Our machines are fully depreciated, but we still use them! What shall we do?
Do you work in the production company? And did you find out that some of your production assets are still in operation but they were fully depreciated?
In this case, the original estimate of machinery’s useful life proved to be incorrect.
Here’s one of the questions I received:
“Dear Silvia, we are a manufacturing company. We use our existing machinery for a longer period than its useful life and therefore, our machinery is fully depreciated. What can we do to correct it?”
What’s wrong with that?
The problem is that as these machines are used beyond their useful life, they are fully depreciated and their carrying amount is zero.
But in this case, what depreciation expense can you recognize in the profit or loss?
None, of course – because the carrying amount of your property, plant and equipment cannot decrease below zero.
So in fact, you use the machines, but you can’t really recognize any depreciation expense, because there’s nothing left. You have fully depreciated these assets in the previous reporting periods.
And as a result, the matching principle does not work here. The expenses simply do not match the benefits gained from these machines.
The problem is in the machines’ useful lives
The standard IAS 16 Property, plant and equipment defines the useful life as either:
- The period over which an asset is expected to be available for use by an entity, or
- The number of production or similar units expected to be obtained from the asset by an entity.
It is not the potential or economic life of the asset. These two will often not be the same!
For example, normal economic life of a car is 4 years, but the company’s policy is to renew car park every 2 years. In this case, car’s useful life is just 2 years.
Or, the economic life of a machine is 6 years, but after 3 years, the company’s experts assess that the machine can be used for another 5 years. In this case, total useful life is 8 years.
Now this is extremely important: Standard IAS 16 requires entities to review assets’ useful lives at least at each financial year-end.
You would not believe how many entities simply forget it!
They just book the annual depreciation charge based on the rates determined for some group of assets and that’s it.
They do not revise the useful lives of their assets and as a result, they end up with using fully depreciated assets in the production process.
How to fix this situation?
Let me suggest 2 possible corrective actions for this situation.
Solution 1: Review useful lives at each financial year-end.
Useful life is an accounting estimate and if you find out that it is different from what you initially set, you need to book this change in line with the standard IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.
It means that you simply set the new remaining useful life, take the carrying amount and recognize the depreciation charge based on the carrying amount and new remaining useful life.
No restatement of previous periods’ financial statements is permitted. IAS 8 requires recognizing change in accounting estimates prospectively (now and in the future).
Now you might say: OK Silvia, I got it, but what should I do when the carrying amount (net book value) of my assets is zero?
Well, it depends.
If you reviewed the useful lives in the past regularly and during the current reporting period you find out that you’d like to use the assets even longer, then there’s not much to do. Just leave these assets as they are and make sure you avoid this situation in the future.
However, if you really forgot to revise the useful lives in the previous reporting period, this failure to apply IAS 16 results in the accounting error.
If this error is material, then you should correct it retrospectively in line with IAS 8. It means restating the previous periods using the revised estimated useful lives. Huge amount of work!
Solution 2: Revalue your assets to their fair value.
Standard IAS 16 permits 2 models for subsequent measurement of your property, plant and equipment: cost model and revaluation model.
And it is true that if you still plan to use existing machines in the future, their fair value is for sure greater than zero.
Revaluing machines with nil book value would effectively mean that you are changing your accounting policy and here the standard IAS 8 gets the word again.
In line with IAS 8, you shall change the accounting policy only if:
- The change is required by an IFRS. This is definitely not the case.
- The change results in the financial statements providing reliable and more relevant information about the effects of transactions, other events or conditions on the entity’s financial position, financial performance or cash flows.
You (and your auditors) can argue that point 2 exactly reflects your situation. But does it really?
It definitely solves nil book value at the end of the current reporting period. Like a pill provides immediate relief from headaches.
But the accounting policy represents some rules and standards setting how you will report certain transactions in the financial statements – not only now, but also in the future.
It’s not like a pill providing immediate relief. It is like a remedy treating the route cause and making you healthy for a long time, so that you don’t need to take pills anymore. But what if you apply the wrong pill?
