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 (see 4.1.4 above).
• 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 (see 7 below).
[IAS 16.55].
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 (see Chapter 20 at 2.1). [IAS 36.12(f)].
Assets held for sale under IFRS 5 are discussed below at 7.1 below.
5.6 Depreciation
methods
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 (see 5.6.1 below) and the units of production method (see 5.6.2 below). 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
1328 Chapter 18
from period to period unless there is a change in the expected pattern of
consumption of those future economic benefits. [IAS 16.60-62].
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]. 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].
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 (see 5.6.2 below).
5.6.1
Diminishing balance methods
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].
Example 18.2: Diminishing balance depreciation
An asset costs €6,000 and has a life of four years and a residual value of €1,500. It calculates that the
appropriate depreciation rate on the declining balance is 29% and that the depreciation charge in years 1-4
will be as follows:
€
Year 1
Cost 6,000
Depreciation
at 29% of €6,000
1,757
Net book value
4,243
Year 2
Depreciation at 29% of €4,243
1,243
Net book value
3,000
Year 3
Depreciation at 29% of €3,000
879
Net book value
2,121
Year 4
Depreciation at 29% of €2,121
621
Net book value
1,500
Property, plant and equipment 1329
The sum of digits method is another form of the reducing balance method, but one that
is based on the estimated life of the asset and which can easily be applied if the asset
has a residual value. If an asset has an estimated useful life of four years then the digits 1,
2, 3, and 4 are added together, giving a total of 10. Depreciation of four-tenths, three-
tenths and so on, of the cost of the asset, less any residual value, will be charged in the
respective years. The method is sometimes called the ‘rule of 78’, 78 being the sum of
the digits 1 to 12.
Example 18.3: Sum of the digits depreciation
An asset costs €10,000 and is expected to be sold for €2,000 after four years. The depreciable amount is
€8,000 (€10,000 – €2,000). Depreciation is to be provided over four years using the sum of the digits method.
€
Year 1
Cost 10,000
Depreciation
at 4/10 of €8,000
3,200
Net book value
6,800
Year 2
Depreciation at 3/10 of €8,000
2,400
Net book value
4,400
Year 3
Depreciation at 2/10 of €8,000
1,600
Net book value
2,800
Year 4
Depreciation at 1/10 of €8,000
800
Net book value
2,000
5.6.2 Unit-of-production
method
&
nbsp; 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.
The essence 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.
5.7 Impairment
All items of PP&E accounted for under IAS 16 are subject to the impairment
requirements of IAS 36. Impairment is discussed in Chapter 20. [IAS 16.63].
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. 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
1330 Chapter 18
subsequent purchase or construction of replacement assets – are ‘separate economic
events’ and should be accounted for separately as follows:
• impairments of PP&E are recognised in accordance with IAS 36 (see Chapter 20);
• derecognition of items of PP&E retired or disposed of should be determined in
accordance with IAS 16 (see 7 below);
• 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 (see 3 and 4 above). [IAS 16.65, 66].
6
MEASUREMENT AFTER RECOGNITION: REVALUATION
MODEL
If the revaluation model is adopted, PP&E is initially recognised at cost and
subsequently carried at a revalued amount, being its fair value (if it can be measured
reliably) at the date of the revaluation, less subsequent accumulated depreciation and
impairment losses. [IAS 16.29, 31]. In practice, ‘fair value’ will usually be the market value
of the asset. There is no requirement for a professional external valuation or even for a
professionally qualified valuer to perform the appraisal, although in practice
professional advice is often sought.
Valuation frequency is not prescribed by IAS 16. Instead it states that revaluations are
to be made with sufficient regularity to ensure that the carrying amount does not differ
materially from that which would be determined using fair value at the end of the
reporting period. [IAS 16.31]. Therefore, the frequency of revaluations depends upon the
changes in fair values of the items of PP&E being revalued. When the fair value of a
revalued asset differs materially from its carrying amount, a further revaluation is
necessary. The standard suggests that some items of PP&E have frequent and volatile
changes in fair value and these should be revalued annually. This is true for property
assets in many jurisdictions, but even in such cases there may be quieter periods in
which there is little movement in values. If there are only insignificant changes in fair
value, frequent revaluations are unnecessary and it may only be necessary to perform
revaluations at three or five-year intervals. [IAS 16.34].
