When to start depreciation?
After graduating from a university I started my career in a famous, then Big 5 audit company.
If you work in auditing I bet you got the worst tasks and assignments during your first year at work!
Just as I did. I remember taking part in numerous inventory counts, including those who should be avoided at all cost.
What can happen in the warehouse?
Once I had to visit cold stores and count the stock of frozen veggies and fruits in the deep-freezer.
What’s so bad about it? Hmmm, try to imagine holding your pen and paper when the air temperature around you is about minus 20 degrees. Brrr! Then coming outside was like a tropical breeze, even when the temperature outside was about minus 1.
Another day my audit senior sent me to participate on the count of fixed asset in a big state-owned company. A part of its equipment was stored in a separate warehouse – these were all assets that were acquired back in the past and not used for years.
So, while I was paddling through ancient dirty machines in my rubber boots, followed by vicious smiles of the company’s employees (they did not like auditors), I spotted something interesting.
Back in the deepest tiny corner, there was one piece covered by some plastic blanket. It immediately dragged my attention. And I had an interesting conversation with a storekeeper:
Me: What is that?
Storekeeper: Ehmmm, hmmm, weeelll, it’s a new machine.
Me: Why is it here?
Storekeeper: Errrrr, hmmmm, well, we did not want to put it into use. Yet.
After some discussions with the company’s staff I found out that they invested in this expensive machine to improve some production process, but they wanted to start using it in 6 months.
They planned to keep a machine in the warehouse to avoid depreciation charges. In other words, they wanted to start depreciation at the moment of putting the machine into use.
That’s not what IAS 16 requires
I shared my story above with you to make you realize that IFRS do not use the concept of “put into use”.
The standard IAS 16, paragraph 55 states that depreciation of an asset begins when it is available for use, or when it is in the desired location and condition.
In the situation described above, the machine was available for use, as has been in the company’s premises, did not require additional installation and was capable of operations.
You can argue that it was in the warehouse of company’s antiques and not in the actual place of production, but I’m not sure this argument would be good enough for approval of your tax authorities or auditors.
Let me give you a few more examples when “available for use” is not the same as “put into use”:
Example 1 – investment property
During February and March 20X1, you paint the walls, make a few repairs and clean the house. At the end of March 20X1, the house is ready for the new tenants.
You start placing ads and negotiate rental contracts. The first tenants move in in June 20X1.
In this example:
Available-for-use date is the end of March 20X1, as the house was ready for the new tenants.
Put-into-use date is in June 20X1, when the first tenants move in and start to use the house.
Under IFRS, you start depreciating this property at the end of March 20X1 (unless you use the fair value model).
Example 2 – specialized machinery
The machine was delivered in February 20X1. Before putting it into use, an installation and testing performed by certified technician is required.
All the work including tests were completed in April 20X1 and ABC launched the new production line in July 20X1.
In this example:
Available-for-use date is in April 20X1, as all the necessary works on the machine were completed.
Put-into-use date is in July 20X1 when the new production line was launched.
ABC starts depreciating the machine in April 20X1.
Fit in the depreciation charges
OK, so now we now that “available for use” matters.
But here’s a problem:
You start depreciating an asset when it’s available for use, but as there are no revenues produced yet (e.g. new production line has not been launched yet), the matching principle is in trouble.
In other words, you have expenses (depreciation), but not the revenues.
Many accountants automatically think about the straight-line depreciation, just as no other methods would have been allowed.
This is what I call a “fixed” thinking.
In fact, IAS 16 does permit using several depreciation methods, such as number of units, diminishing balance, or simply any method that reflects the pattern in which the asset is consumed.
Therefore, you can have zero depreciation charges in a non-production (or idle) period. Simple as that.
What about taxation?
Here, you need to look deeply in the tax rules of your country.
Many tax laws present only limited options for your depreciation methods. As a result, you might be able to choose, for example, either straight-line or accelerated depreciation method.
Or, you might not be permitted to apply zero depreciation charge in a non-production period.
As a result, tax depreciation method might not correspond with the depreciation method selected under IAS 16 and tax depreciation will be different from accounting depreciation.
What’s the outcome?
You guessed it – a deferred tax arises. But that’s another story. 🙂
Please, leave me a comment below this article if you have ever faced with the same issue and share this article with your friends. Thank you!
JOIN OUR FREE NEWSLETTER AND GET
report "Top 7 IFRS Mistakes" + free IFRS mini-course
Please check your inbox to confirm your subscription.