So, do you think that changing your accounting policy from cost model to revaluation model would make you provide better information about your machinery, not only now but also in the future?
Before you answer that question to yourself, please consider this:
- You need to apply the standard IFRS 13 Fair Value Measurement in order to determine the fair value of your machines. It’s very difficult and impracticable.
How can you set the market value of used production machines (mainly if they are so specific to your company)? - Revaluation model is used for buildings and land in 99.9% of cases, because it’s easy to set the market value of these assets regularly.
Is it the case for used production machines, with some specialized nature that only a few similar companies can use them? - You need to revalue your machinery with the sufficient regularity. Can you set the fair value let’s say annually?
- You need to revalue the entire class of assets, not on an individual basis. Can you really set the fair value of all machinery? How practical is it?
If after considering all these aspects you still want to switch from cost model to revaluation model, then IAS 8 makes it easy for you. You don’t need to apply the new policy retrospectively, just prospectively – so no restatement of previous periods.
What solution should we select?
It depends, really.
In my opinion, it’s much better to review estimated useful lives at each financial year-end and recognize the change in accounting estimate, rather than opt to change the accounting policy just for the purpose of curing immediate headaches.
From the long-term point of view, revaluation model is not really suitable for machines used in the production process, especially when they have a specialized nature and their main recovery lies in the production of other assets and not in the capital gains resulting from the movements of their market prices.
Yes, I understand that the potential correction of error resulting from failure to review useful lives in the past can be quite painful process, because you need to make lots of calculations. But you do it JUST ONCE.
Please watch the following video with the STEP BY STEP illustration of treating this problem:
Did this explanation help you? Or, do you have a different opinion?
I would really love to hear that! Please leave a comment right below this post. Thank you!
JOIN OUR FREE NEWSLETTER AND GET
report "Top 7 IFRS Mistakes" + free IFRS mini-course
Please check your inbox to confirm your subscription.
Recent Comments
- ROHAIL on Expected Credit Loss on Intercompany Loans
- Muhammad Anwar on Top 4 Changes in Profit or Loss Statement under IFRS 18 (with video)
- DEBET on How to Account for Compound Financial Instruments (IAS 32)
- Peter on How to account for intercompany loans under IFRS
- Avi on How to account for rentals depending on inflation and future sales?
Categories
- Accounting Policies and Estimates (14)
- Consolidation and Groups (24)
- Current Assets (21)
- Financial Instruments (55)
- Financial Statements (51)
- Foreign Currency (9)
- IFRS Videos (69)
- Insurance (3)
- Most popular (6)
- Non-current Assets (54)
- Other Topics (15)
- Provisions and Other Liabilities (44)
- Revenue Recognition (26)
- Uncategorized (1)
Dear Silvia,
Thank you so much for your continuous and useful articles, i am looking forward to subscribe to the IFRS kit too but right now i have a question: my company had used a machinery and fully depreciated and there was no mistake in estimating its useful life and as well the calculations. However, my company had invested some amount on the particular asset and want to use the asset for few years, in this matter, i would like to hear your advice and suggestion as per IFRS.
Thank you
Hi Silvia,
I am from Bhutan. I am interested to learn valuation of property, plant and equipment and provide consultancy services on PP & E. I went through your lecture and I am very much impressed by the quality of education. Please help me.
Hi Buddhi,
thanks a lot for writing me a comment. Well, I teach IFRS, not valuation – so really, you should seek for good valuation courses instead. And if you find a good one, please recommend it to me and this community – we will all appreciate. Have a nice day!
Hi Silvia,
We have a situation where we disposed some asset in error in previous years.
How do we correct this error.
Thanks
Retrospectively if that error is material. Please refer to this article for further help.
Thank you Silvia, what if the error is immaterial. Please can you provide the journal entries for the correction. I am going to consider the value in use on those assets and it that as base. For example if the machine has further useful life base on value in use as $100000 how I am going to account for the amount and depreciation with accumulated depr. Is that going to revaluation of assets? I am really confuse it is a first time I come across this challenge.
