IAS 16: Depreciation methods

Depreciation methods

The depreciation method used will reflect the pattern in which the asset’s future benefits are likely to be consumed.

The depreciation method applied to an asset will be reviewed at least at each financial year-end and, any significant change in the expected pattern of its future benefits, will cause the method to be changed to reflect this.

Changes will be accounted for as a change in an accounting estimate, in accordance with IAS 8. No change is made to depreciation charged in previous years.

Changes in asset life are common, as these are estimated in advance of asset usage. Changes in depreciation methods are rare.

A variety of depreciation methods can be used, including the straight-line method, the diminishing balance method and the units of production method.

Straight line method

Straight-line depreciation results in a constant charge over the useful life.

EXAMPLE straight line depreciation Your vehicle costs $40.000. You will sell it in 4 years time. The estimated residual value is $16.000. The total amount of depreciation will be $24.000 ($40.000 - $16.000). The depreciation charge is $6.000 per year, or $500 per month.
	I/B	DR	CR
Property, plant & equipment	B	40.000
Cash	B		40.000
This records the buy of the vehicle
Depreciation	I	6.000
Accumulated depreciation	B		6.000
Annual depreciation straight line on (40.000-16.000) = 24.000/4=6.000

Diminishing balance method

The diminishing balance method results in a decreasing charge over the useful life and loads the early years with a much higher charge.

EXAMPLE diminishing balance method You buy a machine for $10.000. It has high risk of technical obsolescence. You depreciate it at 50% as follows: Year 1 $5.000 (50% of 10.000) Year 2 $2.500 (50% of 5.000) Year 3 $1.250 (50% of 2.500) Year 4 $ 625   (50% of 1.250)

Units of production method (more detail and examples in the Annex)

The units of production method results in a charge based on the expected use, or output.

The selected method will closely reflect the expected pattern of future benefits flow. The method is then applied consistently, unless there is a change in the expected benefit pattern.