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17.2.2.2 Replacement of a major components and periodic replacement
17.2.2.3 Separation of land and buildings
17.2.3 Measurement at initial recognition
17.2.3.1 Extract from FRS 102 – Section 17.9-17.13
17.2.3.3 Directly attributable costs
17.2.3.4 Not directly attributable costs
17.2.3.5 Decommissioning costs
17.2.3.6 Self-constructed assets
17.2.3.7 Cessation of capitalisation
17.2.3.9 Deferred payment terms – measurement of cost
17.2.4.1 Extract from FRS 102 – Section 17.14
17.2.5 Measurement after Initial Recognition
17.2.5.1 Extract from FRC – FRS 102 – Section 17.15-17.15F
17.2.5.2.2.1 Frequency of revaluations
17.2.5.2.2.2 Meaning of fair value
17.2.5.2.2.3 Accounting for revaluation surpluses/deficits
17.2.5.2.2.4 Treatment of depreciation on upward revaluations
17.2.6 Depreciation, residual value and useful lives
17.2.6.0 Extract from FRS 102 Sections 17.16 to 17.23
17.2.6.1.2 Depreciation and useful economic life
17.2.6.1.4 Change in residual value, depreciation rate or useful economic life – change in estimate
17.2.6.1.5 Non-depreciable assets
17.2.6.1.6 Commencement and cessation of depreciation
17.2.6.1.7 Depreciation methods
17.2.6.1.5.1: Straight line method
17.2.6.1.5.2: Diminishing balance method/sum of digits
17.2.6.1.5.3: Units of production method
17.2.7 Recognition and measurement of impairment.
17.2.7.1 Extract from FRS 102 Section 17.24-17.26
17.2.8.1 Extract from FRS 102 Section 17.27-17.30
17.2.9.0 Extract from FRS 102 – Section 17.31-17.32A
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17.2.6 Depreciation, residual value and useful lives
17.2.6 Extract from FRS 102 Sections 17.16 to 17.23
17.16 If the major components of an item of property, plant and equipment have significantly different patterns of consumption of economic benefits, an entity shall allocate the initial cost of the asset to its major components and depreciate each such component separately over its useful life. Other assets shall be depreciated over their useful lives as a single asset. There are some exceptions, such as land which generally has an unlimited useful life and therefore is not usually depreciated.
17.17 The depreciation charge for each period shall be recognised in profit or loss unless another section of this FRS requires the cost to be recognised as part of the cost of an asset. For example, the depreciation of manufacturing property, plant and equipment is included in the costs of inventories (see Section 13 Inventories).
17.18 An entity shall allocate the depreciable amount of an asset on a systematic basis over its useful life.
17.19 Factors such as a change in how an asset is used, significant unexpected wear and tear, technological advancement, and changes in market prices may indicate that the residual value or useful life of an asset has changed since the most recent annual reporting date. If such indicators are present, an entity shall review its previous estimates and, if current expectations differ, amend the residual value, depreciation method or useful life. The entity shall account for the change in residual value, depreciation method or useful life as a change in an accounting estimate in accordance with paragraphs 10.15 to 10.18.
17.20 Depreciation of an asset begins when it is available for use, i.e. when it is in the location and condition necessary for it to be capable of operating in the manner intended by management. Depreciation of an asset ceases when the asset is derecognised. Depreciation does not cease when the asset becomes idle or is retired from active use unless the asset is fully depreciated. However, under usage methods of depreciation the depreciation charge can be zero while there is no production.
17.21 An entity shall consider all the following factors in determining the useful life of an asset:
(a) The 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.
(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.
(d) Legal or similar limits on the use of the asset, such as the expiry dates of relate leases.
17.22 An entity shall select a depreciation method that reflects the pattern in which it expects to consume the asset’s future economic benefits. The possible depreciation methods include the straight-line method, the diminishing balance method and a method based on usage such as the units of production method.
17.23 If there is an indication that there has been a significant change since the last annual reporting date in the pattern by which an entity expects to consume an asset’s future economic benefits, the entity shall review its present depreciation method and, if current expectations differ, change the depreciation method to reflect the new pattern. The entity shall account for the change as a change in an accounting estimate in accordance with paragraphs 10.15 to 10.18.
17.2.6.1 OmniPro comment
17.2.6.1.2 Depreciation and useful economic life (see section 17.16 to 17.23 of FRS 102)
Depreciation should be calculated by allocating the cost or revalued amount of an asset less its estimated residual value on a systematic basis over its useful life. Depreciation is charged in operating profit unless it is included in the cost of a product i.e. allocation of overheads to inventory. The useful life of an asset is either the period over which an asset is expected to be available for use by an entity or the number of units expected to be obtained from the asset by an entity.
Therefore, if an entity expects to hold an asset for the whole of its life then the asset would only be good for scrap at the end of the life with negligible value. However, where the entity has a policy to dispose of its assets before they reach the end of their economic life or where there is an alternative use at the end of the life, then the residual value will be higher. For example, a company purchases a car which has a useful life of 5 years however the entity intends on disposing this after 3 years, therefore the useful life for the company is 3 years, however the residual value will have to be estimated in order to determine the depreciation charge.
An entity cannot adopt a policy of not depreciating in the year of acquisition but depreciating in full in the year of disposal as this does not reflect the pattern in which the future economic benefits are expected.
17.2.6.1.3 Residual value
Section 17.19 requires the residual value to be reassessed when indicators of a possible change are present at each reporting date, these would include:
- a change in how the asset is used,
- significant unexpected wear and tear,
- technological advancement, and
- changes in market prices. Where this differs then the adjustment required is posted to the profit and loss prospectively.