If the revaluation model is adopted, IAS 16 specifies that all items within a class of PP&E
are to be revalued simultaneously to prevent selective revaluation of assets and the
reporting of amounts in the financial statements that are a mixture of costs and values
as at different dates. [IAS 16.29, 36, 38]. A class of PP&E is a grouping of assets of a similar
nature and use in an entity’s operations. This is not a precise definition. IAS 16 suggests
that the following are examples of separate classes of PP&E:
(i) land;
(ii) land and buildings;
(iii) machinery;
(iv) ships;
Property, plant and equipment 1331
(v) aircraft;
(vi) motor
vehicles;
(vii) furniture and fixtures;
(viii) office equipment; and
(ix) bearer
plants.
[IAS 16.37].
These are very broad categories of PP&E and it is possible for them to be classified
further into groupings of assets of a similar nature and use. Office buildings and factories
or hotels and fitness centres, could be separate classes of asset. If the entity used the
same type of asset in two different geographical locations, e.g. clothing manufacturing
facilities for similar products or products with similar markets, say in Sri Lanka and
Guatemala, it is likely that these would be seen as part of the same class of asset.
However, if the entity manufactured pharmaceuticals and clothing, both in European
facilities, then few would argue that these could be assets with a sufficiently different
nature and use to be a separate class. Ultimately it must be a matter of judgement in the
context of the specific operations of individual entities.
IAS 16 permits a rolling valuation of a class of assets provided the revaluation of such class
of assets is completed within a short period of time and ‘provided the revaluations are
kept up to date’. [IAS 16.38]. This final condition makes it difficult to see how rolling
valuations can be performed unless the value of the assets changes very little (in which
case the standard states that valuations need only be performed every three to five years)
because if a large change is revealed, then presumably a wholesale revaluation is required.
An entity that uses the cost model for its investment property, as allowed by IAS 40,
should apply the cost model in IAS 16 (see 5 above) for owned investment property.
[IAS 16.5]. Investment property held by a lessee as a right-of-use asset will be measured
in accordance with IFRS 16 (see Chapter 24 at 5.3.1).
6.1
The meaning of fair value
Fair value is defined in IFRS 13. IFRS 13 does not prescribe when to measure fair value
but provides guidance on how to measure it under IFRS when fair value is required or
permitted by IFRS.
IFRS 13 clarifies that fair value is an exit price from the perspective of market
participants. ‘Fair value’ is defined as ‘the price that would be received to sell an asset
or paid to transfer a liability in an orderly transaction between market participants at
the measurement date’. [IAS 16.6, IFRS 13 Appendix A].
6.1.1
Revaluing assets under IFRS 13
IFRS 13 specifies that ‘fair value is a market-based measurement, n
ot an entity-specific
measurement’. [IFRS 13.2]. Some of the new principles that affect the revaluation of PP&E
are the concept of highest and best use and the change in focus of the fair value
hierarchy from valuation techniques to inputs. IFRS 13 also requires a significant
number of disclosures, including the categorisation of a fair value measurement with the
fair value measurement hierarchy.
The requirements of IFRS 13 are discussed in Chapter 14.
1332 Chapter 18
The following sections consider some of the key considerations when measuring the
fair value of an item of PP&E.
6.1.1.A
Highest and best use
IFRS 13 states that ‘a fair value measurement of a non-financial asset takes into account
a market participant’s ability to generate economic benefits by using the asset in its
highest and best use or by selling it to another market participant that would use the
asset in its highest and best use’. [IFRS 13.27]. This evaluation will include uses that are
‘physically possible, legally permissible and financial feasible’. [IFRS 13.28].
The highest and best use is determined from the perspective of market participants that
would be acquiring the asset, but the starting point is the asset’s current use. It is
presumed that an entity’s current use of the asset is the asset’s highest and best use,
unless market or other factors suggest that a different use of the asset by market
participants would maximise its value. [IFRS 13.29].
Prior to the adoption of IFRS 13, IAS 16 did not imply that fair value and market value
were synonymous, which allowed a broader meaning of the term ‘fair value’. The term
could certainly have been interpreted as encompassing the following two commonly
used, market derived, valuation bases:
• market value in existing use, an entry value for property in continuing use in the
business which is based on the concept of net current replacement cost; and
• open market value, which is an exit value and based on the amount that a property
that is surplus to requirements could reach when sold.
Both of these bases are market-derived, yet they can differ for a variety of reasons. A
property may have a higher value on the open market if it could be redeployed to a more
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 262