Depreciation (Amortization)

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International Accounting Standard 16 (IAS 16) defines depreciation as “the systematic allocation of the depreciable amount of an asset over its useful life”.

The term “amortization” is usually used in the case of intangible assets instead of “depreciation”. The meaning of both of these terms is the same.

From the above definition of depreciation, explanation of the terms “systematic allocation”, “depreciable amount” and “useful life” is required. Depreciable amount is the cost of an asset less its residual value. Depreciable amount of an asset is the value which is systematically allocated over the useful life of asset. The depreciable amount of an asset takes into account the expected residual value of the asset.

Systematic allocation means that the depreciation is charged according to a consistent policy and method. For example the depreciation can be charged on straight line basis, reducing balance method, or accelerated method.

Useful life of an asset the period over which an asset is expected to be utilized or the number of production units expected to be obtained from the use of the asset. Expected useful life is the period “used” not the assets economic life, which can be significantly longer. The useful life is determined on the basis of use, expected capacity, expected output, legal limits, maintenance program, expected wear and tear, and technical or commercial innovations.

Depreciation starts being charged when an asset is in the location and condition that allows it to be used in the intended manner. The depreciation should be charged even if the asset is temporarily idle because future economic benefits are consumed not only through usage but also through wear and tear and obsolescence. Depreciation ceases at the earlier of its derecognition (i.e. disposal or scrapping) or its reclassification as “held for sale”.

Each part of an item of property plant and equipment with a significant cost shall be depreciated separately. The depreciation should be charged to the statement of comprehensive income unless it is included in the cost of producing another asset. 

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