Key Takeaways
- Depreciation begins when the asset is available for use, not when it is first put into operation or when it generates revenue.
- The depreciable amount equals cost (or revalued amount) minus residual value, and both residual value and useful life must be reviewed at least annually under IAS 16.51 .
- Straight-line is the most common method in European IFRS filings, but IAS 16.62 permits declining-balance and units-of-production where the consumption pattern differs.
- Choosing an inappropriate method or failing to update useful life estimates is a recurring finding in FRC and AFM inspection reports.
What is Depreciation?
We've seen the depreciation charge come back as a review note on more engagements than almost any other routine balance. Not because the arithmetic is hard, but because teams SALY the prior-year useful life into the new schedule without asking whether anything has changed. IAS 16.51 requires that annual review, and skipping it is one of the most common findings in FRC and AFM inspection reports.
IAS 16.50 requires each asset's depreciable amount to be allocated on a systematic basis over its useful life. The depreciable amount is cost minus residual value ( IAS 16.53 ). Residual value is the estimated amount the entity would obtain today from disposing of the asset, assuming the asset were already at the age and condition expected at the end of its useful life.
Four methods appear in practice. Straight-line depreciation produces a constant charge. Declining-balance depreciation produces a decreasing charge. Units-of-production depreciation ties the charge to output or usage. Sum-of-the-years'-digits is rare under IFRS but still permitted. IAS 16.60 states that the method selected must reflect the pattern in which the entity expects to consume the asset's future economic benefits. A revenue-based method is explicitly prohibited for property, plant, and equipment (PP&E) by IAS 16 .62A unless revenue closely mirrors consumption (an exception that is almost never met in practice).
IAS 16.51 requires annual review of both the useful life and the residual value. When the expected pattern of consumption changes, the entity revises the depreciation method prospectively as a change in accounting estimate under IAS 8 . ISA 540.13 (a) requires the auditor to evaluate whether the entity's method for the estimate is appropriate, which means testing not only the arithmetic but also the underlying assumptions about useful life and residual value.
Worked example: Hoffmann Maschinenbau GmbH
Client: German engineering company, FY2025, revenue €28M, HGB reporter also preparing IFRS consolidated accounts for its parent. Hoffmann acquires a CNC milling centre on 1 March 2025 for €640,000. Estimated useful life is eight years. Estimated residual value at the end of year eight is €40,000 based on recent disposal prices for comparable second-hand machines.
Step 1 — Determine the depreciable amount
Cost of €640,000 minus residual value of €40,000 gives a depreciable amount of €600,000.
Documentation note: record the cost per the supplier invoice, the installation certificate, the residual value estimate with reference to the second-hand market source (dealer quote dated February 2025), and the useful life assessment under IAS 16.50 –51.
Step 2 — Select the depreciation method
Hoffmann operates the CNC centre on a stable two-shift schedule year-round. The expected consumption pattern is approximately even across the useful life. Straight-line is appropriate.
Documentation note: record the method selection under IAS 16.60 , stating that even usage across shifts supports straight-line allocation. File the shift-schedule evidence.
Step 3 — Calculate the annual charge and the part-year amount for FY2025
Annual depreciation is €600,000 divided by eight years, producing €75,000. The machine is available for use from 1 March 2025, so the FY2025 charge covers ten months: €75,000 multiplied by 10/12 equals €62,500. The carrying amount at 31 December 2025 is €640,000 minus €62,500, giving €577,500.
Documentation note: record the commencement date (1 March 2025, the date the machine passed commissioning tests and was available for use per IAS 16.55 ), the part-year calculation, the year-end carrying amount, and the depreciation method applied. Cross-reference to the fixed-asset register.
Step 4 — Annual review at year end
Hoffmann's production manager confirms no change in expected usage pattern or useful life. The second-hand market for CNC equipment has softened slightly, but residual value remains within a reasonable range of the original €40,000 estimate. No revision is required for FY2025.
Documentation note: record the annual review under IAS 16.51 . Document the enquiry of the production manager and the market evidence considered. If the review had indicated a reduced useful life, record the prospective adjustment under IAS 8.36 .
The FY2025 depreciation charge of €62,500 on the CNC milling centre is defensible because the method reflects an even consumption pattern, the residual value ties to external market data, the annual review is documented with named sources, and the commencement date matches the commissioning certificate.
Why it matters in practice
- The FRC's 2023 inspection cycle flagged that entities frequently fail to perform the annual review of useful life and residual value required by IAS 16.51 . In several cases, useful lives had not been revisited since initial recognition despite material changes in the operating environment. ISA 540.18 requires the auditor to evaluate whether management's point estimate remains reasonable given current conditions, and accepting an unchanged useful life without challenge does not satisfy that requirement. In our experience, the annual review is the single most common tick box exercise on PP&E. Teams note "no change" and move on without documenting what evidence they considered.
- Teams often begin depreciation from the date the asset is first used in production rather than the date it is available for use. IAS 16.55 is explicit: depreciation begins when the asset is in the location and condition necessary for it to operate in the manner intended by management. A machine that passes commissioning tests on 1 March but does not run its first production batch until 15 March has a depreciation start date of 1 March.
- Getting this wrong is one of the more frustrating review outcomes because the fix is so mechanical. You rework the schedule, adjust the charge by a few thousand euros, update the lead schedule, and explain in the review response why the original date was incorrect. The actual audit effort to correct it is disproportionately large relative to the misstatement, which is why getting the commencement date right the first time saves real hours.
Depreciation vs. impairment
| Dimension | Depreciation ( IAS 16 ) | Impairment ( IAS 36 ) |
|---|---|---|
| Purpose | Systematic allocation of cost over useful life | One-off reduction to recoverable amount when future economic benefits have fallen |
| Trigger | Automatic from the date the asset is available for use | Indicator-driven assessment; annual for goodwill and indefinite-life intangibles |
| Reversibility | Not reversible; prior depreciation is not recalculated retrospectively | Reversible for all assets except goodwill ( IAS 36.110 ) |
| Measurement | Depreciable amount divided by useful life using a chosen method | Recoverable amount: higher of value in use and fair value less costs of disposal |
| Audit focus | Useful life, residual value, method appropriateness, annual review | Cash flow projections, discount rate, CGU identification, sensitivity analysis |
Depreciation continues even when an impairment loss has been recognised. After impairment, the revised carrying amount becomes the new basis for allocating the remaining depreciable amount over the remaining useful life ( IAS 36.63 ).
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Frequently asked questions
How do I document the useful life estimate for a depreciable asset?
Record the basis for the estimate (manufacturer specifications, historical replacement cycles for comparable assets, engineering assessments, or management representations supported by operating data) and the factors considered under IAS 16.56: expected usage, expected physical wear, technical obsolescence, and legal limits such as expiry of related licences. Update the documentation each year when performing the IAS 16.51 annual review.
Does depreciation stop when an asset is idle?
No. IAS 16.55 states that depreciation does not cease when the asset becomes idle or is retired from active use, unless the asset is fully depreciated. Depreciation continues because the passage of time still causes obsolescence and physical deterioration. The cessation triggers are full depreciation, derecognition, reclassification as held for sale under IFRS 5, or disposal.
Can I use a revenue-based depreciation method for property, plant, and equipment?
IAS 16.62A prohibits a revenue-based method for depreciating PP&E. The IASB concluded that revenue generated by an asset reflects factors (pricing, volume, demand shifts, inflation) beyond the consumption of economic benefits. The prohibition applies even when revenue correlates with usage. For intangible assets, IAS 38.98A permits a rebuttable presumption against revenue-based amortisation, but the bar for rebuttal is high.