150 Comments
Leave a Reply
I can relate with the counting stuff in freezing temperatures part. I had a similar experience, counting fish in a cold room, minus 20 degrees, dressed like an astronaut heading to outer space 🙂 :). It didn’t help that the fish were stored in large metallic containers that required a forklift to weigh, empty then weigh the container alone to determine the net weight of the fish. The short of it is that we had to issue a limitation of scope audit opinion 🙂 🙂
But thank you Sylvia, I’ve learnt something new. I actually didn’t think much about “Available for use” and “Put into use”.
“unless you use the fair value model” Now It s Clear why Some Companies dose not make Deprecation for the investment Property
thank you for all – GOD bless YOU
Hi Mostafa, true – if you apply FV model, you do not depreciate the investment property.
Hello Sylvia
What about an ERP implementation, where we have applied IAS 38 and capitalized development costs. Then we pilot 10 sites during the development and then once the pilot sites are complete and we are satisfied with the ERP we roll out the ERP across another 150 sites. Is the asset available for use and therefore amortised after the first pilot, after the 10 site pilot is complete or when it is fully rolled out?
Hello Silvia,
Greetings from Bangladesh,
In a NGO, they are showing purchase of 25 nos of computers in ‘Work in Progress’ in asset side. There logic is that the computers are in testing phase and if any fault fund they will return them to vendor. Thus they are not charging depreciation. My question is that whether they can show such purchase in “Work in Progress”.
Thanking you
Salsabil
Hi Sylvia,
Imagine an equipment bought at a particular time due to speculation of possible price hike in the nearest future not necessarily that it was needed at the time but will be needed at a more future time, and the asset is not put into use for some period, however somehow this asset was disposed to another buyer when there has not been wear and tear due to usage, How does the IAS 16 apply to the new buyer?
Well, the new buyer will simply recognize the acquisition of the new asset at its cost, that is purchase price+directly attributable expenses+removal provision if any. The purchase price is whatever the new buyer paid to the seller. I just mention here that yes, assess this purchase in the broader context as there might be some related transactions to it.
Hi Silvia,
I think your explanation is very clear and easily understood. There is this question I would like to seek more clarification on. An Oil distributing company initially classified a line of asset as non-depreciable (Land) from 2013, subsequently in 2021, they reclassified the asset to a depreciable asset (Pipeline Asset). I would like to know when will the depreciation charge for the year 2021 begin. Should the depreciation start from 2021 or calculate all depreciation from 2013 to 2021 and charge it in 2021.
Yes but why entities choose the cost model if the value of Buildings and land for sure will be increases over time and they will increase the equity for the revaluation ?
Because it is easier to use and also, perhaps it better reflects the usage of that asset.
Thank you Silvia for your explanation,
I have a question regarding the carrying amount of PPE, I live in Jordan and in our country the value of buildings and apartments increases over time not decreases, for example if you purchase a building in 2005 and decided to sell the building in 2015 the value of the building in 2015 will be higher than in 2005,please can you give a reason for that increases?
Thanks in advance,
Regards,
Mohammad
Reason? I guess you are talking about the market value, not the carrying amount. I would say market is the reason. Or I did not get your question, since the answer is quite obvious.
Hi Silvia,
Please give a solution for a case when we buy a machine but after a week of using it we realise that it has a defect and supplier agrees for return of the machine and the consideration paid that happens next month. Do we still have to depreciate?
Thank you much Silvia 🙂
Hello i am following you to increase my working skills , its very helpful for all of us indeed.
my question is we imported 1st jan 2020 i component(jaw) of machine (crusher line) valuing 200,000 $ as spare in case any time our component(jaw) which is currently being used breakdown so we have alternate component to fix it instead of waiting & buying as its not available in our country, we kept it in store & didnt depreciate it as we are thinking we will depreciate it when it will be fixed in our production unit, so please clarify this treatment is correct or not thanks
Selvia
I still Learning from you
you make the IFRS – More Clear more than thank for you
but if you pls i have One Qusttion
what if i want to use more the one Deprcation Method like
I deprcat the Bulding Straight Line Method & the Machiens with production hours
Hi Silvia,
Are companies allowed to charge a half-year depreciation for assets bought in the second half of the year and a half year depreciation in the last year of its useful life under IAS 16. Of course, I am assuming that this is consistently applied and part of the company’s policies. I coludn´t find any details regarding this issue in the standard.
Yes, of course – if you are using straight-line method. But I am speaking about accounting depreciation, not depreciation for tax purposes – you have to check that with your own tax law.
Thank you for your reply. I was wondering whether this kind of approach was acceptable for accounting purposes as well since the standard says that depreciation should start when the asset is available for its intended use. If the half-year convention is applied for accounting purposes then the depricitaion charge might be under- or overstated.
Will depreciation be charged on standby equipment? When The assets are not used from the date of purchase.
