IAS 16 : Measurement After Recognition : Cost Model

Question 1

IAS 16 allows one of two alternatives to be chosen as the accounting policy for measurement of PP&E after initial recognition. The choice made must be applied to an entire class of PP&E, which means that not all classes are required to have the same policy. [IAS 16.29].

Answer 1

IAS 16 allows one of two alternatives to be chosen as the accounting policy for measurement of PP&E after initial recognition. The choice made must be applied to an entire class of PP&E, which means that not all classes are required to have the same policy. [IAS 16.29].

Question 2

The first alternative is the cost model whereby the item, after recognition as an asset, is carried at cost less any accumulated depreciation and less any accumulated impairment losses. [IAS 16.30]. The alternative, the revaluation model

Answer 2

The first alternative is the cost model whereby the item, after recognition as an asset, is carried at cost less any accumulated depreciation and less any accumulated impairment losses. [IAS 16.30]. The alternative, the revaluation model

Question 3

Significant parts of assets 1

IAS 16 links its recognition concept of a ‘part’ of an asset, discussed at 3.2 above, with the analysis of assets for the purpose of depreciation. Each part of an asset with a cost that is significant in relation to the total cost of the item must be depreciated separately,
which means that the initial cost must be allocated between the significant parts by the entity.
[IAS 16.43, 44].

Answer 3

IAS 16 links its recognition concept of a ‘part’ of an asset, discussed at 3.2 above, with the analysis of assets for the purpose of depreciation. Each part of an asset with a cost that is significant in relation to the total cost of the item must be depreciated separately,
which means that the initial cost must be allocated between the significant parts by the entity.
[IAS 16.43, 44].

Question 4

Significant parts of assets 2

The standard once again refers to the airframe and engines of an aircraft but also sets out that if an entity acquires PP&E subject to an operating lease in
which it is the lessor, it may be appropriate to depreciate separately amounts reflected in the cost of that item that are attributable to favourable or unfavourable lease terms relative to market terms.
[IAS 16.44].

Answer 4

The standard once again refers to the airframe and engines of an aircraft but also sets out that if an entity acquires PP&E subject to an operating lease in
which it is the lessor, it may be appropriate to depreciate separately amounts reflected in the cost of that item that are attributable to favourable or unfavourable lease terms relative to market terms.
[IAS 16.44].

Question 5

Significant parts of assets 3

Because parts of an item of PP&E are identified by their significant cost rather than their effect on depreciation, they may have the same useful lives and depreciation method and the standard allows them to be grouped for depreciation purposes. [IAS 16.45].

Answer 5

Because parts of an item of PP&E are identified by their significant cost rather than their effect on depreciation, they may have the same useful lives and depreciation
method and the standard allows them to be grouped for depreciation purposes. [IAS 16.45].

Question 6

Significant parts of assets4

The depreciation charge for each period is recognised in profit or loss unless it forms part of the cost of another asset and included in its carrying amount.
[IAS 16.48].

Answer 6

The depreciation charge for each period is recognised in profit or loss unless it forms part of the cost of another asset and included in its carrying amount. [IAS 16.48].

Question 7

Significant parts of assets 5

Sometimes, the future economic benefits embodied in an asset are absorbed in producing other assets, for example, the depreciation of manufacturing plant and
equipment is included as part of the cost of conversion of finished manufactured goods held in inventory in accordance with IAS 2, and similarly, depreciation of PP&E used for development activities may be included as part of the cost of an intangible asset recognised in accordance with IAS 38. [IAS 16.49].

Answer 7

Sometimes, the future economic benefits embodied in an asset are absorbed in producing other assets, for example, the depreciation of manufacturing plant and
equipment is included as part of the cost of conversion of finished manufactured goods held in inventory in accordance with IAS 2, and similarly, depreciation of PP&E used for development activities may be included as part of the cost of an intangible asset recognised in accordance with IAS 38. [IAS 16.49].

