Revision of Estimates – Depreciation rate, Useful life, Residual Value

Calculation of depreciation expense involves estimation of several elements that may change or require revision during the life of asset due to internal or external factors. As a result of change in any of these estimates entity will have to incorporate the change by in prospective manner i.e. change will be implemented from the date of revision and onward. Previous periods are not adjusted for change in estimates.



Estimates that may need revision are:

  1. Useful life of asset: the period for which asset is expected to stay operational may change
  2. Depreciation rate: if the rate of cashflows (benefits) from the asset has increased or decreased, entity may have to adjust depreciation rate to match up.
  3. Residual value of asset: the value entity is expecting to recover at the end of useful life by scrapping or recycling the asset may be different than expected. This will change the depreciable value of asset.

Factors that may invoke revision of above estimates can be internal to entity or external.

Internal factors include:

  1. Change in use and application of asset e.g. working for longer hours, used by untrained workers.
  2. New information obtained that is different from previous estimates and expectations
  3. Damage resulting in shorter useful life

External factors include:

  1. Market value has reduced significantly that will eventually change salvage value of asset
  2. Technological advancement as new equipment is available or restrictions by government may force entity to abandon the asset sooner than expected

Accounting for change in depreciation related estimates

As it is a change in estimate therefore, it will be accounted for in prospective manner i.e. from the date of revision until the end of useful life of asset. No adjustments are made in previous years calculations.

The process is pretty simple. Calculate the opening net book value of asset (brought forward value of asset from previous year prior to revision) and calculate the depreciation charge according to revised estimates.

Example: Change in useful life of asset

Bashkargol Plc bought an asset for $20,000 three years back. At the time of acquisition it was estimated that it has 20 years of useful life. Three years have passed and in the fourth year as a result of new information it is found that remaining useful life of asset is only 10 years.

Entity depreciates asset on straight line basis using years of useful life.

Calculate the depreciation charge for the year

Solution:

Step 1: Calculate net book value of asset for the year:

Cost of the asset20,000
Less: Accumulated depreciation
[20,000 x 3/20]
(3,000)
Net book value17,000

Step 2: Calculate depreciation charge using revised useful life:

= 17,000 / 10 = $1,700 will be the depreciation charge for the fourth year.

Example: Change in depreciation rate

Bashkargol Plc bought an asset for $20,000 three years back. Three years have passed and in the fourth year as a result of new information it is found that depreciation rate should be 15% under straight-line method.

Entity was depreciating the asset at 10% previously.

Calculate the depreciation charge for the year

Solution:

Step 1: Calculate carrying amount of asset:

Cost of the asset20,000
Less: Accumulated depreciation
[20,000 x 0.1] x 3
(6,000)
Net book value14,000

Step 2: Calculate depreciation charge using revised estimate:

= 14,000 x 0.15 = $2,100 will be the depreciation charge for the fourth year.

Example: Change in salvage value of asset

Bashkargol Plc bought an asset for $20,000 three years back with a total useful life of 10 years. At the time of acquisition entity estimated the salvage value to be $2,000. Entity depreciates the asset using straight-line method.

Survey of same asset in during fourth year mentioned the salvage value of asset to be nill.

Calculate the depreciation charge for the year if other estimates remain the same

Solution:

Step 1: Calculate the net book value of asset:

Cost of the asset20,000
Depreciable value20,000 – 2,000 = 18,000
Accumulated depreciation[18,000 x 3/10](5,400)
Net book value14,600

Step 2: Calculate depreciation charge using revised estimates.

As salvage value is NILL therefore, the whole amount of remaining carrying amount is now depreciable value over the remaining useful life of 7 years.

= 14,600 / 7 = $2,086 will be the depreciation charge for the fourth year.