IAS 16 Property, plant, and equipment is the standard that deals with depreciation. Under this standard, an entity requires to depreciate fixed assets and then charge these depreciation expenses to its income statement in the period that the entity uses those assets.
There are many varieties of depreciation methods that allow by IAS16 for the entity to select based on the nature of assets and how the assets contribute to the entity’s future economic benefit.
Three main depreciation methods mentioned in the IFRS point IAS 16/ 62 are:
Three Main Depreciation Methods:
- Straight-line depreciation method, depreciation charge is equally from period to period over assets useful life when the residual value and assets useful life does not change. For example, if assets books value is 120,000 USD and has residual value 20,000 at the end of year fifth, the annual depreciation charge based on the straight-line method is 20,000 USD per year. This value is changed only if the useful life or residual value of assets is changed.
- Diminishing balance method, the depreciation expenses are charged highly at the beginning and then subsequently decrease over the useful life of assets. This method is sometimes called reducing balance, declining, or double declining. This method, the depreciation charge is high at the beginning, and them reducing subsequently. This is because the calculation is based on carrying value (Net Book Value) of assets of the earlier period rather than the value of the book of assets.
- Units of production method, the depreciation expenses are charged based on the output that assets could possibly produce, deliver, or use. This method is applicable for assets like types of machinery that the usage of them could be quantified in term of the number of hours that machines run, the number of output product compare to the total expected number of hours or units that machines could produce in its lifetime. Selecting the right depreciation methods are so important for the entity not only it is complying with the accounting standard but also making sure that financial statements reflect closely to the entity real economic value which is really important for the users.
- Books Value is the cost of assets that initially capitalize on the entity financial statements.
- Netbooks value is the carrying amount of assets after deducting accumulate depreciation.
- Depreciable value or depreciable amount is the amount after deducting the residual amount from books value of assets.
- Accumulate depreciation could not exceed the depreciable amount. At the end of assets useful life, these two amounts must be the same.