Nice. Nice.
Thank you so much Silvia. The article is of great help. I will appreciate your reply to Nijem’ s question in the comment box. I believe it will help a great deal to differentiate between Fair Value and Revaluation.
thank you
Hello sivia ,
could you please explain to me why the change from Cost model to Fair value model is considered change in Accounting policy while change from Cost model to revaluation model consider change in estimate ? i am confused about that
Hi Silvia,
May thanks for sharing this article.
You are a source of great knowledge.
Thanks!
Hi,
You lost me a bit when you said:
“If after considering all these aspects you still want to switch from cost model to revaluation model, then IAS 8 makes it easy for you. You don’t need to apply the new policy retrospectively, just prospectively – so no restatement of previous periods.”
I thought you mentioned earlier that once there is a change in policy the new policy must be applied retrospectively?
Many Thanks
silvia really you are a great personal
Dear Silvia,
greetings
i am working in shipping company and our value of PPP is shown in books at residual value ( Fully Depreciated -Some some residual value) but we expet that the PPE will be used for nother 10 yeras ( Cash Generating Uints) so how we deals with and Increase the value of assets in balance sheet
Hi Pankaj,
that is a change in accounting estimate, if either the useful life changes (here it increases by another 10 years), or residual value changes. S.
Dear Silvia,
Many thanks for your great efforts. In fact we have argument with our external auditors in how to treat the positive income from the re-estimate the useful live of assets, is it in P&L statement or should be go direct to the Retained Earning?,
your valuable explanation will be highly appreciated.
Regards,
Well, this is a change in estimate and you account for it prospectively – thus there should not be any correction of past periods and no reason to correct previous statements via retained earnings. This relates to the depreciation charges AFTER you change the estimate. You DO NOT recalculate previous depreciation charges. However, if you are correcting error and you treat change in useful lives as a correction of error that should have happened in the previous periods, then you book it retrospectively.
Hello Madam.
Thanks for a conceptual article
Hi Silva,
How do you do?
We are working in the beer manufacturing Company. And, we are adopting IFRS for the first time. We have advertising materials like refrigerators which were given to our customers as a promotional campaign. How do we treat these materials as per IFRS? Can we treat them as a prepayment of advertising expense and measure the expired portion as per their economic life or as a fixed assets?
Our proposal to the Company is to treat as a prepayment of advertising expense since the definition of these assets could not meet as per IAS 16 and IAS 38.
Again, our business purpose is a production of bottled beer to sell to our whole sellers not as a retailer which cools and sales bottled Beer!
Thanks for your deep assistance in advance.
Regards,
Thanx a lot for the easy and simple explanation of such complex subject.
How to calculate the estimated useful life of fully depreciated assets?
You do not calculate it, you estimate it – that’s the trick. You should look at your asset, its physical condition, your business operations and intentions and ask – how long am I going to use that asset until it breaks? When do I plan to replace it? When are there more modern and technically better assets available and this one becomes obsolete?
Hi, Silvia,
The Excel file for this excellent presentation is not within the IFRS kit. Would you like to put it here or send to me an email?
Thanks for the reminder, I will insert it to IAS 8 topic, but if you send me an e-mail, I can send it.
How can I download excel file
thanks
It is available within the IFRS Kit.
I already have access to IFRS kit
and nothing excel available under “IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors” Section, there are three articles and two videos
Thanks
Ah, OK, in this case I’ll send it to your e-mail address and I’ll attach it to the IFRS Kit – apologies!
Excellent presentation on the subject and the simplification breaks it into bite size understanding of options and treatment….
Dear Silvia,
our company has more than 60,000 non-current assets, and almost 13,000 assets have Zero NBV. it is impossible to adjust retrospectively because of error as our company in history never accessed the useful life of assets. Ww want continue cost model for fixed assets, what would be right treatment for assets having zero NBV , Using cost model but impractical to retrospectively adjust the depreciation expenses.
if we don’t know when assets was fully depreciated then what would be the treatment.?
