(188)---DEPRECIATION FOR TAX PURPOSES IN CASH FLOW

Depreciation for Tax Purposes in Cash Flow

Two most popular methods of charging depreciation are:

1. Straight line method
2. Diminishing balance or written-down value (WDV) method

For reporting to the shareholders, companies could charge depreciation either on the straight-line or the written-down value basis. However, no choice of depreciation method and rates for the tax purpose is available to companies.

Depreciation is allowed as deduction every year on the written-down value basis in respect of fixed assets as per the rates prescribed in the income tax rules. Depreciation is computed on the written down value of the block assets. Block assets means a group of assets falling within a class of assets, being building, machinery, plant or furniture, in respect of which some percentage of depreciation is prescribed. Ocean-going ships are also included in the block of assets.

For example, plant and machinery has been divided into three blocks with three rates of depreciation: 25%, 50% and 100%. Most of the plants and machinery's are covered in the 25% depreciation block. No depreciation is allowed on land.

Depreciation base

In the case of block assets, the written down value is calculated as follows:

• The aggregate of the written down value of all assets in the block at the beginning of then year
• Plus the actual cost of any asset in the block acquired during the year
• Minus the proceeds from the sale of any asset in the block during the year (provides such reduction does not exceed the written down value of the block arrived in the first two items above)

Thus, in a replacement decision, the depreciation base of a net asset (assuming that the new and the old assets belong to the same block assets) will be equal to:

Cost of new equipment + written down value of old equipment – salvage value of old equipment