IAS 16 Property, plant, and equipment are the standard that deals with depreciation. Under this standard, an entity must depreciate fixed assets and then charge these depreciation expenses to its income statement in the period the entity uses those assets.
Under this standard, depreciation starts when fixed assets are ready for us, and depreciation is stopped or discharged when assets are unrecognized from the company book.
Many depreciation methods allow 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 and allowed in the IFRS point IAS 16/ 62 are:
Three Main Depreciation Methods:
- Straight-line depreciation method, the depreciation charge is equal from period to period over the assets’ useful life when the residual value and useful life do not change. For example, if the asset’s book value is 120,000 USD and has a residual value of 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 assets’ useful life or residual value 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. In this method, the depreciation charge is high at the beginning and then reduced subsequently. This is because the calculation is based on the carrying value (Net Book Value) of assets of the earlier period rather than the value of the book of assets.
- For units of production method, the depreciation expenses are charged based on the output assets that could produce, delivered, or used. This method is applicable for assets like types of machinery the usage of them could be quantified in terms of the number of hours that machines run, the number of output products compared to the total expected number of hours or units that machines could produce in their lifetime. Selecting the right depreciation methods is important for the entity because it complies with the accounting standard and ensures that financial statements closely reflect the entity’s real economic value, which is important for the users.
- Books Value is the cost of assets that initially capitalize on the entity’s financial statements.
- Netbooks value is the carrying amount of assets after deducting accumulated depreciation.
- Depreciable value or depreciable amount is the amount after deducting the residual amount from the book value of assets.
- Accumulated depreciation could not exceed the depreciable amount. These two amounts must be the same at the end of the asset’s useful life.
How to determine whether assets are ready?
The asset is considered ready for use and the company should recognize the depreciation expenses in the income statement during the period under the depreciation method that allows by IFRS.
The asset is considered ready for use there is no further procedure or process for an asset to be used.
For example, the aircon is already installed and ready for use. Even if the company does not use the aircon, depreciation still needs to perform and charged to the company’s financial statements.
When should the depreciation of fixed assets be stopped?
Depreciation of fixed assets should not be stopped when assets are idle or not used. The company should stop depreciating fixed assets when fixed assets are written off or discharged from the company’s financial statements.