How New Cos Act's Depreciation Policy Will Impact Q1 Nos
On Friday, Infosys declared quarterly earnings that were ahead of street estimates. But as details came out, at least some improvement in the IT major’s net profit margin -- a good 1.1 percent, according to some analysts -- was attributed to the company changing its depreciation policy to align itself with new norms stipulated in the Companies Act 2013.
Schedule II of new Companies Act 2013, which came into effect on April 1 this year, has prescribed useful lives for companies to depreciate their various assets, as opposed to a fixed depreciation rate outlined in Schedule XIV of the Companies Act, 1956.
The new norms have brought about some major changes in the way companies calculate depreciation charge – a non-cash element on the profit-and-loss statement that impacts profitability and tax outgo of companies – and their full impact will likely play out as companies report earnings this quarter.
Also read: How the new Companies Act will affect NBFCs
“The government’s thinking [in bringing about the change] was that many assets do not have the lives that the old schedule prescribed,” Jamil Khatri of KPMG told CNBC-TV18’s Senthil Chengalvarayan and Menaka Doshi. “For instance, the old schedule prescribed a useful life of 14 years for some office equipments.”
Khatri added that, on average, the new norms will be negative for many companies from the earnings standpoint as it prescribes a shorter useful life for many assets, and thereby a higher depreciation charge. “For instance, the useful life for plant and equipment has come down from 21 years to 15 years.”
Companies, however, have been given the freedom to go beyond what the new schedule prescribes – even using a higher useful life for an asset if it wants to -- as long as it has a reasonable justification for the same, Khatri added.
Below is the transcript of Jamil Khatri's interview with CNBC-TV18's Menaka Doshi and Senthil Chengalvarayan.
Menaka: Can you explain the change: what this new Act and the new Schedule mean in terms of how companies look at depreciation?
A: There are two parts to this. One is in certain cases, the rates of deprecation will go up, which means the useful lives [of assets] have come down.
A very simple illustration is office equipment, furniture or laptops and computers where earlier there was a higher useful life and that useful life has come down, which means higher depreciation.
Menaka: Does the Companies Act prescribes a lower useful life or is that companies are choosing a lower useful life, which is a flexibility that this new Companies Act and the Schedule gives them?
A: As I said in the first instance, it is the Companies Act itself, which brings down the useful life in many cases. So the asset examples that I gave you fall in that category – that’s one.
Second is, as you said, the Companies Act also allows you to make your own estimate of useful life. For example, even if there are assets which have a prescribed useful life, you can now go beyond that.
So if a company with a chemical plant determines that the useful life [of the plant], instead of 21 years prescribed before or 15 years prescribed now, it can depreciate that asset over the extended period.
Menaka: As long as it provides an explanation as to why it is choosing a useful life different than what the Companies Act has laid out?
A: That is correct.
Menaka: There are differing impacts now across the industry. How are various companies going to look at some of these and what can we expect -- whether it is IT or infrastructure -- on what the depreciation changes could likely bring?
A: Generally for most people, this is likely to be a negative because earlier, as I said, plant and machinery could be depreciated over 21 years. That 21 has now come down to 15. So that would result in a negative for most companies.
Many companies are trying to make a justification, rightfully, that the useful life continues to be 21 which is what it was earlier and therefore they may end up with a very small impact or no impact.
So on an overall level, you could see either a small negative impact or you could see no impact at a general level.
For example, in the financial services sector, where companies have a lot of office equipments or computer assets or furniture, earlier they were using rates from schedule 14 which were [prescribing] much higher [useful lives]. This would come down and would result in a negative impact for some of financial services companies.
Senthil: What was the government’s thinking when they came to this?
A: The government’s thinking was in the right direction: which is that these assets do not have the lives which companies were earlier using.
For example, the old schedules have certain office equipment or furniture at 14 years life. That is not realistic because most assets would run down within five years, which is what the new life is.
In fact it is an alignment of the lives to what is realistically the useful life for an asset in that category.
Senthil: Would it be broadly correct to say that services companies would get affected more adversely than manufacturing?
A: Services companies [will be impacted] to the extent they were not already following an assessment of useful life.
For example, many IT companies were already using for office equipment and laptops and furniture lives that are now reflected in the new schedule. So they were always using a shorter life, they will be impacted to a lesser extent.
But companies that were blindly following the old schedule would be impacted in a big manner within the services industry.
Menaka: TCS in its pre-earnings analyst meet indicated that it will likely change its depreciation policy, prompted by the new Companies Act and they seem to have indicated that it will have a somewhat negative impact. How is it that companies in the same sector may see different impacts?
A: The real reason could be that your starting points are different, because you are converging on to a common estimate of useful life. But if you were at 14 years [earlier] and you are coming down to 5, versus if you were at 3, you are moving in different directions.
Menaka: What about manufacturing and infrastructure sectors? How will some of these sectors get impacted by the changes in the depreciation policy?
Senthil: Does it affect leasing companies, for instance, which have largely leased out equipment and base their depreciation on leasing it.
A: I will take leasing companies as being equivalent to a general kind of manufacturing company because they have equipment out, so you are talking about depreciation of a plant and machinery.
As I said at the beginning of the conversation in most cases people could get adversely impacted if they decide to bring down the useful life from 21 to 15.
However, many of these companies are trying to make a justification that the useful life is closer to 21 based on the flexibility that you now have.
Menaka: Or even more than 21?
A: Not many companies in general are going beyond 21 but overall most manufacturing companies are either going to be slightly negatively impacted or it will be status quo because they will be able to justify that the old lives continue to be reasonable and logical.
There are some sectors which will be positively impacted depending on how they play this out: so for example power generation and distribution companies now have ability to use a 40-year useful life versus the 21 that they had earlier.
Companies that are into production of non-ferrous metal, again have the flexibility to go up to 30-40 years versus what 21 years that they had earlier. There are certain kinds industries -- more towards heavy kind of infrastructure like power, oil and gas refining -- which will have a positive impact.
In other cases, it will be either the same or a slight negative as I said earlier.