Question 8

Depreciable amount and residual values 1

The depreciable amount of an item of PP&E is its cost, or other amount substituted for cost (e.g. valuation), less its estimated residual value. [IAS 16.6]. The standard states that an entity should review the residual value of an item of PP&E, and therefore all parts of it, at least at each financial year-end.

If the estimated residual value differs from the previous estimate, the change should be accounted for prospectively as a change in accounting estimate in accordance with IAS 8. [IAS 16.51].

Answer 8

The depreciable amount of an item of PP&E is its cost, or other amount substituted for cost (e.g. valuation), less its estimated residual value. [IAS 16.6]. The standard states that an entity should review the residual value of an item of PP&E, and therefore all parts of it, at least at each financial year-end.

If the estimated residual value differs from the previous estimate, the change should be accounted for prospectively as a change in accounting estimate in accordance with IAS 8. [IAS 16.51].

Question 9

Depreciable amount and residual values 2

The residual value of an item of PP&E :

the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and assuming that it was already in the condition it will be in at the end of its useful life.
[IAS 16.6].

Answer 9

The residual value of an item of PP&E :

the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated costs of disposal, if the asset were already of the age and assuming that it was already in the condition it will be in at the end of its useful life. [IAS 16.6].

Question 10

Depreciable amount and residual values 3

Therefore, IAS 16 contains an element of continuous updating of one component of an asset’s carrying value because it is the current disposal amount (e.g. value at financial reporting date) of an asset’s future
state (i.e. asset’s condition in the future when the entity expects to dispose of it). This means that only the changes up to the financial reporting date are taken into account and that expected future changes in residual value other than the effects of expected
wear and tear are not taken into account.
[IAS 16.BC29]

Answer 10

Therefore, IAS 16 contains an element of continuous updating of one component of an asset’s carrying value because it is the current disposal amount (e.g. value at financial reporting date) of an asset’s future
state (i.e. asset’s condition in the future when the entity expects to dispose of it). This means that only the changes up to the financial reporting date are taken into account and that expected future changes in residual value other than the effects of expected
wear and tear are not taken into account. [IAS 16.BC29]

Question 11

Depreciable amount and residual values 4

As any change in the residual value directly affects the depreciable amount, it may also affect the depreciation charge. This is because the depreciable amount (i.e. the amount actually charged to profit or loss over the life of the asset) is calculated by deducting the residual value from the cost (or other amount substituted for cost, such as valuation) of the asset. Sometimes, the residual value of an asset may increase to an amount equal to or greater than the asset’s carrying amount. If it does, the residual value is capped at the asset’s carrying amount. This means that in such a case, the asset’s depreciation charge is zero unless and until its residual value subsequently decreases to an amount below the asset’s carrying amount. [IAS 16.53, 54].

Answer 11

As any change in the residual value directly affects the depreciable amount, it may also affect the depreciation charge. This is because the depreciable amount (i.e. the amount actually charged to profit or loss over the life of the asset) is calculated by deducting the residual value from the cost (or other amount substituted for cost, such as valuation) of the asset. Sometimes, the residual value of an asset may increase to an amount equal to or greater than the asset’s carrying amount. If it does, the residual value is capped at the asset’s carrying amount. This means that in such a case, the asset’s depreciation charge is zero unless and until its residual value subsequently decreases to an amount below the asset’s carrying amount. [IAS 16.53, 54].

Question 12

Depreciable amount and residual values 5

In practice, many items of PP&E have a negligible residual value. This is usually because they are kept for significantly all of their useful lives. Residual values are of no relevance if the entity intends to keep the asset for significantly all of its useful life. If an entity uses residual values based on prices fetched in the market for a type of asset that it holds, it must also demonstrate an intention to dispose of that asset before the end of its economic life.

Answer 12

In practice, many items of PP&E have a negligible residual value. This is usually because they are kept for significantly all of their useful lives. Residual values are of no relevance if the entity intends to keep the asset for significantly all of its useful life. If an entity uses residual values based on prices fetched in the market for a type of asset that it holds, it must also demonstrate an intention to dispose of that asset before the end of its economic life.

