1. Depreciation of property, plant and equipment
Chapter 5
Depreciation of property, plant and equipment

2. Objectives of the lecture
Understand the role of accounting in allocating the depreciable amount of a non-current asset over the asset’s expected useful life
Be aware that the practice of calculating depreciation requires a number of decisions to be made including determining:
The depreciable base
The useful life
Appropriate method of cost apportionment

3. Objectives of the lecture (cont.)
Understand the various approaches (straight line, sum-of-digits, declining balance, production basis) for allocating the depreciable amount of a non- current asset to particular financial periods
Understand when to start depreciating a depreciable asset
Know how to account for the disposal of a depreciable asset
Know the disclosure requirements of AASB 116 Property, Plant and Equipment as they pertain to depreciation

4. Relevant accounting standards
Depreciation requirements for property, plant and equipment are contained in AASB 116 Property, Plant and Equipment
Amortisation of intangible assets is governed by AASB 136 Intangible Assets

5. Introduction Depreciation
recognises the decrease in the service potential of a non- current asset across time
involves allocating the cost of an asset or revalued amount over periods in which benefits are expected to be derived
involves recognising such allocation as an expense, unless included in another asset’s carrying amount
should not be confused with the decline in fair value of an asset over time

6. Introduction (cont.) Depreciable assets
Non-current assets having limited useful lives
Depreciable assets may comprise a significant proportion of total assets
Depreciation expense can have a significant effect on profits
To allocate the cost of an asset three issues must be addressed
Which depreciable base should be used?
What is the asset’s useful life?
Which method of cost apportionment is most appropriate for the asset?

7. Depreciable amount (base) for assets
Depreciable amount (also referred to as depreciable base)
Historical cost of a depreciable asset (or revalued amount if this is substituted for cost) less its residual value
Residual value
The estimated amount that an entity would currently obtain from the disposal of an asset, after deducting the estimated costs of disposal, if the asset were already of the age and condition expected at the end of its useful life (AASB 116)
Usually based on professional judgment
Choice of residual value will influence future profits and assets
If the residual value is equal to or greater than the asset’s carrying amount, no depreciation is recognised (AASB 116, par. 54)

8. Determination of useful life
Useful life (AASB 116)
An asset’s useful life:
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
Useful life is based on professional judgment
Refer to Worked Example 5.2, p. 184—Determination of useful life

9. Method of cost apportionment
Should best reflect the economic reality of the asset’s use
Must consider underlying physical, technical, commercial and/or legal facts (AASB 116)
Available methods include:
Straight-line method
Sum-of-digits method
Declining-balance method
Units-of-production basis
Refer to Worked Example 5.3, p. 185—A review of alternative depreciation methods

10. When to start depreciating an asset
From the time an asset is first put into use, or is held ready for use
If constructing an asset, it is not depreciated until ready for use
If an asset is able to be used but is not actually used for a number of periods, the asset is still depreciated from the time it was able to be used
This would account for obsolescence rather than wear and tear

11. Revision of depreciation rate and method
Residual value and useful life must be reviewed at least annually (AASB 116)
Depreciation method must also be reviewed annually (AASB 116)
Revisions of depreciation rates can have significant effects on profits
Any material changes in depreciation charges are to be disclosed as a change in accounting estimate in accordance with AASB 108 Accounting Policies, Changes in Accounting Estimates and Errors

12. Land and buildings
Where acquired together, cost must be apportioned between land and buildings (AASB 116)
Buildings to be systematically depreciated over time
Land not usually depreciated owing to unlimited useful life (with some exceptions, for example quarries and sites used for landfill)

13. Modifying existing non-current assets
Accounting treatment when modifications or improvements are made to existing non-current assets
Where expenditure is capitalised, the expenditure would subsequently be depreciated to the entity’s statement of comprehensive income
Additions or extensions to an existing depreciable asset that becomes an integral part of that asset
Addition or extension to an existing depreciable asset that retains a separate identity and will be capable of being used after that asset is disposed of

14. Derecognition of assets
Gain or loss from derecognition of asset
Difference between net disposal proceeds (measured at fair value) and asset’s carrying amount (AASB 116)
‘Carrying amount’ is the amount at which an asset is recognised after deducting any accumulated depreciation and accumulated impairment losses
Derecognition means (AASB 116):
Disposal of an asset (perhaps through a sale); or
When no future economic benefits are expected in respect of an asset

15. Sale of a depreciable asset
The profit or loss on sale is generally referred to as a gain or loss on sale (or derecognition)
Recognised on a ‘net basis’ in the statement of comprehensive income (that is, the proceeds from the sale are not separately shown as revenue)
For example, the journal entries to record a sale of machinery for cash might be:
Dr Cash at bank
Dr Accumulated depreciation—machinery 50
Cr Gain on sale of machinery 100
Cr Machinery 250
See Worked Example 5.6, p. 191—Disposal of a depreciable asset

16. What if the sale proceeds are deferred?
When the receipt of the sale proceeds on the disposal of an item of property, plant and equipment is deferred for a period of time, AASB 116, paragraph 72, requires the fair value of the consideration to be recognised initially at its ‘cash price equivalent’.

17. What if the sale proceeds are deferred? (cont.)
Specifically, AASB 116, paragraph 72 states:
The consideration receivable on disposal of an item of property, plant and equipment is recognised initially at its fair value. If payment for the item is deferred, the consideration received is recognised initially at the cash price equivalent. The difference between the nominal amount of the consideration and the cash price equivalent is recognised as interest revenue in accordance with AASB 118 reflecting the effective yield on the receivable

18. What if the sale proceeds are deferred? (cont.)
The discount rate to be used is the rate at which the vendor could invest the amount under similar terms and conditions
See worked Example 5.7, p. 192—Sale proceeds deferred

19. Contractual implications of building depreciation
Recognition of building depreciation will increase expenses and decrease profits
Likely to lead to unfavourable movements in accounting-based ratios
Managers facing possible debt-covenant violations would be less inclined to want to comply with AASB 116

20. Contractual implications of building depreciation (cont.)
Clinch (1983) found the following cash-flow effects associated with the decision to comply/not comply with the requirement to depreciate buildings:
non-compliance with depreciation requirement led to greater auditing costs
benefits included cost savings associated with avoiding violation of debt contracts

21. Disclosure requirements
For each class of property, plant and equipment the following must be disclosed (AASB 116):
Measurement basis used for gross carrying amount
Depreciation methods used
Useful lives or depreciation rates used
Gross carrying amount and accumulated depreciation at beginning and end of period
Reconciliation of carrying amount at beginning and end of period

22. Summary
Depreciation is an allocation process rather than a valuation process
The depreciable base of an asset is its historical cost (or revalued amount) less any expected residual value and less any accumulated impairment losses
Determination of useful life depends on judgments
Depreciation method used should reflect pattern of benefits being derived from asset’s use

23. Summary (cont.)
Available methods include: straight line, sum-of digits, declining balance and production basis
Depreciation starts from time when asset is put into use or is ready for use
When an asset is sold the difference between the carrying amount and sales proceeds must be recognised as a gain or a loss