Fully depreciated assets can be a headache for a company when an external audit revises the financial statements.
Many auditors find that in the time of physically comparing the inventory of fixed or intangible assets, there are fully depreciated assets within the financial statements that the entity is still using.
Why does this problem occur within companies?
The calculation of the useful life of assets is an estimate that a company makes about the period in which an entity will receive the economic benefits associated with using the asset.
That is, it does not make any sense that a company continues to obtain such benefits, and within the financial statements, these assets own a zero carrying amount.
When this type of problem occurs, the entity’s management has made poor planning and management of its property, plant, and equipment or its intangibles.
Let’s remember that paragraph 51 of IAS 16 establishes that the residual value and the useful life of an asset will be reviewed, at a minimum, at the end of each annual period.
If expectations differ from previous estimates, the changes will be accounted for as a change in an accounting estimate.
At the time of the acquisition of an asset, the management of an entity must make the best estimate of the useful life according to the information that the company has at that time.
However, on many occasions, the management of the companies forgets to carry out an annual review of these useful lives to establish if it has changed according to new circumstances.
In other words, not carrying out this annual review has the consequence that problems such as the one we are analyzing appear.
The useful lives established at the initial moment of the acquisition of an asset are not a straitjacket that forces companies to depreciate or amortize an asset in a certain period.
Rather, these useful lives could change throughout the use of the asset as a result of new information arising.
The fact that an entity correctly plans the management of assets is essential to avoid fully depreciated assets within the financial statements and that the entity continues to use them.
Factors to determine the useful life of a property, plant, and equipment
Paragraph 56 of IAS 16 establishes that a company consumes future economic benefits associated with using an asset in the first instance through its use.
Nevertheless, there are factors, such as technical or commercial obsolescence and natural impairment caused by the lack of use of the asset.
This produces a decrease in the economic benefits that an entity obtains for using the asset.
In this way, to determine the useful life of elements such as property, plants, and equipment, all the factors mentioned below will be considered.
The intended use of the asset.
Expected physical wear.
Legal limits or similar restrictions on the use of the asset.
How to solve this problem?
If, for example, an entity has on its balance sheet 10,000 fully depreciated or amortized assets and these are still being used by the company, the management of an entity should review these assets and establish according to the criteria of IAS 16 and IAS 38 it’s remaining useful life.
Let’s remember that this change is a change in an estimate that should not affect the previously recognized financial statements in previous periods.
In this way, on certain occasions, adjusting the useful lives of fully depreciated assets is not as easy as it seems.
If an entity or an external audit finds that the initial calculation of the useful lives of certain assets was carried out without taking into account the parameters established in IAS 16 or IAS 38, we would not be in the presence of a change in an accounting estimate, but rather in the presence of an error.
Consequently, the entity must affect prior periods’ financial statements under IAS 8