Question 13

Depreciable amount and residual values 6

The requirement concerning the residual values of assets highlights how important it is that residual values are considered and reviewed in conjunction with the review of useful lives.

The useful life : the period over which the entity expects to use the asset, not the asset’s economic life.

Answer 13

The requirement concerning the residual values of assets highlights how important it is that residual values are considered and reviewed in conjunction with the review of useful lives.

The useful life : the period over which the entity expects to use the asset, not the asset’s economic life.

Question 14

Depreciation charge 1

The standard requires the depreciable amount of an asset to be allocated on a systematic basis over its useful life. [IAS 16.50]. The standard makes it clear that depreciation must be charged on all items of PP&E,
including those carried under the revaluation model, even if the fair value of an asset is higher than its carrying amount, as long as the residual value of the asset is lower than its carrying amount. [IAS 16.52].

Answer 14

The standard requires the depreciable amount of an asset to be allocated on a systematic basis over its useful life. [IAS 16.50]. The standard makes it clear that depreciation must be charged on all items of PP&E,
including those carried under the revaluation model, even if the fair value of an asset is higher than its carrying amount, as long as the residual value of the asset is lower than its carrying amount. [IAS 16.52].

Question 15

Depreciation charge 2

If the residual value exceeds the carrying amount, no depreciation is charged until the residual value once again decreases to less than the carrying amount.
[IAS 16.54].

There is no requirement in IAS 16 for an automatic impairment review if no depreciation is charged.

Answer 15

If the residual value exceeds the carrying amount, no depreciation is charged until the residual value once again decreases to less than the carrying amount.
[IAS 16.54].

There is no requirement in IAS 16 for an automatic impairment review if no depreciation is charged.

Question 16

Useful lives 1

One of the critical assumptions on which the depreciation charge depends is the useful life of the asset. The standard requires the useful life of an asset to be estimated on a realistic basis and reviewed at least at the end of each financial year. The effects of changes in useful life are to be recognised prospectively as changes in accounting estimates in accordance with IAS 8, over the remaining useful life of the asset. [IAS 16.51].

Answer 16

One of the critical assumptions on which the depreciation charge depends is the useful life of the asset. The standard requires the useful life of an asset to be estimated on a realistic basis and reviewed at least at the end of each financial year. The effects of changes in useful life are to be recognised prospectively as changes in accounting estimates in accordance with IAS 8, over the remaining useful life of the asset. [IAS 16.51].

Question 17

Useful lives 2

The useful life of an asset is defined in terms of the asset’s expected utility to the entity. [IAS 16.57].
It is the period over which the present owner will benefit from using the asset and not the total potential life of the asset; the two will often not be the same.

Answer 17

The useful life of an asset is defined in terms of the asset’s expected utility to the entity. [IAS 16.57].
It is the period over which the present owner will benefit from using the asset and not the total potential life of the asset; the two will often not be the same

Question 18

Useful lives 3

It is quite possible for an asset’s useful life to be shorter than its economic life. The estimation of the useful life of the asset is a matter of judgement based on the experience of the entity with similar assets. Many entities have an asset management policy that may involve disposal of assets after a specified time or after consumption of a specified proportion of the future economic benefits embodied in the assets. [IAS 16.57]. This often occurs when disposing of assets when they still have a residual value, which means that another user can benefit from the asset. This is particularly common with property and motor vehicles, where there are effective second-hand markets, but less usual for plant and machinery.

Answer 18

It is quite possible for an asset’s useful life to be shorter than its economic life. The estimation of the useful life of the asset is a matter of judgement based on the
experience of the entity with similar assets. Many entities have an asset management policy that may involve disposal of assets after a specified time or after consumption of a specified proportion of the future economic benefits embodied in the assets. [IAS 16.57]. This often occurs when disposing of assets when they still have a residual value, which means that another user can benefit from the asset. This is particularly common with property and motor vehicles, where there are effective second-hand markets, but less usual for plant and machinery.

