A variety of depreciation methods can be used to allocate the depreciable amount of an asset on a systematic basis over its useful life, in accordance with International Accounting Standards (IAS) 16 Property, Plant and Equipment. These methods include the straight-line method, the diminishing balance method and the units of production method.
Straight-line depreciation results in a constant charge over the useful life if the asset’s residual value does not change. The diminishing balance method results in a decreasing charge over the useful life. The units of production method results in a charge based on the expected use or output. The entity selects the method that most closely reflects the expected pattern of consumption of the future economic benefits embodied in the asset. That method is applied consistently from period to period unless there is a change in the expected pattern of consumption of those future economic benefits.
Note that revenue-based methods are not included with those that are specifically mentioned under IAS 16, but International Accounting Standards Board (IASB) noted that there are many entities using revenue as basis for depreciation (such as based on sales units, revenue amounts).
(When used in this article, International Financial Reporting Standards (IFRS) and IAS shall also mean Philippine Financial Reporting Standards (PFRS) and Philippine Accounting Standards (PAS) as Philippines adopt its reporting standards from the international standard-setting bodies)
What has changed?
The depreciation method used shall reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the entity. IAS 16 and IAS 38 Intangible Assets, both establish the principle for the basis of depreciation and amortization as being the expected pattern of consumption of the future economic benefits of an asset.
The IASB has clarified that the use of revenue-based methods to calculate the depreciation of an asset is not appropriate because revenue generated by an activity that includes the use of an asset generally reflects factors other than the consumption of the economic benefits embodied in the asset. Thus, revenue-based methods to calculate depreciation of property plant and equipment is prohibited under the amended IAS 16.
A depreciation method that is based on revenue that is generated by an activity that includes the use of an asset is not appropriate. The revenue generated by an activity that includes the use of an asset generally reflects factors other than the consumption of the economic benefits of the asset. For example, revenue is affected by other inputs and processes, selling activities and changes in sales volumes and prices. The price component of revenue may be affected by inflation, which has no bearing upon the way in which an asset is consumed.
The IASB also clarified that revenue is generally presumed to be an inappropriate basis for measuring the consumption of the economic benefits embodied in an intangible asset under IAS 38. This presumption, however, can be rebutted in certain limited circumstances and limits the use of revenue-based amortization for intangible assets to where the contract establishing those rights applies a limit to their use based on revenue.
There is a rebuttable presumption that an amortisation method that is based on the revenue generated by an activity that includes the use of an intangible asset is inappropriate. The revenue generated by an activity that includes the use of an intangible asset typically reflects factors that are not directly linked to the consumption of the economic benefits embodied in the intangible asset. For example, revenue is affected by other inputs and processes, selling activities and changes in sales volumes and prices. The price component of revenue may be affected by inflation, which has no bearing upon the way in which an asset is consumed. This presumption can be overcome only in the limited circumstances:
- in which the intangible asset is expressed as a measure of revenue, as described in paragraph 98C; or
- when it can be demonstrated that revenue and the consumption of the economic benefits of the intangible asset are highly correlated.
In choosing an appropriate amortisation method in accordance with paragraph 98, an entity could determine the predominant limiting factor that is inherent in the intangible asset. For example, the contract that sets out the entity’s rights over its use of an intangible asset might specify the entity’s use of the intangible asset as a predetermined number of years (ie time), as a number of units produced or as a fixed total amount of revenue to be generated. Identification of such a predominant limiting factor could serve as the starting point for the identification of the appropriate basis of amortisation, but another basis may be applied if it more closely reflects the expected pattern of consumption of economic benefits.
In the circumstance in which the predominant limiting factor that is inherent in an intangible asset is the achievement of a revenue threshold, the revenue to be generated can be an appropriate basis for amortisation. For example, an entity could acquire a concession to explore and extract gold from a gold mine. The expiry of the contract might be based on a fixed amount of total revenue to be generated from the extraction (for example, a contract may allow the extraction of gold from the mine until total cumulative revenue from the sale of gold reaches CU2 billion) and not be based on time or on the amount of gold extracted. In another example, the right to operate a toll road could be based on a fixed total amount of revenue to be generated from cumulative tolls charged (for example, a contract could allow operation of the toll road until the cumulative amount of tolls generated from operating the road reaches CU100 million). In the case in which revenue has been established as the predominant limiting factor in the contract for the use of the intangible asset, the revenue that is to be generated might be an appropriate basis for amortising the intangible asset, provided that the contract specifies a fixed total amount of revenue to be generated on which amortisation is to be determined.
The issue originated from a submission to the IFRS Interpretations Committee.
To summarize,revenue-based depreciation/amortization methods are prohibited for properly, plant and equipment and are allowed but in limited circumstances for intangible assets.
Clarification of Acceptable Methods of Depreciation and Amortisation (Amendments to IAS 16 and IAS 38), issued in May 2014 shall be effective for annual periods beginning on or after January 1, 2016.
Earlier application is permitted. If an entity applies those amendments for an earlier period it shall disclose that fact.
This amendment shall be applied prospectively.
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