IAS 16 – Property, Plant and Equipment

3 Depreciation

The assets acquired are used by the business to further its operations. This use and other factors result in the reduction of asset’s value. In order to give a true and fair view of business, asset’s value (depreciable value) is reduced systematically over its useful life.

Depreciable amount of the asset is determined by deducting residual value out of its cost.

The depreciation charge for a period is usually recognized in profit and loss account as an expense but there are two exceptions to this:

If the asset is used to produce an inventory then the depreciation charge will form part of the cost of the inventory i.e. cost of goods sold

If the asset is used to produce or develop another asset (tangible or intangible) then it can be included in the cost of the relevant asset in accordance with relevant provisions.

Depreciation of an asset commences when that asset is available for use and will cease ONLY at the earlier of:

1. The date asset is classified as held for sale
2. The date asset is derecognized

Therefore, depreciation will not cease even if the asset is idle or is retired from active use. However, depreciation might be zero because of the methods used for depreciation by the entity. But certainly zero depreciation DOES NOT mean that depreciation will not be calculated.

Depreciation is recognized even if the fair value of an asset exceeds its carrying value. However, if residual value of an asset is found to be more than carrying value then certainly there is no point in depreciating it further and depreciation charge will stay at ZERO until the residual value falls below the carrying amount of an asset.

Land usually has an unlimited useful life. Therefore, it is not depreciated. Sometimes, land and building are acquired together but they are separable assets and are accounted separately. Also, increase in the value of land on which building is situated has no effect on the determination of depreciable value of building.

However, in some cases cost of land is depreciated which are as follows:

1. If the cost of land includes the costs of site dismantlement, removal and restoration then that portion of cost of the land asset is depreciated over the period of these costs render benefits.
2. In some cases, the land itself may have a limited useful life, in which case it is depreciated in a manner that reflects the benefits to be derived from it e.g. coal mines

Entity shall select such depreciation method that best reflects the consumption pattern of the economic benefits in the asset.

Standard has mentioned three depreciation methods, but entity can select any other method of depreciation as well. Methods mentioned in the standard are:

1. Straight line method
2. Reducing balance method
3. Units of production method

Under straight-line method depreciation charge stays constant over the period of time and does not change from period to period provided that useful life or residual value of asset does not change. Straight-line method is best suited in situations where entity expects to derive equal amounts of benefits every period.

Reducing balance method results in a decreasing charge over the useful life. This method is in line with most of the assets. As asset gets older its efficiency drops and thus the rate of derivation of benefits also decreases over the useful life of the asset. Therefore, recognition of depreciation expense and the benefits are both in line.

Units of production or hours method is used where consumption pattern of the benefits cannot be predicted and the rate of consumption varies from period to period.

Change in residual value should be accounted for as change in accounting estimate i.e. the change will be accounted for prospectively and the depreciation charged already recognized in previous periods will not be adjusted and will be done according to the provisions of IAS 8 – Accounting Policies, Changes in accounting estimates and Errors

Change in useful life of the asset should be accounted for as change in accounting estimate i.e. the change will be accounted for prospectively and the depreciation charged already recognized in previous periods will not be adjusted and will be done according to the provisions of IAS 8 – Accounting Policies, Changes in accounting estimates and Errors

Change in depreciation method should be accounted for as change in accounting estimate i.e. the change will be accounted for prospectively and the depreciation charged already recognized in previous periods will not be adjusted and will be done according to the provisions of IAS 8 – Accounting Policies, Changes in accounting estimates and Errors