Question 19

Useful lives 4

For example, an entity may have a policy of replacing all of its motor vehicles after three years, so this will be their estimated useful life for depreciation purposes. The entity will depreciate them over this period down to the estimated residual value. The residual values of motor vehicles are often easy to obtain and the entity will be able to reassess these residuals in line with the requirements of the standard. Thus, the estimation of the useful life of the asset is a matter of judgement based on the experience of the entity with similar assets. [IAS 16.57].

Answer 19

For example, an entity may have a policy of replacing all of its motor vehicles after three years, so this will be their estimated useful life for depreciation purposes. The entity will depreciate them over this period down to the estimated residual value. The residual values of motor vehicles are often easy to obtain and the entity will be able to reassess these residuals in line with the requirements of the standard. Thus, the estimation of the useful life of the asset is a matter of judgement based on the experience of the entity with similar assets. [IAS 16.57].

Question 20

Useful lives 5

The future economic benefits embodied in an asset are consumed principally through usage. Other factors, however, should be taken into account such as technical or commercial obsolescence and wear and tear while an asset remains idle because they often result in the diminution of the economic benefits expected to be obtained from the asset.

Answer 20

The future economic benefits embodied in an asset are consumed principally through usage. Other factors, however, should be taken into account such as technical or commercial obsolescence and wear and tear while an asset remains idle because they often result in the diminution of the economic benefits expected to be obtained from the asset.

Question 21

Useful lives 6

IAS 16 provides guidance that all the following factors are to be considered when estimating the useful life of an asset:

(a) expected usage of the asset. Usage is assessed by reference to the asset’s expected capacity or physical output;
(b) expected physical wear and tear, which depends on operational factors such as the number of shifts for which the asset is to be used and the repair and maintenance programme, and the care and maintenance of the asset while idle

Answer 21

IAS 16 provides guidance that all the following factors are to be considered when estimating the useful life of an asset:

(a) expected usage of the asset. Usage is assessed by reference to the asset’s expected capacity or physical output;
(b) expected physical wear and tear, which depends on operational factors such as the number of shifts for which the asset is to be used and the repair and maintenance programme, and the care and maintenance of the asset while idle

Question 22

Useful lives 7

(c) technical or commercial obsolescence arising from changes or improvements in production, or from a change in the market demand for the product or service output of the asset. Expected future reductions in the selling price of an item that was produced using an asset could indicate the expectation of technical or commercial obsolescence of the asset, which, in turn, might reflect a reduction of the future economic benefits embodied in the asset (see Technological change below); and
(d) legal or similar limits on the use of the asset, such as the expiry dates of related leases. [IAS 16.56].

Answer 22

(c) technical or commercial obsolescence arising from changes or improvements in production, or from a change in the market demand for the product or service output of the asset. Expected future reductions in the selling price of an item that was produced using an asset could indicate the expectation of technical or commercial obsolescence of the asset, which, in turn, might reflect a reduction of the future economic benefits embodied in the asset (see Technological change below); and
(d) legal or similar limits on the use of the asset, such as the expiry dates of related leases. [IAS 16.56].

Question 23

Useful lives 8

Factor (d), above, states that the ‘expiry dates of related leases’ is considered when determining the asset’s useful life. Generally, the useful life of the leasehold improvement is the same or less than the lease term, as defined by IFRS 16.
However, a lessee may be able to depreciate an asset whose useful life exceeds the lease term over a longer period if the lease includes an option to extend that the lessee expects to exercise, even if the option is not considered ‘reasonably certain’ at inception (a higher threshold than the estimate of useful life in IAS 16).
In such a case, the asset may be depreciated either over the lease term or over the shorter of the asset’s useful life and the period for which the entity expects to extend the lease.

