IFRS Ready? Initial assessments of IAS16-Fixed Assets have led many accounting professionals and experts to believe 'group' depreciation as practiced in the United States and Canada, particularly among rate-regulated entities will not be allowed. I have not agreed with this assessment and, after attending the Society of Depreciation Professionals (www.depr.org) conference this week in St. Louis, I heard further reinforcement that 'group' depreciation, in fact, is the only method that meets the IAS16 standard...for regulated as well as non-regulated companies.
'Group' depreciation, in brief, means an asset within a pool of like assets, upon write-off (derecogniton in IFRS language), is recorded against the depreciation reserve on the balance sheet, and NOT to the income statement gain or loss. IAS16, paragraph 68 states income statement gain or loss is required on asset derecognition. So, how is this seeming discrepancy in interpretation resolved. Here's how...
- An asset should be depreciated over its life, and if the life is accurate, there will be no gain or loss upon retirement. (IAS16, paragraph 60 actually says '...shall reflect the pattern in which the asset's economic benefits are expected to be consumed by the entity...', so I paraphrased.)
- Depreciation begins when the asset is in use and ceases when it is retired (derecognized). (IAS16, paragraph 55)
- It is a fact, that a pool of like as
sets, assigned an average life, will have some assets that retire before the average life and some that retire after the average life. And further, you cannot know which specific asset will live less or more than the average.
- So, if you calculate a gain or loss on an asset that retires early, the result is wrong. If you possessed paranormal powers maybe you knew this asset would retire early, but if you did, you would have assigned its actual life, and not an average...and there would be no gain or loss!
- Of course, assigning our best estimate of actual lives to individual assets would not be easy nor practical.
- Therefore, grouping like assets (if life and depreciation method are the same, IAS16, paragraph 43), and recording each retirement to the depreciation reserve (gain or loss is zero) is the only depreciation method that complies with the depreciation principles outlined in IAS16!!
Many non-regulated companies today calculate depreciation using an average life (usually derived from tax tables or from discussions with engineers and technical experts) because it is easy to calculate and 'simple' to understand. However, from a principle perspective, it is wrong. But, this is what is taught in our colleges and universities, on the CPA exam, and within the audit firms.
If you work for a regulated company or a regulatory commission, you understand the depreciation principle and concepts well...and you know it should respresent an appropriate recovery of capital investment that is important to the company, shareholders, and customers. The purpose of the Society of Depreciation Professionals (www.depr.org) is to educate the community of users regarding depreciation
methods, procedures, and techniques.
Confused? This is why you need to assess the impact of IFRS and get IFRS Ready!
PS - Asset componentization (IAS16, paragraph 43) does not impact the application of the group depreciation method, other than you might have a few more balance sheet depreciation reserve pools.