Hi Imran, well, if it takes undue cost and effort to analyze every single asset (I believe so), then how about grouping them and trying to estimate their average age and restatement per groups? Make some approximation? It would not be precise, but much better than presenting it with error. Or, you can risk an audit qualification in your audit report. S.
In the UK we can leave the NBV of an asset as zero. I was working for a steel company that had a 150 year old metal press. NBV was zero. Company was bought out and asset revalued at £1.5M! Useful life = another 100 years probably…
Hi Silvia, I have an query in my mind what accounting treatment of an FA which i received as a gift suppose from my father, will i show it in my company books as i am using this FA in my company admin purpose not in my personal use.
If i not show in books how will i convince my auditor that it was received in gift not purchased by company.
Hie Silvia, i have client who have scaled down his operations and due to the scaling down of the operations the client still owns some of the assets which are not specialized, the assets are fully depreciated. The client intends to resume operations next year.May you help me with the accounting treatment.
Dear Silvia,
Thanks a lot for this nice article and video.
I’m currently working on a program that would handle depreciations in aviation. The start value of the asset is the invoice amount. The asset starts being monthly depreciated (not annually as in your article) and several months later you get a discount that should be applied to the start value (Invoicing takes decades in aviation industry 🙂 ) .
What should happen if the carrying amount is lower than the new start value?
Ex: Start value: 1200$ – Useful life: 12 months -> monthly depreciation: 100$
10 months later you have a carrying of 200$ and you receive a 250$ discount.
Thanks in advance for your reply (& time)
Best regards,
Dany
Hi Dany,
well, this situation is not directly addressed by the standards – you can use IAS 8 as the reference, but I would not call it either estimate or error. The question is whether the discount was promised at the time of purchase as a part of a contract or not. If yes, and you expect to receive it, then you should recognize the discount right at the initial recognition as a deduction from the cost of an asset. If not, and the discount was for some reason promised and provided subsequently, then it depends on timing and materiality. S.
Thank you for this excellent solution.
Please assist by sending the download link for the excel file to my email at tyman4top@gmail.com.
Best regards.
Hi Silvia,
I have a question, if I have a NBV for a machine of 0$ for 4 years, and after realizing that it should have more useful live of 3 years, and we used the FV method for revaluation for 200$. We book depreciation expense again on 3 years starting from 200$?
Thank you
Technically speaking yes, but remember that you should apply the revaluation model for all class of assets, not on one by one basis – so unless you apply revaluation model on all of your machines, then you would not be doing the right thing. S.
The article was really helpful
Hello Silvia. I have one question regarding the methods. Can i use cost model for one class of PPE and revaluation model for other class of PPE? or do i have to use one chosen model for all the class of PPE?
Salome, you should use the same model for one class and for all assets within that class (not on asset by asset basis). However, you can use different models for different classes. S.
Silvia,
thank you so much!
Dear Silvia,
We have depreciated out full warehouse over the period of 20 years and carrying cost the same in 0 beginning of the year. However, we have done modification in cool room. We would like to charge depreciation for that over the period of five years. Please advise in this matter.
Thanks and Regards
Malav,
if you still use the warehouse and it’s carrying amount is zero, then you should correct the error in the previous years as written above in the article. Regarding cooling unit – yes, you can depreciate it over its useful life.
Thanks a lot. However, just to reconfirm that warehouse (20 years) and modification in cool room of warehouse (5 years) can have different useful lives. Kindly confirm.
Yes, they can.
hi sir,
my name is farhan qureshi i have one question. there is was no accounting system. now they want to start accounting system butt which machinery they are using it is fully depreciated. but its working very well kindly tell me ho to revalue of machinery what will b his life and where i take as assets but his life is also completed to how i start the accounting for these
Hi Farhan, are you just implementing IFRS for the first time? If yes, then take the assets’ fair value as their deemed cost. If not, then you should do as described above. S.
Hi Sylvia,
IAS 16 gives us the discretion to chose between cost and revaluation model. But isn’t more to it than just a management choice?