Answer 23

Factor (d), above, states that the ‘expiry dates of related leases’ is considered when determining the asset’s useful life. Generally, the useful life of the leasehold improvement is the same or less than the lease term, as defined by IFRS 16.
However, a lessee may be able to depreciate an asset whose useful life exceeds the lease term over a longer period if the lease includes an option to extend that the lessee expects to exercise, even if the option is not considered ‘reasonably certain’ at inception (a higher threshold than the estimate of useful life in IAS 16).
In such a case, the asset may be depreciated either over the lease term or over the shorter of the asset’s useful life and the period for which the entity expects to extend the lease.

Question 24

Useful lives : Repairs and maintenance 1

The initial assessment of the useful life of the asset will take into account the expected routine spending on repairs and expenditure necessary for it to achieve that life. Although IAS 16 implies that this refers to an item of plant and machinery, care and maintenance programmes are relevant to assessing the useful lives of many other types of asset.

Answer 24

The initial assessment of the useful life of the asset will take into account the expected routine spending on repairs and expenditure necessary for it to achieve that life. Although IAS 16 implies that this refers to an item of plant and machinery, care and maintenance programmes are relevant to assessing the useful lives of many other types of asset.

Question 25

Useful lives : Repairs and maintenance 2 For example, an entity may assess the useful life of a railway engine at 35 years on the assumption that it has a major overhaul every seven years. Without this expenditure, the life of the engine would be much less certain and could be much shorter. Maintenance necessary to support the fabric of a building and its service potential will also be taken into account in assessing its useful life. Eventually, it will always become uneconomic for the entity to continue to maintain the asset so, while the expenditure may lengthen the useful life, it is unlikely to make it indefinite.

Answer 25

For example, an entity may assess the useful life of a railway engine at 35 years on the assumption that it has a major overhaul every seven years. Without this expenditure, the life of the engine would be much less certain and could be much shorter. Maintenance necessary to support the fabric of a building and its service potential will also be taken into account in assessing its useful life. Eventually, it will always become uneconomic for the entity to continue to maintain the asset so, while the expenditure may lengthen the useful life, it is unlikely to make it indefinite.

Question 26

Useful lives : Land The standard requires the land and the building elements of property to be accounted for as separate components, even when they are acquired together. Land, which usually has an unlimited life, is not usually depreciated, while buildings are depreciable assets because they have limited useful life. IAS 16 states that the determination of the depreciable amount and useful life of a building is not affected by an increase in the value of the land on which it stands. [IAS 16.58].

Answer 26

The standard requires the land and the building elements of property to be accounted for as separate components, even when they are acquired together. Land, which usually has an unlimited life, is not usually depreciated, while buildings are depreciable assets because they have limited useful life. IAS 16 states that the determination of the depreciable amount and useful life of a building is not affected by an increase in the value of the land on which it stands. [IAS 16.58].

Question 27

Useful lives : Technological change 1 A current or expected future reduction in the market demand for the product or service output of an asset may be evidence of technical or commercial obsolescence, which, in turn, might reflect a reduction of the future economic benefits embodied in the asset. If an entity anticipates such technical or commercial obsolescence, it should reassess both the useful life of an asset and the pattern of consumption of future economic benefits. [IAS 16.56(c), 61]. In such cases, it might be more appropriate to use a diminishing balance method of depreciation to reflect the pattern of consumption (see Diminishing balance methods below).

Answer 27

A current or expected future reduction in the market demand for the product or service output of an asset may be evidence of technical or commercial obsolescence, which, in turn, might reflect a reduction of the future economic benefits embodied in the asset. If an entity anticipates such technical or commercial obsolescence, it should reassess both the useful life of an asset and the pattern of consumption of future economic benefits. [IAS 16.56(c), 61]. In such cases, it might be more appropriate to use a diminishing balance method of depreciation to reflect the pattern of consumption (see Diminishing balance methods below).

