How can we change the Depreciation method?

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Most of the non-current assets held by the entities require depreciation because of use devaluation as a result of use of the asset in business operations or other factors.

Many different depreciation methods can be used by the entities to record the effect of devaluation. However, IAS 16 Property, Plant and Equipment requires that:

IAS 16 | Para 60
The depreciation method used shall reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the entity.

In simple words it means that depreciation expense should be recognized in the same fashion as benefits are derived from the asset through its use.

Due to this requirement, if the consumption pattern of economic benefits changes then entity might have to change the depreciation method.

Change in depreciation method is a change in accounting estimate and NOT a change in accounting policy. For example if entity was previously using straight-line method of depreciation and now the circumstances require a change in depreciation method then IAS 16 allows such change and such change is just a change in accounting estimate.

Also a change in accounting estimate does not mean rectification of prior period error. Revision accounting estimate does not mean that we have discovered an error that we were continuously doing in previous accounting periods.

Important
According to IAS 8 change in accounting estimate is treated prospectively i.e. if a depreciation method is changed then the carrying amount of the asset at the date of change will be depreciated on the basis of new method. Consider the example to understand.

Example

A company bought an asset for 100,000 with an expected useful life of five years. After two years of use company decided to change the depreciation method from straight-line basis to reducing balance method at the rate of 15%.

Required: Calculate the depreciation for the third and fourth year

Step 1: Find the carrying amount at the date of change

Change in depreciation is made after two years so we will depreciate the asset for two years and it was on straight line basis.

100,000 / 5 = 20,000 per year

For two years it will be 20,000 x 2 = 40,000

Thus, carrying amount of the asset at the end of second year was 100,000 – 40,000 = 60,000

Step 2: Depreciate the carrying amount on the new basis from the date of change

Carrying amount at the date of change = 60,000

New basis of depreciate = Reducing balance method @ 15%

Depreciation for the third year will be calculated as follows:

60,000 x 0.15 = 9,000

Depreciation for the fourth year will be calculated as follows:

(60,000 – 9,000) x 0.15 = 7,650

3 COMMENTS

  1. Example for switching to DDB would be helpful including increase from improvement and increase in salvage value and useful life

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