The residual value of an asset is the estimated amount that an entity would currently obtain from disposal of the asset, after deducting the estimated cost of disposal, if the asset were of the age and in the condition expected at the end of its useful life (FRS 102 Appendix I). Under Section 35.9 , a change in residual value or useful life cannot be adjusted retrospectively in the first set of FRS 102 financial statements, instead they must be adjusted retrospectively.
17.2.6.1.4 Change in residual value, depreciation rate or useful economic life – change in estimate
Section 17.19 of FRS 102 makes it clear that a change in residual value, depreciation method or useful life is a change in accounting estimate which is adjusted prospectively. The disclosures required by Section 10.18 of FRS 102 have to be included in the financial statements i.e. the effect of the change on the current and future periods must be disclosed. Where the residual value increases such that no further depreciation is required, or it has been over depreciated, the standard requires that the asset be no longer depreciated and any over charge is not reversed. See Section 10.15 of FRS 102 Change in Estimate
Example 12: Revising a residual value of an asset
In year 1 an asset was purchased for CU100,000. It had an estimated life of 6 years. Its estimated residual value was estimated to be CU10,000. This residual value was assessed for indicators of change at each year end and there were no issues up to the end of year 4. At the start of year 5, due to a change in the market for this type of asset the residual value increased to CU20,000 (being the present value of future residual amount). At the end of year 4, the asset had a carrying amount as follows:
| CU | |
| Cost | 100,000 |
| Residual Value | (10,000) |
| Depreciable Amount | 90,000 |
| Depreciation (CU90,000 / 6 yrs * 4 yrs) | (60,000) |
| Carrying Amount | 30,000 |
In year 5, the residual amount is CU20,000, therefore the depreciable amount is CU80,000. Deducting depreciation charged to date of CU60,000 leaves CU20,000 to be depreciated over the remaining useful life of 2 years. Therefore, depreciation of CU10,000 is charged in year 5 and year 6. Disclosure of the change in estimate would be required in the financial statements detailing the effect on current and future years.
If we take this example and assume the residual value increases to CU50,000, then the carrying amount in year 5 of CU30,000 is in excess of the residual amount. Therefore no depreciation is required in year 5 and 6 and any over depreciation is not reversed. Disclosure of the change in estimate would be required in the financial statements.
Detailed below is an example of a disclosure requirement for a change in the depreciation rates used (i.e. a change in estimate)
Example 13: Change in accounting policy disclosure
During the year ended 31 December 201X the company changed its depreciation method for freehold buildings and leasehold improvements to depreciating same over 50 years on a straight line basis as opposed to 10 years. The effect of same was to reduce the depreciation charge by CU680,000 for the current year. In future years the depreciation charge will be extended whereby the depreciation charge will be lower but will go on for a longer period of time as it is being depreciated over its useful economic life. The depreciation charge will reduce by CUXXX in future years. The reason for the change in depreciation method is that the new policy more correctly reflects the useful economic life of these assets.
17.2.6.1.5 Non-depreciable assets
Section 17.16 of FRS 102 states that land is not depreciated unless it is land used for extractive purposes. As stated previously on acquisition, there is a need to separate the land from the property so that depreciation can be charged.
17.2.6.1.6 Commencement and cessation of depreciation (see section 17.20 of FRS 102)
Depreciation begins when the asset is available for use i.e. when the asset is in the location and condition necessary for it to be capable of operating in the manner intended by management.
Depreciation ceases when the asset is derecognised. Therefore, an entity does not stop depreciating an asset merely because it has become idle from active use.
Example 14: Commencement of depreciation
Company A completed construction of a factory on 1 January, but the company did not use this until 1 April. Here the entity should charge depreciation from the date it is ready for use i.e. 1 January.
17.2.6.1.7 Depreciation methods
Section 17.22 of FRS 102 standard specifies three methods which can be used in order to determine how the future economic benefits are used.
The standard specifies three methods which can be used in order to determine how the future economic benefits are used.
1) 17.2.6.1.5.1: Straight line method (see section 17.22 of FRS 102)
This is the most common method of depreciation and should be used when the pattern of consumption of assets economic benefits cannot be determined. This method is illustrated in the example on residual values above.
2) 17.2.6.1.5.2: Diminishing balance method/sum of digits
This method charges a higher amount of depreciation in the earlier years. In the example below a 20% reducing balance basis is used.
| CU | |
| Cost | 100,000 |
| Depreciation at 20% (CU100,000 *20%) | 20,000 |
| NBV | 80,000 |
| Depreciation at 20% (CU80,000 *20%) | 16,000 |
| NBV | 64,000 etc. etc. |
3) 17.2.6.1.5.3: Units of production method (see section 17.22 of FRS 102)
This method relates depreciation to the asset’s estimated use or output.
Example 15: Depreciation on basis of units of production
A machine cost CU100,000, over its useful life it will produce 200,000 widgets. The asset has no residual value. Therefore, the depreciation charge posted is based on the number of products produced by the machine. Therefore, the depreciation charge per product is CU0.50 (CU100,000 / 200,000 widgets). This can be done on the basis of hours also.
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Example 2: Replacement of a major component which was previously not separated
Example 3: Periodic replacement
Example 4: Separation of land and buildings
Example 5: Employee costs during construction
Example 6: purchasing on deferred credit terms
Example 7: Exchange of assets- assets that lack commercial substance
Example 8: Revaluation of assets of the same class
Example 9: Accounting for revaluations and subsequent movements – depreciable assets
Example 11: Transfer of depreciation on revalued amount from profit and loss reserves
Example 12: Revising a residual value of an asset
Example 13: Change in accounting policy disclosure
Example 14: Commencement of depreciation
Example 15: Depreciation on basis of units of production
Example 17: Extract from notes to the financial statements (assuming revaluation upwards)
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