Question 28

Useful lives : Technological change 2 The effects of technological change are often underestimated. It affects many assets, not only high technology plant and equipment such as computer systems. For example, many offices that have been purpose-built can become obsolete long before their fabric has physically deteriorated, for reasons such as the difficulty of introducing computer network infrastructures or air conditioning, poor environmental performance or an inability to meet new legislative requirements such as access for people with disabilities. Therefore, the estimation of an asset’s useful life is a matter of judgement and the possibility of technological change must be taken into account. [IAS 16.56, 57].

Answer 28

The effects of technological change are often underestimated. It affects many assets, not only high technology plant and equipment such as computer systems. For example, many offices that have been purpose-built can become obsolete long before their fabric has physically deteriorated, for reasons such as the difficulty of introducing computer network infrastructures or air conditioning, poor environmental performance or an inability to meet new legislative requirements such as access for people with disabilities. Therefore, the estimation of an asset’s useful life is a matter of judgement and the possibility of technological change must be taken into account. [IAS 16.56, 57].

Question 29

When depreciation starts 1 The standard is clear on when depreciation should start and finish, and sets out the requirements succinctly as follows: * Depreciation of an asset begins when it is available for use, which is defined by the standard as occurring when the asset is in the location and condition necessary for it to be capable of operating in the manner intended by management. This is usually the point at which capitalisation of costs relating to the asset ceases as the physical asset is operational or ready for intended use * Depreciation of an asset ceases at the earlier of the date that the asset is classified as held for sale (or included in a disposal group that is classified as held for sale) in accordance with IFRS 5 and the date that the asset is derecognised. [IAS 16.55].

Answer 29

The standard is clear on when depreciation should start and finish, and sets out the requirements succinctly as follows: * Depreciation of an asset begins when it is available for use, which is defined by the standard as occurring when the asset is in the location and condition necessary for it to be capable of operating in the manner intended by management. This is usually the point at which capitalisation of costs relating to the asset ceases as the physical asset is operational or ready for intended use * Depreciation of an asset ceases at the earlier of the date that the asset is classified as held for sale (or included in a disposal group that is classified as held for sale) in accordance with IFRS 5 and the date that the asset is derecognised. [IAS 16.55].

Question 30

When depreciation starts 2 Therefore, an entity does not stop depreciating an asset merely because it has become idle or has been retired from active use unless the asset is fully depreciated. However, if the entity is using a usage method of depreciation (e.g. the units-of-production method), the charge can be zero while there is no production. [IAS 16.55]. Of course, a prolonged period in which there is no production may raise questions as to whether the asset is impaired because an asset becoming idle is a specific example of an indication of impairment in IAS 36. [IAS 36.12(f)].

Answer 30

Therefore, an entity does not stop depreciating an asset merely because it has become idle or has been retired from active use unless the asset is fully depreciated. However, if the entity is using a usage method of depreciation (e.g. the units-of-production method), the charge can be zero while there is no production. [IAS 16.55]. Of course, a prolonged period in which there is no production may raise questions as to whether the asset is impaired because an asset becoming idle is a specific example of an indication of impairment in IAS 36. [IAS 36.12(f)].

Question 31

Depreciation methods 1 There is a variety of depreciation methods that can be used to allocate the depreciable amount of an asset on a systematic basis over its useful life. The standard is not prescriptive about what methods of depreciation should be used. It simply says that ‘the depreciation method used shall reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the entity’, mentioning the possible methods that can be used such as the straight-line method (which is the most common method where the depreciation results in a constant charge over the useful life if the asset’s residual value does not change), the diminishing balance method and the units of production method.

Answer 31

There is a variety of depreciation methods that can be used to allocate the depreciable amount of an asset on a systematic basis over its useful life. The standard is not prescriptive about what methods of depreciation should be used. It simply says that ‘the depreciation method used shall reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the entity’, mentioning the possible methods that can be used such as the straight-line method (which is the most common method where the depreciation results in a constant charge over the useful life if the asset’s residual value does not change), the diminishing balance method and the units of production method.

