IAS 16 : Depreciation - start and end

Depreciation - start and end

Depreciation of an asset starts when the asset is available for use, that is when it is in the location and condition necessary for it to be capable of operating in the manner intended by management.

Depreciation of an asset ceases at the earlier of the date that:

(1)   the asset is classified as held for sale (or included in a disposal group that is classified as held for sale) - see IFRS 5 and

(2)   the date that the asset is derecognised (written out of the balance sheet) or is fully depreciated.

EXAMPLE        When should depreciation of property, plant and equipment start? Issue Depreciation of an asset begins when it is available for use. That is when the asset is in the location and condition necessary for it to be capable of operating in the manner intended by management.  Depreciation of an asset ceases at the earlier of when the asset is classified as held for sale or is when the asset is derecognised. When should management start to charge depreciation on an asset? Background A bank has built an office for its own use. The construction was completed on 1 November 20X3 but the office was not used until 1 March 20X4. Management uses the straight-line depreciation method for such equipment. Solution Management should start to charge depreciation when the office is available for use, that is on 1 November 20X3. Periods when the asset is available for use but before actual usage commences should not affect the annual depreciation charge if the straight-line method of depreciation is used. Management should take into account the asset's expected usage when determining its useful life. Depreciation should be provided on a systematic basis over the asset's useful life.

Depreciation does not cease when the asset becomes idle, or is retired from active use, and held for disposal, unless the asset is fully-depreciated.

EXAMPLE        Should depreciation cease when an item of PPE is temporarily idle? Issue Depreciation of an asset begins when it is available for use. That is when the asset is in the location and condition necessary for it to be capable of operating in the manner intended by management.  Depreciation of an asset ceases at the earlier of when the asset is classified as held for sale or is when the asset is derecognised. Should management continue to provide depreciation when an item of PPE is idle? Background A bank owns a branch, which is shut down for six weeks during the year for restyling. The bank provides depreciation on the branch assets using the straight-line method. Solution Management should continue to provide depreciation when the branch is idle because depreciation of an asset only ceases when the asset is classified as held for sale or derecognised. Shut-down periods should not affect the annual depreciation charge if the straight-line method of depreciation is used. Management should take into account the asset's expected usage and maintenance periods when determining its useful life. However, a usage-based depreciation method (see Annex) for plant and machinery, for example unit-of-production, results in no depreciation during a shut-down period because no units would be produced.

EXAMPLE Calculation of depreciation for additions during the year Issue The depreciable amount of an asset is allocated on a systematic basis over its useful life. When should management start to provide depreciation in respect of assets acquired during the year? Background K has a financial year to 31 December. K acquired a computer centre on 1 March 20X1 for 2 million. The computer centre has a useful life of 25 years. Management proposes to charge a full year’s depreciation on assets acquired in the first half of the year. No depreciation will be charged on assets acquired in the second half of the year until the following year. Management proposes to charge a full year’s depreciation charge in the year of disposal. Solution Management should provide for depreciation from the date when an asset is ready for use until the date of disposal. The new policy it is proposing is not consistent with this requirement. The depreciation charge for 20X1, calculated from the date on which the assets were ready for use and on management’s proposed basis, is illustrated below: Depreciation from date of availability for use Depreciation on management’s proposed basis Difference Computer centre (cost 2 million, 25 year life) 66,667 80,000 13,333 (20%) The short-cut approach to the calculation of depreciation that management is proposing has resulted in a 20% overstatement of depreciation, compared with the more precise calculation based on the date from which the asset became available for use.

Asset Useful life

Factors, such as technical, or commercial obsolescence, and wear and tear (even when the asset is idle), often reduce life.

Consequently, all of the following are considered in determining the useful life of an asset:

1.     expected usage of the asset.

2.     expected physical wear and tear, which depends on operational factors, such as the number of hours for which the asset is to be used, the amount of repair and maintenance.

3.     technical, or commercial obsolescence, arising from changes or improvements in production, or from a change in the market demand for the product, or service output, of the asset.

4.     legal, or similar, limits on the use of the asset, such as safety limitations or the expiry dates of asset leases.

5.     the asset management policy may involve the disposal of assets after a specified time. Therefore, the useful life of an asset may be shorter than its economic life.

The estimation of the useful life of the asset is a matter of judgement, based on the experience of the undertaking with similar assets.

EXAMPLE useful life Your vehicle costs $20.000. You will sell it in 4 years time, or after 150.000 km., whichever is sooner. The residual value is estimated at $8.000. The vehicle will have an economic life longer than its useful life to the firm. This is reflected in the residual value.

The longer the life of an asset, the more years it will be depreciated, and the less each year’s depreciation charge will be for the same asset.

If the estimated life is too long, this will result in a loss on disposal and inflated profits in the periods before disposal.