What if carrying value are substantially different from the fair value? for fully depreciated assets I have read you article, very clear thanks.
How do we guide management in making the choice between the two methods? what I see is a compromise between relevance (more relevant if I revalue under-valued assets) and reliability (how accurate are these revaluations).
I am working on a case with first adoption which means that application will be fully retrospective and IAS 8 doesn’t really apply, right?
Thanks
Didier
Hi Didier,
yes, it is a management’s choice, but it should be justified with something. If management wishes to utilize the assets until the end of their useful lives, then it’s more rational and logical to apply the cost model. If management wishes to show that despite the assets are used by the company, they have fair value and could be potentially sold, then it’s better to apply the revaluation model.
You can apply these models class by class – not for all assets necessarily (but for all assets within the same class). S.
Hi Sylvia
I have a question,is the assets already depreciated even there is salvage value remaining?
Example the cost of an asset as of September 30 2017, is 100
Salvage value is 20
Acumulated Depreciacion is 80
the asset is fully depreciated in my opinion,
Thanks
Hi Silvia – great article, thank you!
A slight twist on the above (and apologies if this has already been answered, but I browsed through the questions and couldn’t find what I was looking for).
What happens if an organisation has a Fixed Asset Register where some of the assets are fully depreciated but cannot be identified by the FAR entry and hence no one knows if they’re still in service or not – would you just write them off, and is there some IFRS guidance on this treatment? Currently I’m seeing a Fixed Asset Register where the entries as such that the underlying asset or purchase order that prompted the entry cannot be identified, with the FAR full of old assets listed with descriptions like “Capital Purchase of IT Equipment”!!
Best wishes,
Steve
Steve, this is not a matter of IFRS, but of internal controls. The best thing would be to perform a fixed assets count and see what’s in operation – then track it to the FAR and clear the differences. S.
Hi Silvia,
I can’t see this video :
Please watch the following video with the STEP BY STEP illustration of treating this problem
Just reload this page and it will appear. Thanks!
Hi Sivia,
If some entity involves in a solar power planets how they should recognize the revenue. Since it will take some months to construct and fix the panels. But they complete their tasks stagewise. It should be treated under revenue or construction contract?
Hi Silvia,
Situation: We have different kind of Assets, like: Fixture and furniture, Plant & Machinery, Office Equipment etc and their cost respectively $10,000, $8,000 and $5,000 and Accumulated Depreciation respectively $6,000, $5,000 and $3,000 (Addition and disposal was made during the period) we are now in end of the year 30th June 2017. Depreciation rate was 20% each.
Most important think is there are no information about Acquisition and Disposal that is why we have no acquisition date of those assets.
We want to revalue the assets but lake of information (Acquisition date) we unable to do this.
Please advise me how we revalue the assets in this particular situation.
Thanks in advance.
Jesun
Hi Silvia,
thank you for making this article it was very helpful, i have watched the lecture but I cannot find the excel sheet for the illustrative that was shown in this video, how can I download it please?
Hi Slivia,
You are so amazing. Your aritcal is really helpful and easy understand. Thank you very much.
Meanwhile, I have one silly question which is I find that in the previous article. You said that if you change your accounting policy voluntarily, then you should apply it “retrospectively”.
However, why you said that if you still switch from cost model to revaluation model, then IAS 8 makes it easy for you. You don’t need to apply the new policy retrospectively, just “prospectively” – so no restatement of previous periods in above solution two. This is the one of exception case? How we can apply it? Thanks.
Hi Maggie,
it’s not a silly question. Yes, this is the exception, because IAS 8 says that this particular case should NOT be accounted for as a change in accounting policy (although it is).
When you switch from the cost to revaluation, you just revalue at the date of change and go ahead. No restatements in previous years. S.
O i see Thank you very much. It’s really helpful. Thanks again for your knowledge sharing : )
Hi Silvia – we have two same machines. One using in regular production process, however other one is used as spare (in case of failure, to be used), however as of now we have not used the spare machine, not rented out. Can we consider that as PPE and apply depreciation on the same.