Question 32

Depreciation methods 2 The overriding requirement is to select the depreciation method that most closely reflects the expected pattern of consumption of the future economic benefits the asset brings over its useful life; and that the selected method is applied consistently from period to period unless there is a change in the expected pattern of consumption of those future economic benefits. [IAS 16.60-62].

Answer 32

The overriding requirement is to select the depreciation method that most closely reflects the expected pattern of consumption of the future economic benefits the asset brings over its useful life; and that the selected method is applied consistently from period to period unless there is a change in the expected pattern of consumption of those future economic benefits. [IAS 16.60-62].

Question 33

Depreciation methods 3 IAS 16 contains an explicit requirement that the depreciation method be reviewed at least at each financial year-end to determine if there has been a significant change in the pattern of consumption of an asset’s future economic benefits. If there has been such a change, the depreciation method should be changed to reflect it. [IAS 16.61].

Answer 33

IAS 16 contains an explicit requirement that the depreciation method be reviewed at least at each financial year-end to determine if there has been a significant change in the pattern of consumption of an asset’s future economic benefits. If there has been such a change, the depreciation method should be changed to reflect it. [IAS 16.61].

Question 34

Depreciation methods 4 However, under IAS 8, this change is a change in accounting estimate and not a change in accounting policy. [IAS 8.32(d), IAS 16.61]. This means that the consequent depreciation adjustment should be made prospectively, i.e. the asset’s depreciable amount should be written off over current and future periods using the new and more appropriate method of depreciation. [IAS 8.36]

Answer 34

However, under IAS 8, this change is a change in accounting estimate and not a change in accounting policy. [IAS 8.32(d), IAS 16.61]. This means that the consequent depreciation adjustment should be made prospectively, i.e. the asset’s depreciable amount should be written off over current and future periods using the new and more appropriate method of depreciation. [IAS 8.36]

Question 35

Depreciation methods 5 A revenue-based approach, e.g. using the ratio of revenue generated to total revenue expected to be generated, is not a suitable basis for depreciation. Depreciation is an estimate of the economic benefits of the asset consumed in the period. The revenue generated by an activity that requires the use of an asset generally reflects factors other than the consumption of the economic benefits of the asset. Revenue reflects the output of the asset, but it also reflects other factors that do not affect depreciation, such as changes in sales volumes and selling prices, the effects of selling activities and other inputs and processes. The price component of revenue may be affected by inflation or foreign currency exchange rates. This means that revenue does not, as a matter of principle, reflect how an asset is used or consumed. [IAS 16.62A]. While revenue-based methods of depreciation are considered inappropriate under IAS 16, the standard does permit other methods of depreciation that reflect the level of activity, such as the units of production method

Answer 35

A revenue-based approach, e.g. using the ratio of revenue generated to total revenue expected to be generated, is not a suitable basis for depreciation. Depreciation is an estimate of the economic benefits of the asset consumed in the period. The revenue generated by an activity that requires the use of an asset generally reflects factors other than the consumption of the economic benefits of the asset. Revenue reflects the output of the asset, but it also reflects other factors that do not affect depreciation, such as changes in sales volumes and selling prices, the effects of selling activities and other inputs and processes. The price component of revenue may be affected by inflation or foreign currency exchange rates. This means that revenue does not, as a matter of principle, reflect how an asset is used or consumed. [IAS 16.62A]. While revenue-based methods of depreciation are considered inappropriate under IAS 16, the standard does permit other methods of depreciation that reflect the level of activity, such as the units of production method

Question 36

Depreciation methods : Diminishing balance methods 1 The diminishing balance method involves determining a percentage depreciation that will write off the asset’s depreciable amount over its useful life. This involves solving for a rate that will reduce the asset’s net book value to its residual value at the end of the useful life. The diminishing balance method results in a decreasing depreciation charge over the useful life of the asset. [IAS 16.62].

Answer 36

The diminishing balance method involves determining a percentage depreciation that will write off the asset’s depreciable amount over its useful life. This involves solving for a rate that will reduce the asset’s net book value to its residual value at the end of the useful life. The diminishing balance method results in a decreasing depreciation charge over the useful life of the asset. [IAS 16.62].

