being divided into different parts. For other buildings and equipment, division into different components occurs
only if major components with different useful lives can be identified. For other machinery and equipment,
the depreciation period is normally between five and 10 years. Minor equipment is depreciated immediately.
Gravel pits and stone quarries are depreciated as materials are removed. Land is not depreciated. Assessments
of an asset’s residual value and period of service are performed annually.
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]. It also identifies other circumstances in which the significant parts do not
correspond to the depreciable components within the asset. To the extent that an
entity depreciates separately some parts of an item of PP&E, it also depreciates
separately the remainder of the item. The remainder of such asset that has not
separately been identified into parts may consist of other parts that are individually
not significant and if the entity has varying expectations for these parts, it may need
to use approximation techniques to calculate an appropriate depreciation method
for all of these parts in a manner that faithfully represents the consumption pattern
and/or useful life of such parts. [IAS 16.46]. The standard also allows an entity to
depreciate separately such parts that are not significant in relation to the total cost
of the whole asset. [IAS 16.47].
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].
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].
Property, plant and equipment 1323
5.2
Depreciable amount and residual values
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 (see Chapter 3 at 4.5). [IAS 16.51].
The residual value of an item of PP&E is 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]. 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].
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].
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.
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 is the period over which the entity expects to use the asset,
not the asset’s economic life.
5.3 Depreciation
charge
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]. If the residual value exceeds the carrying amount, no
1324 Chapter 18
depreciation is charged until the residual value once again decreases to less than the
carrying amount (see 5.2 above). [IAS 16.54]. IAS 16 makes it clear that the repair and
maintenance of an asset do not, of themselves, negate the need to depreciate it.
[IAS 16.52].
There is no requirement in IAS 16 for an automatic impairment review if no
depreciation is charged.
5.4 Useful
lives
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 (see Chapter 3 at 4.5), over the remaining useful life
of the asset. [IAS 16.51].
As described in 2.2 above, 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.
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. 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].
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. Consequently, 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;
Property, plant and equipment 1325
(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 (see 5.4.1 below);
(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 5.4.3 below); and
(d) legal or similar limits on the use of the asset, such as the expiry dates of related
leases. [IAS 16.56].
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. ‘Lease term’ under IFRS 16
and IAS 17, if still applied, is discussed in Chapters 24 and 23, respectively.
ArcelorMittal is an example of an entity depreciating an asset over its expected usage
by reference to the production period.
Extract 18.8: ArcelorMittal (2017)
Notes to the consolidated financial statements [extract]
Note 5:
Goodwill, intangible and tangible assets [extract]
5.2
Property, plant and equipment and biological assets [extract]
Property, plant and equipment used in mining activities is depreciated over its useful life or over the remaining life
of the mine, if shorter, and if there is no alternative use. For the majority of assets used in mining activities, the
economic benefits from the asset are consumed in a pattern which is linked to the production level and accordingly,
assets used in mining activities are primarily depreciated on a units-of-production basis. A unit-of-production is
based on the available estimate of proven and probable reserves.
5.4.1
Repairs and maintenance
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. For example, an entity may assess the useful life of a railway engine at thirty-
five 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
1326 Chapter 18
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.
Note that this applies whether the expenditure is capitalised because it meets the
definition of a ‘major inspection’ (see 3.3.2 above) or if it is repairs and maintenance that
is expensed as incurred.
5.4.2 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].
There are circumstances in which depreciation may be applied to land. In those instances
in which land has a finite life (e.g. land that is used either for extractive purposes such as
a quarry or mine, or for some purpose such as landfill), it will be depreciated in an
appropriate manner that reflects the benefits to be derived from it, but it is highly unlikely
that there will be any issue regarding separating the interest in land from any building
element. [IAS 16.58, 59]. Further, the cost of such land may include an element for site
dismantlement, removal or restoration, e.g. the initial estimate of the costs of dismantling
and removing the item and restoring the site on which it is located, and any subsequent
changes thereto (described in 4.3 above). [IAS 16.16]. This element will have to be separated
from the land element and depreciated over an appropriate period. The standard
describes this as ‘the period of benefits obtained by incurring these costs’ which will often
be the estimated useful life of the site for its purpose and function. [IAS 16.59]. An entity
engaged in landfill on a new site may make a provision for restoring it as soon as it starts
preparation by removing the overburden. It wil
l separate the land from the ‘restoration
asset’ and depreciate the restoration asset over the landfill site’s estimated useful life. If
the land has an infinite useful life, an appropriate depreciation basis will have to be chosen
that reflects the period of benefits obtained from the restoration asset.
If the estimated costs are revised in accordance with IFRIC 1, the adjusted depreciable
amount of the asset is depreciated over its useful life. Therefore, once the related asset
has reached the end of its useful life, all subsequent changes in the liability will be
recognised in profit or loss as they occur, irrespective of whether the entity applies the
cost or revaluation model. [IFRIC 1.7].
5.4.3 Technological
change
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 5.6.1 below).
Property, plant and equipment 1327
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].
5.5
When depreciation starts
The standard is clear on when depreciation should start and finish, and sets out the
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 261