Tuesday, August 19, 2008

Changes in Estimated Useful Life of Property, Plant and Equipment, how to handle it ?

In accordance with one of the more important of the basic accounting conventions, the matching principle, the cost of property, plant and equipment are allocated through depreciation to the periods that will have benefited from the use of the assets.

Whatever method of depreciation is chosen, it must result in the systematic and rational allocation of the depreciable amount of the asset (initial cost less residual value) over the asset’s expected useful life.

The determination of the useful life must take a number of factors into consideration. These factors include technological change, normal deterioration, actual physical use, and legal or other limitations on the ability to use the property.

(Wiley – IFRS 2008 Bound Volume, Interpretation and Application)

International Accounting Standard (IAS) 16 Property, Plant and Equipment defined useful life as the period over which an asset is expected to be available for use by an entity, or the number of production or similar units expected to be obtained from the asset by an entity.

Par. 50 of IAS 16 stated that the depreciable amount of an asset shall be allocated on a systematic basis over its useful life.

Par. 51 stated that the residual value and the useful life of an asset shall be reviewed at least at each financial year-end and, if expectations differ from previous estimates, the change(s) shall be accounted for as a change in an accounting estimate in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.

Wiley – IFRS 2008 Interpretation and Application explained further, that if it is determined, when reviewing the depreciation method, that the estimated life is greater or less than previously believed, the change is handled as a change in accounting estimate, not as a correction of an accounting error.

Accordingly, no restatement is to be made to previously reported depreciation; rather, the change is accounted for strictly on a prospective basis, being reflected in the period of change and subsequent periods.

Example of changes in estimated useful life of asset and implementation of Par. 51 of IAS 16 as follows :

To illustrate this concept, consider an asset costing € 100,000 and originally estimated to have a productive life of 10 years. The straight-line method is used, and there was no residual value anticipated. After 2 years, management revises its estimate of useful life to a total of 6 years. Since the net carrying value of the asset is € 80,000 after 2 years (= € 100,00 x 8/10), and the remaining expected life is 4 years (2 of the 6 revised total years having already elapsed), depreciation in years 3 through 6 will be € 20,000 (= € 80,000/4) each.

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