Hi Sylvia, I have a question where the company I work with, is using straight line and yearly basis to account for depreciation. Is it possible to depreciate a single asset by only 1 month instead of 12 months if it is available for use in the month of 1 December? The rest of the depreciation arising from new PPE keep using 12-month basis irregardless of monthly ownership..
Hello Sylvia, thank you for making things a little easier. I was auditing a client whose depreciation policy provides that “full depreciation will apply in the year of acquisition and no depreciation in the year of disposal..” Is this consistent with IAS 16 as it is now?
Can we start depreciating an uncompleted self build asset
Dear Sylvia thank you a good understandable presentation. My challenge is, we have moved to our new office building in August 2019, but the construction was still in final stage until December 2019 when the construction was full finished. How do i charge depreciation in this situation ?
Thanks
Hi Silvia,
I read your article regarding when to start depreciating assets. I want to clarify two situations:
1) A company ordered 100 laptops for the new joiners on the beginning of the year and only 50 have been given as there were only 50 new joiners. When will the company start depreciating the laptops and what about the remaining 50 laptops which is not given.
2) A company purchased land and building in prior year. The company didnot depreciate the building in last year stating that the building is old and they have plans to demolish it.In the current year, the company decided not to demolish the building. In that case, do we have to depreciate from last year or start it depreciating in the current year. The company also did not start using it in the current year as in the building is still vacant and not in use.
Please clarify this as i am still confused.
Thanks in advance.
Hi Silvia
You mention of several depreciation methods,now does IFRS allow having two or more methods applicable to on asset category ie with plan and equip you having others assets running on straight line and other on reducing balance.
Regards
Hello respected sir I would like to know when do we start the depreciation if the machinery is brought in January and put to use in July
Hi Silvia ,
I have an issue relating to construction industry. We have purchased a specialised machine for a road construction project ( Use full life of the machine is 5 years) Construction period was two years and we used Strait line method to depreciate the machine using it’s useful life ( 5 Yesrs). End of this road project , company don’t have any road project received. we will receive another project after one year. Can we stop the depreciation till we receive new project.
Thank you Silvia for the good works. Pls I have 2 questions. First, if you carry out a major repair on an existing asset and you intend to capitalise it, will such amount be added to the carrying amount of the main asset and depreciated over the unexpired years or treated as a separate line item in the Fixed Assets Register?
Second, if you replace a part of an asset, how do you treat it in your asset register. The part replaced was bought alongside the complete asset and as a result you cannot single out its cost/NBV and impair it solely. Pls educate me further
Dear Silva, I had cases where the company (client) paid for an asset at 30 November of 2017 and the asset wasn’t delivered until 20th January 2018. However, the client has started depreciating the asset before the asset was finally delivered and available for use. we as an audit team advised the client that the asset shouldn’t be depreciated until such asset is available for use. but the client insist it was going to recognize an allowance for depreciation. what is your take on this
I fully agree with auditors.
Dear Silvia
Greetings from Bangladesh,
I have been working as an accountant of an under construction company in our country. Machinery & Plants of this company are not ready for use. But we purchased some mini bus( for Employee & Labor) & construction vehicles which have been using for the construction of the factory( Oil & Refinery Company).
Now, will we charge depreciation against motioned mini bus( for Employee & Labor) and Construction vehicles? or is there any scope of not charging depreciation as there is no revenue arising this financial year?
Best Regards
Shamol
Well, IAS 16 directly prohibits charging depreciation based on revenue patterns – in fact, depreciation has nothing to do with “matching revenues”, but with the consumption of an asset. Thus yes, as soon as the minibus has been available for use, you should charge depreciation. However, if it qualifies and is directly attributable to the construction, you may capitalize depreciation charge into the cost of another asset (factory) – but you have to check that carefully in your own situation.
Thanks for immediate response and now the point is clear ..
Hi Silvia,
Is there any lesson about what is capital charge and how is it calculated on AuC?
Thanks.
My
Hello Silvia. When I was an audit senior at one of the Big 4 or 5 audit firms, I had the chance to be involved in an inventory count in a fish factory in Argentina, and the count was inside a minus 20 celsius huge freeze chambers. Just like your first comment of this article! In fact, such experience provided me the idea of an insertion in my blog https://relatoscontables.blogspot.com , a blog with anecdotes of accountants. You can see there “El pasado del futuro” and “El pasado del futuro II” where an auditor is frozen alive in middle of an inventory count, and is brought to life some 30 years later or so. Many thanks for your very interesting articles and your kndness of sharing them with us. Best regards.
Very nice!!! I love these funny stories – which don’t seem funny at all when you are in minus 20!!! All the best!
