FR - Accounting for transactions in financial

statements
Tangible Non-current Assets - IAS16 – Part 2

INTRODUCTION TO DEPRECIATION:

IAS 16 defines depreciation as the systematic allocation of the depreciable amount of an asset over its useful
life.

Useful Life

Useful life refers to the period over which the present owner of the asset expects to derive economic benefits
from it. The useful life of the asset is different from its actual or potential life.

Depreciable Amount

Depreciable amount is the cost of an asset less its residual value. Residual value is the estimated amount
obtainable from the sale of the asset at the end of its useful life.

METHODS OF DEPRECIATION:

IAS 16 mentions three possible methods for depreciation. These are:

- Straight line method;

- Diminishing balance method; and
- Units of production method.
-
Straight Line Method

The straight line depreciation method charges the cost evenly throughout the useful life of an asset.

Annual depreciation = (Cost – Residual value) / Useful life

Diminishing Balance Method

This method is useful when economic benefits from an asset are expected to decline over time. This method
charges higher depreciation in the earlier years and lower depreciation in the latter years.

Annual depreciation = Carrying value x Depreciation percentage

Sum of Digits Method

Sum of digits is an alternative method to charge higher depreciation in earlier years. This method takes the
number of years and reverses their order so that highest depreciation is charged in the first year and lowest
depreciation is charged in the final year.

Units of Production Method

Under this approach, the asset’s depreciation charge reflects the proportion of overall capacity utilised over a
given period.

Annual depreciation = (Depreciable amount / Total capacity) x Units produced in the year

EXAMPLE:

Consider the following information about a newly purchased non-current asset:

- Purchase price = $800

- Residual value = $50
- Useful life = 4 years
- Total production capacity = 100,000 units
- Diminishing balance method = 50% per annum
- Production in year 1 and 2 = 20,000 units each year
- Production in year 3 and 4 = 30,000 units each year

Calculate the depreciation charge for each of the 4 years under straight line method, diminishing balance
method, sum of digits method and units of production method.

Straight Line Method

Depreciation (Year 1) = ($800 - $50) / 4 = $187.5
Depreciation (Year 2) = ($800 - $50) / 4 = $187.5
Depreciation (Year 3) = ($800 - $50) / 4 = $187.5
Depreciation (Year 4) = ($800 - $50) / 4 = $187.5

Diminishing Balance Method

Depreciation (Year 1) = ($800 x 50%) = $400
Depreciation (Year 2) = ($400 x 50%) = $200
Depreciation (Year 3) = ($200 x 50%) = $100
Depreciation (Year 4) = ($100 x 50%) = $50
Sum of Digits Method
Depreciation (Year 1) = $750 x 4 / 10 = $300
Depreciation (Year 2) = $750 x 3 / 10 = $225
Depreciation (Year 3) = $750 x 2 / 10 = $150
Depreciation (Year 4) = $750 x 1 / 10 = $75

Units of Production Method

Depreciation (Year 1) = $750 x 20,000 / 100,000 = $150
Depreciation (Year 2) = $750 x 20,000 / 100,000 = $150
Depreciation (Year 3) = $750 x 30,000 / 100,000 = $225
Depreciation (Year 4) = $750 x 30,000 / 100,000 = $225

DEPRECIATION - COMMENCEMENT AND ENDING:

Depreciation of an asset begins as soon as it is available for use. Charging of depreciation cannot be delayed
even if the asset is not actually used in production.

Depreciation ceases either when the asset is classified as held for sale, under IFRS 5, or is derecognised from
the statement of financial position.