Question 37

Depreciation methods : Diminishing balance methods 2 Example page 1351 refer OneNote - Example 18.2: Diminishing balance depreciation - Example 18.3: Sum of the digits depreciation

Answer 37

Example page 1351 refer OneNote Example page 1351 refer OneNote - Example 18.2: Diminishing balance depreciation - Example 18.3: Sum of the digits depreciation

Question 38

Depreciation methods : Unit-of-production method 1 Under this method, the asset is written off in line with its expected use or estimated total output. [IAS 16.62]. By relating depreciation to the proportion of productive capacity utilised to date, it reflects the fact that the useful economic life of certain assets, principally machinery, is more closely linked to its usage and output than to time. This method is normally used in extractive industries, for example, to amortise the costs of development of productive oil and gas facilities.

Answer 38

Under this method, the asset is written off in line with its expected use or estimated total output. [IAS 16.62]. By relating depreciation to the proportion of productive capacity utilised to date, it reflects the fact that the useful economic life of certain assets, principally machinery, is more closely linked to its usage and output than to time. This method is normally used in extractive industries, for example, to amortise the costs of development of productive oil and gas facilities.

Question 39

Depreciation methods : Unit-of-production method 2 The essence (intipati) of choosing a fair depreciation method is to reflect the consumption of economic benefits provided by the asset concerned. In most cases the straight-line basis will give perfectly acceptable results, and the vast majority of entities use this method. Where there are instances, such as the extraction of a known proportion of a mineral resource, or the use of a certain amount of the total available number of working hours of a machine, it may be that a unit of production method will give fairer results.

Answer 39

The essence (intipati) of choosing a fair depreciation method is to reflect the consumption of economic benefits provided by the asset concerned. In most cases the straight-line basis will give perfectly acceptable results, and the vast majority of entities use this method. Where there are instances, such as the extraction of a known proportion of a mineral resource, or the use of a certain amount of the total available number of working hours of a machine, it may be that a unit of production method will give fairer results.

Question 40

Impairment 1 All items of PP&E accounted for under IAS 16 are subject to the impairment requirements of IAS 36. The question has arisen about the treatment of any compensation an entity may be due to receive as a result of an asset being impaired.

Answer 40

All items of PP&E accounted for under IAS 16 are subject to the impairment requirements of IAS 36. The question has arisen about the treatment of any compensation an entity may be due to receive as a result of an asset being impaired.

Question 41

Impairment 2 For example an asset that is insured might be destroyed in a fire, so repayment from an insurance company might be expected. IAS 16 states that these events – the impairments or losses of items of PP&E, the related claims for or payments of compensation from third parties and any subsequent purchase or construction of replacement assets – are ‘separate economic events’ and should be accounted for separately as follows:

Answer 41

For example an asset that is insured might be destroyed in a fire, so repayment from an insurance company might be expected. IAS 16 states that these events – the impairments or losses of items of PP&E, the related claims for or payments of compensation from third parties and any subsequent purchase or construction of replacement assets – are ‘separate economic events’ and should be accounted for separately as follows:

Question 42

Impairment 3 * impairments of PP&E are recognised in accordance with IAS 36; * derecognition of items of PP&E retired or disposed of should be determined in accordance with IAS 16; * compensation from third parties for items of PP&E that were impaired, lost or given up is included in determining profit and loss when it becomes receivable; and * the cost of items of PP&E restored, purchased or constructed as replacements is determined in accordance with IAS 16

Answer 42

* impairments of PP&E are recognised in accordance with IAS 36; * derecognition of items of PP&E retired or disposed of should be determined in accordance with IAS 16; * compensation from third parties for items of PP&E that were impaired, lost or given up is included in determining profit and loss when it becomes receivable; and * the cost of items of PP&E restored, purchased or constructed as replacements is determined in accordance with IAS 16