IAS 16 requires the depreciable amount of an item of property, plant and equipment to be allocated on a systematic basis over its useful life, using a depreciation method that reflects the pattern in which the asset's future economic benefits are expected to be consumed.
When Does Depreciation Begin and End?
The Standard states that depreciation of an asset begins when it is available for use, ie when it is in the location and condition necessary for it to be capable of operating in the manner intended by management. Depreciation continues until the asset is classified as held for sale or is derecognised, whichever is earlier.
Factors Considered in Determining Useful Life
The Standard identifies several factors considered in determining an asset's useful life: expected usage of the asset, assessed by reference to its expected capacity or physical output; expected physical wear and tear, which depends on operational factors such as the number of shifts for which the asset is used and the repair and maintenance programme; technical or commercial obsolescence arising from changes or improvements in production or changes in market demand; and legal or similar limits on the use of the asset, such as the expiry dates of related leases.
What Depreciation Methods Does the Standard Allow?
The Standard notes that a variety of depreciation methods can be used to allocate the depreciable amount of an asset on a systematic basis over its useful life. These methods include the straight-line method, the diminishing balance method and the units of production method.
- Straight-line depreciation results in a constant charge over the useful life if the asset's residual value does not change.
- The diminishing balance method results in a decreasing charge over the useful life.
- The units of production method results in a charge based on the expected use or output.
The entity selects the method that most closely reflects the expected pattern of consumption of the future economic benefits embodied in the asset, and applies it consistently unless there is a change in that expected pattern.
The Standard also states that a depreciation method based on revenue generated by an activity that includes the use of an asset is not appropriate.
Does Ongoing Maintenance Stop Depreciation?
The Standard provides that depreciation is recognised even if the fair value of the asset exceeds its carrying amount, as long as the asset's residual value does not exceed its carrying amount, and that repair and maintenance of an asset do not negate the need to depreciate it.
Is Useful Life or the Depreciation Method Reviewed Later?
Yes. The Standard requires the residual value and the useful life of an asset to be reviewed at least at each financial year-end, and if expectations differ from previous estimates, the change is accounted for as a change in an accounting estimate in accordance with IAS 8.
Illustrative example (assumed figures): Assume an entity purchased equipment at a cost of 50,000, estimated its residual value at 5,000, and its useful life at five years. Using the straight-line method, the depreciable amount = 50,000 − 5,000 = 45,000, and the annual depreciation charge = 45,000 ÷ 5 = 9,000 for each year of the useful life.
Legal References
- IAS 16 — Property, Plant and Equipment, paragraph 50 (allocation of the depreciable amount)
- IAS 16 — Property, Plant and Equipment, paragraph 55 (when depreciation begins)
- IAS 16 — Property, Plant and Equipment, paragraph 56 (factors in determining useful life)
- IAS 16 — Property, Plant and Equipment, paragraph 60 (rule for selecting a depreciation method that reflects the pattern of benefit consumption)
- IAS 16 — Property, Plant and Equipment, paragraph 62 (straight-line, diminishing balance and units of production methods)
- IAS 16 — Property, Plant and Equipment, paragraph 62A (revenue-based methods are not appropriate)
- IAS 16 — Property, Plant and Equipment, paragraph 51 (annual review of residual value and useful life)
- IAS 16 — Property, Plant and Equipment, paragraph 52 (depreciation continues despite higher fair value or maintenance)
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