ltd.’s transition to WDV must be backed by regulatory compliance, tax efficiency, and transparent investor disclosures. Key strategies include:
Correct Classification: Treating the change as an accounting estimate, not policy.
Prospective Implementation: Applying WDV from 1st April 2024 with no retrospective impact.
Tax & Capitalization Planning: Ensuring depreciation aligns with tax optimization and cash flow strategies.
Investor & IPO Compliance: Structuring detailed explanations in financial statements and DRHP to maintain market confidence.
Risk & Audit Preparedness: Securing approvals and conducting risk reviews to prevent compliance issues.
