Choosing a depreciation method under IAS 16
Which depreciation methods a client can use for its assets, why a revenue-based method has been prohibited since 2014, and how to word the policy.
By Achekam · · 4 min read · For Accountants & audit firms in South Africa, Nigeria, Kenya
When a client's asset register shows every asset on straight line, nobody asks why. When a haulage contractor proposes depreciating its trucks in line with the revenue each one earns, the question arrives at once. IAS 16 gives a client a choice of method, but not an unlimited one.
The common methods
ACCA explains that the straight-line method charges the same amount each year, while the diminishing-balance method charges a percentage of the carrying amount, so the expense is higher early in the asset's life.
Investopedia describes the straight-line method as the simplest and most common, spreading the depreciable cost evenly across the asset's life. It explains that the double-declining balance method doubles the straight-line rate and applies it to the remaining balance, front-loading depreciation, and that the units-of-production method bases depreciation on usage rather than time, dividing the depreciable amount by the expected lifetime output.
In summary:
| Method | Pattern of the charge | Often suits |
|---|---|---|
| Straight line | The same each year | Assets used evenly, such as buildings and furniture |
| Diminishing (reducing) balance | Higher early, lower later | Assets that lose usefulness fastest when new, such as vehicles and computers |
| Double-declining balance | A steeper version of reducing balance | Assets with a sharp early decline |
| Units of production | Follows output or usage | Machines and trucks whose wear tracks hours, kilometres or units |
The 2014 prohibition on revenue-based methods
In May 2014 the IASB amended IAS 16 to prohibit the use of a revenue-based depreciation method. The haulage contractor's proposal therefore fails, however intuitive it sounds.
It helps to spell out the difference from units of production. Units of production follows the physical use of the asset: hours run, tonnes moved, kilometres driven. A revenue-based method follows what the asset earns, and earnings also move with prices, contract rates and inflation. A truck earning more because the client negotiated a better rate has not worn out any faster.
So the contractor may depreciate its trucks by kilometres or engine hours, but not by the rand, naira or shilling value of the loads they carry.
Matching the method to how the asset is used
The method should reflect the way the client actually uses up the asset. Questions to ask for each class:
- Does the asset wear out with time, with use, or through obsolescence?
- Is use spread evenly across its life, or heavy early and lighter later?
- Can usage be measured reliably, from hour meters, odometers or output counts?
- Does the client keep the records to support a usage-based method every single year?
A usage-based method without reliable usage records is worse than straight line, because nobody can check it.
Two examples in words. A firm of attorneys replaces its laptops every few years whatever their condition, because software outgrows them; obsolescence drives their decline, and a reducing-balance charge reflects the steep early fall in usefulness. A brick manufacturer's kiln wears with every firing, and the client logs firings; a units-of-production charge based on firings follows the actual wear, and the log gives the reviewer something to test. Lives, residual values and methods all deserve a regular look; the annual review is covered in reviewing useful lives and residual values.
What the client's register can run, and what the Studio does not calculate
For clients that keep their own books on Achekam, the fixed-asset register lets a business add assets at cost, depreciate them monthly by straight line or reducing balance with a journal each month, and dispose of them with the profit or loss posted. The register does not work out tax wear-and-tear, and it is not part of Business Essentials. How a client's register feeds the firm's work is described in the client's fixed asset register.
Those two methods cover most small-company needs. A client using units of production, or any other method, calculates the charge outside the register and posts it by journal, with the working kept on file.
In the Financials Studio, Achekam does not calculate depreciation at all. It presents what the trial balance holds, flags any charge that does not agree with the movement in accumulated depreciation, and lets staff post a year-end adjusting entry. The method question is therefore settled in the client's register or the firm's own working, and the Studio checks that the result hangs together. That check is explained in depreciation in the statements.
Wording the depreciation policy
The policy should name the method for each class of asset, the basis for the useful lives and the treatment of land. Some patterns:
- "Property, plant and equipment is depreciated on the straight-line basis over its expected useful life, except motor vehicles, which are depreciated on the reducing-balance basis."
- "Earth-moving equipment is depreciated on the basis of engine hours used in the period relative to the total hours expected over its life."
- "Useful lives, residual values and depreciation methods are reviewed at each reporting date."
Make sure the words match what the register actually does. A policy that says "straight line" sitting over a register that runs reducing balance is a review finding waiting to happen, and an easy one to avoid.
The IFRS Foundation's summary of IAS 16 sets out the principles for recognising property, plant and equipment and working out depreciation charges.
Choosing a method is a once-off decision for most asset classes, but it shapes every year's profit after it. Spend a little time on it at the start, write down why, and the choice will survive any reviewer's question.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
