The relevance of depreciable amount in IFRS

The depreciable amount of an asset is the basis on which the expense for depreciation or amortization of property plant and equipment, or any intangibles must be calculated.

To calculate this value, it’s necessary to deduct the residual value from the asset cost.

Let’s remember that this value is the estimated amount that an entity expects to receive in the future for the sale of a fixed
asset or an intangible asset after a certain period of use.

For example, If an entity acquires a building, and the company plans to use it for 50 years and determines that once sold the asset, the entity will obtain a 1 million, this means that the residual value is equal to 10%, in this case, the depreciable amount in this example is 9 million.

That is, the asset cost is less than the residual value, in this way, this value will be the basis on which an entity must recognize the depreciation of an asset.

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What is the adjusted depreciable amount?

The depreciable amount can change due to any of the following situations:

  • Changes in residual value.
  • Changes in the useful life of an asset.
  • Impairment losses Asset revaluations
  • Changes in decommissioning costs.

The changes in residual value

The first element that we are going to analyze is the changes in the residual value of an asset.

The residual value is an estimate that an entity makes on the initial recognition of an asset.

The value may change over time due to new information that the company receives

When there is a change in this value, the immediate consequence is a variation in   is a depreciable amount, in this way the depreciation charge will be affected.

For example, an entity in year 1 acquires a warehouse for 500,000,  with a useful life of 25 years is set out, and a residual value of 10% of  the asset cost.

At the beginning of year 5, due to new information, the company considers that the residual value should increase to 15%.

The depreciable amount in year 1 is 450,000 = 500,000 – (500,000 X10% = 50,000)

Thus, the depreciation expense in year 1 is 18,000 (450,000 / 25 years)

Now, at the beginning of year 5, the new depreciable amount is 425,000 = 500,000 – (500,000 X 15% = 75,000)

The changes in the useful life of an asset

Changes in the useful life of an intangible or property plant and equipment, are changes in the accounting estimates that must be recognized prospectively according to IAS 8. 

For example, in year 1, an entity acquires a patent for 200,000 with a useful life of 15 years, however, at the beginning of year 12, due to new information, the company considers that the useful life of the asset must be 30 years from the acquisition, this means that the remaining useful life of the asset is 19 years, taking into account that the patent has already been used for 11 years.

Asset cost : 200,000

Accumulated amortization : 146,666 (200,000 /15)x11

Carrying amount : 53,333

Of this way, the carrying value of the intangible in year 11 is 53,333, however, because there was a change in the useful life of the asset, the new depreciable amount is equal to the carrying value, that is, 53,333, This value must be distributed over the remaining useful life of the intangible, ie, the amortization expense from year 12 must be 2,807 (53,000 / 19 years).

Depreciable amount and impairment of assets

Property plant and equipment, as well as intangibles are subject to impairment, this means that their carrying amount is above their recoverable amount, the recoverable amount is the maximum price that third parties would be willing to pay under conditions of mutual independence, after deducting the estimated costs to sell, so to speak, if a company has a building whose carrying amount is 700,000 and the fair value of this is 600,000 and the estimated costs associated with the sale amount to 30,000, this means that according to the effects of supply and demand, the maximum purchase price that third parties are willing to pay to acquire this building will be 570,000, therefore, a company must recognize an impairment loss of 130,000, this with the objective of mach the carrying amount to the recoverable amount and show the economic reality of an asset

 Now, the carrying amount value is 570,000, which will be the new depreciable amount, since on this basis we must calculate the new depreciation for the following years, based on paragraph 63 of IAS 36, which establishes the following:

After the recognition of an impairment loss, the depreciation (amortization) charge for the asset shall be adjusted in future periods to allocate the asset’s revised carrying amount, less its residual value (if any), on a systematic basis over its remaining useful life.

Paragraph 63 IAS 36

The depreciable amount and the revaluation of assets.

Just as some property, plant and equipment, or some intangibles can to lose value, some others can present increases. 

When an entity uses the revaluation model in its accounting policy for subsequent measurement, it must reflect the increase in the fair value of assets.

let’s remember that IAS 16 set out two models for the subsequent measurement of a property plant and equipment or an intangible, cost model or revaluation model, the cost model is static, in other words it’s based on historical costs, ie , does not take into account the market value assets, while the revaluation model is a dynamic model that is based in the fair value assets.

When an entity chooses the revaluation model as its accounting policy, it must adjust the carrying amount of its assets to match the revalued amount, let’s see an example.

An entity in year 1 acquires a building for 2 million, the useful life of the asset is 20 years, at the end of year 5 the fair value of the asset is 1,900,000, on the other hand, the carrying amount to that same year is 1,500,000, therefore, we must adjust the asset by 400,000.

The paragraph 35 of IAS 16 establishes two methods to adjust the asset to the revalued amount, in this example we will use method B.

 This method indicates that the accumulated depreciation recognized to date must be eliminated, this amounts to 500,000 (2,000,000 / 20) X 5, once eliminated this value, the carrying amount becomes 2,000,000, however the fair value tells us that we must adjust this value in 100,000 to equal it to the market value, in this way, the new carrying amount is 1,900,000, than is equal to the revalued amount and in the same way to the depreciable amount, since on this value we will calculate the new depreciation for subsequent years.

Depreciable amount and decommissioning costs

IAS 16, specifically in paragraph 16 establishes that within the cost components of a property, plant and equipment, its acquisition price, directly attributable costs and dismantling costs must be taken into account, the dismantling costs are the disbursements that  a company should incur as a consequence of having used a place where a property, plant and equipment operated, and rehabilitate this place to leave it in similar conditions to those found initialy.

For example, an entity acquired a specialized machine for 300,000, so that this asset can function according to the specifications of the management, it is necessary to make a series of modifications in the warehouse where the asset will operate for 30,000, the entity estimates that will use the asset for 10 years, and once this period of time ends, it will be sold for 26,000, in addition, it will be necessary to carry out a series of reforms to rehabilitate the place for 45,000.

What should be the cost of the asset considering a rate discount of 10%?

The cost of the asset is as follows:

Acquisition price: 300,000

Directly attributable costs: 30,000

Dismantling costs: 45,000

Since decommissioning costs are an estimate of a future outflow of resources, they should be discounted to present value to show the effect of the value of money over time.

Present Value = (1+Interest) ^-n X Estimated amount.

Interest rate = 10%

N = 10 years.

Estimated amount = 45,000

Present value: 17,349

Total asset cost = 300,000 + 30,000 + 17,349 = 347,349

In this way, our depreciable amount is as follows:

Asset cost = 347,349

Residual value = 26,000

Depreciable amount = 321,349

The residual value is 26,000, since this is the value for which the entity expects to sell the asset after 10 years.

Now, what happens if at the beginning of year 6, the entity considers that due to new information, the estimate made of dismantling costs should decrease by 12,000.

The carrying amount of the asset at the end of year 5 is: 186,675 = 347,349 – (321,349 / 10) X5)

When there is a variation in the estimate of decommissioning costs, the change in value will affect the cost of the asset according to paragraph 5 of IFRIC 1 as shown below:

ifric 1 paragraph 5

In this way, the new depreciable amount is as follows:

Asset cost: 347,349

Residual value: 26,000

Changes in decommissioning costs: (12,000)

Accumulated depreciation: 160,675

New depreciable amount: 148,674

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