Many companies face the dilemma of when to begin depreciating valuable assets, especially when they remain unused for months. The key question: Should you start calculating depreciation as soon as an asset is purchased, or only when it begins generating revenue? The answer lies in IAS 16 Property, Plant, and Equipment.
What Does IAS 16 Say?
Paragraph 55 of IAS 16 states that depreciation begins when an asset is “ready for use”—not when it’s actively generating revenue. This means that as soon as the asset is in a usable condition, depreciation should be calculated, regardless of whether it’s currently being used in operations.
Common Violation: Depreciating “In Use”
A frequent mistake companies make is delaying depreciation until the asset is actively being used. This is a violation of IFRS standards. Depreciation needs to start when the asset is ready for its intended purpose, even if it remains idle for some time.
Example: Special Purpose Equipment
Imagine your company purchased new equipment on February 1, 2020, to manufacture a new product. The equipment requires installation and testing, which is completed by April 2020. However, production of the new product only begins in June 2020.
Here’s the timeline:
- The equipment is ready for use in April 2020 after installation and testing are complete.
- Production doesn’t start until June 2020, but under IFRS, depreciation should begin in April 2020 when the equipment is fully operational, not when it’s actively used.
Challenges: Depreciation Without Revenue
One issue with starting depreciation before an asset generates income is that it creates an expense on your financial statements without corresponding revenue. This appears to conflict with the coherence principle, which links expenses to revenue generation.
Solution: Imposition on Units of Manufactured Products
A practical approach to this issue is the “units of production” method. Under this method, depreciation is tied to the output of the equipment. If no products are being manufactured, depreciation costs do not accrue for that period. This aligns depreciation expenses more closely with revenue generation.
Key Takeaways:
- Depreciation should start when the asset is ready for use, not when it begins generating income.
- Starting depreciation too late can lead to IFRS non-compliance.
- Consider the “units of production” method to better align depreciation with asset output.
Understanding and applying IAS 16 properly can save your business from compliance issues and ensure accurate financial reporting.
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