IAS 16-Property, Plant and Equipment (PPE) sets the principles for recognizing, measuring, and depreciating PPE in financial statements, ensuring consistent accounting while promoting transparency and comparability in financial reporting.
Depreciation allocates the cost of an asset over its useful life, reflecting its gradual wear and tear. However, real-world changes such as revised estimates, revaluations, or impairments can affect how depreciation is calculated.
This article discusses how businesses can handle the subsequent accounting of depreciation for PPE under various scenarios, ensuring compliance with IAS 16.
Scenario 1: Change in Estimated Useful Life
Over time, factors such as technological advancements, shifting market conditions, or unexpected wear and tear may necessitate a reassessment of an asset’s estimated useful life. The residual value and the useful life of an asset shall be reviewed at least at each financial year‑end and, if expectations differ from previous estimates, the change(s) shall be accounted for as a change in an accounting estimate in accordance with IAS 8.
Accounting Treatment: Adjust the undepreciated balance over the remaining years of the revised useful life, thus lowering the annual depreciation charge. Changes are applied prospectively, with no need to restate prior periods.
Example: A machine with a carrying amount of AED 100,000 was initially expected to last five more years. Due to improved maintenance, its remaining useful life is extended to eight years. The carrying value shall be depreciated over the remaining years as per revised useful life.
Scenario 2: Change in Depreciation Method
The depreciation method applied to an asset shall be reviewed at least at each financial year‑end. If there has been a significant change in the expected pattern of consumption of the future economic benefits embodied in the asset, the method shall be changed to reflect the changed pattern. The entity selects the method that most closely reflects the expected pattern of consumption of the future economic benefits. Such a change shall be accounted for as a change in an accounting estimate in accordance with IAS 8.
Accounting Treatment: The depreciation method shall be changed and accounted for as a change in accounting estimate in line with IAS 16. Changes shall be applied prospectively. There shall be no restatement of prior periods.
Example:A company bought an asset for AED 50,000 with an expected useful life of five years. After two years of use, the company decided to change the depreciation method from straight-line basis to the reducing balance method at a rate of 15%. Depreciation shall be charged on prospectivebasis under the new method.
Scenario 3: Transition from Cost Model to Revaluation Model and Subsequent Revaluation:
The initial application of a policy to revalue assets in accordance with IAS 16 Property, Plant and Equipment is a change in an accounting policy to be dealt with as a revaluation in accordance with IAS 16, rather than in accordance with IAS 8.
Accounting Treatment: When an item of property, plant and equipment is revalued, any accumulated depreciation at the date of the revaluation is treated in one of the following ways to adjust the carrying value to the revalued amount:
- Restate accumulated depreciation to reflect the difference between the change in the gross carrying amount of the asset and the revalued amount (so that the carrying amount of the asset after revaluation equals its revalued amount); or
- Eliminate the accumulated depreciation against the gross carrying amount of the asset.
At the time of subsequent revaluation, depreciation is recalculated based on the revalued amount over the remaining useful life. Revaluation surpluses are transferred to Revaluation Reserve under Other Comprehensive Income (in Equity), the increase shall be recognized in profit or loss to the extent that it reverses a revaluation decrease of the same asset previously recognized in profit or loss. Revaluation deficits are recognized as expense in Profit & Loss Account, the decrease shall be recognized in other comprehensive income to the extent of any credit balance existing in the revaluation surplus in respect of that asset.
Example: A machine was acquired for AED 60,000; it had an estimated useful life of 8 years. Accounting was done on a historical cost basis. At the end of fourth year, the company switches to revaluation method. Asset is valued at AED 70,000. Any accumulated depreciation at the date of the revaluation is treated in one of the above ways and asset shall be now valued based on revaluation model. Consider, at the next year end, the asset is further revalued to AED 80,000. Then depreciation is recalculated based on the revalued amount over the remaining useful life.
Scenario 4: Impairment of PPE
When the recoverable amount of PPE (higher of fair value less costs to sell and value in use) drops below its carrying amount, impairment must be recognized. This impacts the asset’s carrying value and future depreciation to be charged.
Accounting Treatment: Reduce the carrying amount to the recoverable amount. Recalculate future depreciation based on the impaired value.
Example: A vehicle with a carrying amount of AED 50,000 is impaired to AED 40,000 due to market conditions. Depreciation for subsequent periods is based on AED 40,000.
Scenario 5: Repairs vs. Capital Improvements
Routine repairs to an asset are expensed through the Profit & Loss Account, while significant improvements that enhance an asset’s value, extend its life, or increase its capacity are capitalized.
Accounting Treatment:Routine repairs do not affect depreciation calculation as they are expensed through P&L. Capital improvements increase the asset’s value, requiring adjustments to depreciation.
Example: A company spends AED 5,000 to repair the doors and windows of its office building, which shall be charged as expenses. The office building undergoes a AED 70,000 upgrade, enhancing its functionality. This amount is capitalized, and the revised carrying amount is depreciated over the remaining useful life.
Summary Table of Scenarios
Best Practices for Depreciation Accounting
- Review Estimates Regularly: Periodically reassess useful life and residual values to ensure they reflect current conditions relating to the asset.
- Document Adjustments: Maintain clear records of changes in value, useful life, or impairment.
- Monitor Repairs and Improvements: Differentiate between routine and capitalizable expenses.
- Train Staff: Train staff on current standards and practices related to PPE and depreciation.
- Engage Experts: For complex scenarios, seek advice from accounting professionals.
Depreciation accounting for PPE is dynamic, requiring adjustments as circumstances evolve. Appropriate handling of these changes guarantees compliance with IAS 16 and ensures reliable financial reporting. By staying proactive, businesses can reflect their asset values accurately and make better financial decisions.
Navigating the complexities of depreciation accounting? Consult Suntech today for expert guidance tailored to your accounting needs.