Thank you Silvia for your explanation,However I wanted some clarification on unit of production method,You said that when an asset is available for use but it hasn’t been put to use yet then depreciation is zero but Depreciable amount divided by units produced does not equal to zero.
Julius, using the units of production method does not mean that you need to book the depreciation for that particular year on a straight-line basis. Let’s say your machine with cost of 2 000 will produce 1 000 units: year 1- 0, year 2 – 500, year 3 – 500. Thus you book 0 in year one (0/1 000*2 000), 1 000 in year 2 (500/ 1 000*2 000) and 1 000 in year 3 (same as year 2). Some companies have an automatic booking of depreciation based on the machine’s real activity. S.
A new factory is under established and one A/C unit installed, amount 2MM but still operation not started.
1. Shall i record as an asset and start depreciation.
2. Shall i have to just record asset under construction once factory will be established i have to record as an asset as whole (Factory cost+Air condition unit cost)
First of all I would like to say thank you.?You are doing great work,i’m really interest to read your articles & please continue it as long as use can.
I want to clearly get idea about following,
As per IAS 16 we need to depreciate assets not at ready for use, but when the assets are available for use.
Assume that, A & B are companies which operate in same industry. Both companies purchased machine called “X”.Both companies SOFP represent the cost of the asset as 100,000$.(lets assume asset can be use 5 yrs & asset can use to produce 7,500 units).Company A use Straight Line method for Depreciation & Company B use unit of product method for depreciation. Both companies acquired the machine on 01-January-2017 (Assume year end on 31-December-2017).Both companies assets are available for use on 01st January 2017.But Both companies not use asset yet.As per the above scenarios extracts of the financial statements as follows(as at 31-Dec-2017),
Company Name A B
Cost of Asset $ 100,000.00 $ 100,000.00
Acqusition date 1-Jan-17 1-Jan-17
Dep. Method Straight Line Unite of product Method
Extracts of SOFP as at 31-Dec-2017
Company A B
Machine X – Cost $ 100,000.00 $ 100,000.00
Acc. Depreciation $ (20,000.00) $ –
WDV of Asset $ 80,000.00 $ 100,000.00
Extracts of P&L for the period 2017
Company A B
Depreciation $ (20,000.00) $ –
Effect on PBT $ (20,000.00) $ –
As per the above scenario Company A’s effect on PBT is -20,000$ & B’s effect on PBT is 0.00$.Company A’s profit reduce by 20,000$, because of the method they use for depreciation.is this correct ? or is there any other way to present financial statements.If this happen intended uses may get completely incorrect idea about company A.Please help me to solve this matter.
Hi
An asset depreciated straight line method with a EUL of 10 years. It completed 6 years and depreciated for 6 years. Then temporarily shut down for 2 years due to poor output. The depreciation also ceased during this two years, Now the asset is resumed after two years,
a. was it correct to stop depreciation during these two years?
b. Are we to charge balance 4 years depreciation equally for the next 2 years as a solution?
c. Can we extend the EUL by two years as the asset was idling for two years
Thanks
Hazar
Hi Hazar,
depreciation is an accounting estimate and you should revise it each year. Naturally, when you stopped the operation of that asset for 2 years, you should have revised your accounting estimate, too and reflect the changed pattern of asset’s usage in changed depreciation (did you think about the impairment, too?). As to useful life – are you going to use that asset for 2 year longer? Then of course, change its useful life. S.
Thanks Silvia for your valuable advice. Unfortunately they did not revive their accounting estimate nor considered impairment. They are not sure whether asset is going to be used for another additional twp years. More likely it will be retired as per the original EUL. In that case, I believe that we need to depreciate the balance within next two years end of which the assets will be retired
Dear Silvia, there is one situation i am trying to get the answer . One of the machine’s part was broken. The company couldn’t buy the part for this machine for some reasons and therefore the company haven’t used this machine for about 2 years. So does the company depreciate the machine during this 2 years when it wasn’t in use?
Thank you in advance
Hi silva,
Is’t dependency need to be consider? for example machine was placed and ready to use. But the place is not ready yet. Can we start depreciate the machine first? There was any issue for dependency?
With my little understanding, we start depreciating only when we have started using the asset. so back to your question, you will need the place (venue) before you start your operation so depreciation cannot start until operation start.
kind regards
Emma
Highly sophisticated Machine is required to be kept inside the freezer before installation. Company started paying rental charges immediately on import till its installation at a separate location. In total around 12 months rental paid. Can we capitalize this rental charges
Are these rental charges for the sophisticated machine? In this case yes, you can capitalize the expense, because it is inevitable to bring the freezer into the intended condition and location.