Dear John,
if the spare machine is absolutely necessary to make sure that your operations don’t stop when the first machine fails, then yes, you can do as you proposed. S.
i like you good explanations S
Dear Silvia
We have unique fixed assets of significant amount. We bought these 10 years back and have been charging depreciation @10% reducing balance method. Now we found out that in the purchase document it says that the life of that asset is 20 years. We want to use straightline depreciation now on. What do we do? Retrospective or prospective?
Dear Harun,
the question is whether you revised the useful life of these assets in the past (as you should have done so in line with IAS 16) or not. If you did not do so, then it means you did not apply IAS 16 properly and you have an error in your financial statements – in this case, if it’s material, you should correct it retrospectively.
But if you revised useful life each year and only this year you decided to use the assets for 10 more years, then it’s a change in accounting estimate and it’s accounted for prospectively.
It requires your judgement. S.
Dear Silvia,
I have a question degrading PPE..
There is a fully depreciated asset and it is still using for the production. And there is a residual value of this asset. Can you give me the current accounting treatment for this asset. And what can I do for the residual amount of the asset?
Dear Piumali,
I think this article is all about this issue. If it’s material for your accounts, you need to correct the error in the previous reporting periods. It means changing the useful life of this asset, recalculating its depreciation charges (take residual value into account), setting the correct carrying amount, comparing it to what you have in your books and recognizing a difference in the previous periods directly in equity as correction of error. S.
thank you for a detail explanation. I learn a lot from you.
Amazingly explained. I have Never come across any site with such a beautiful explanation of such a complex accounting issue.
Hi Silvia,
My issue is the companys Fixed Asset Register has lots of old fully depreciated assets, some still in use, most not (and it is not possible to identify which are still being used and which are not). Is it better to just dispose all fully depreciated assets?
Thank you
Hi Anthony,
if the assets just sit in your register and you don’t use them, then yes, you better dispose them off. However, if you still use them, then it would be more appropriate to take the solution described above. Always take materiality into account – if carrying amount of your fixed assets after correction is not material to your financial statements, then I would not make a correction. S.
Dear Anthony,
it depends on careful analysis and your materiality level (i.e. significance for your financial statements). So for example, you estimate that the total fair value of these old assets is 1 000 and the level of significance is 10 000, then don’t bother with it. But if your rough estimate comes closer to the materiality, then disposing these assets off the register might not be a great idea. S.
Dear Silvia
I am not cleared with one issue that if we switch from cost model to revaluation model for the asset having zero carrying value, then how should we depreciate such accretion. Should we again re-estimate the useful life of the asset for amortization or will there not be any amortization? In case we re-estimate the useful life then shall it be treated accounting error though the asset is revalued? Also, such depreciation shall be part of comprehensive income or other comprehensive income?
Thanks
Sincerely.
Arsh,
as I wrote above, this is not the best solution. But if you insist on it – then you should revalue to its fair value at the date of change of the accounting policy and then depreciate the fair value over the remaining useful life. But in practice, any auditor will try to remove this adjustment and instead, correct any errors in the previous periods (e.g. not revising useful lives). S.
Hi Silvia, I’m a US CPA and I work for the State Tax Agency as an Corporate Income Tax Auditor. I like your IFRS explanations. I always read about the convergence projects between US GAAP and IFRS.
US tax laws are complex! and so US GAAP. In the CPA exams these days I guess they introduced IFRS as well. I would like to brush up IFRS.
I thought of buying your online course, but thought it might be a scam to make money. Kindly assure us that it is not.
Imtiaz
Dear Imtiaz,
please do not insult me and my work. Do you really think that I would publish so much work for free, including videos, articles and personal responses to many comments – just to earn money on some scam? I can assure you that my courses are not scam and helped a lot of people to pass their exams. S.
My company purchases assets abroad it means there is exchange rate profit or loss everything we purchase the plant and machinery. Kindly advise the capitalization rate to use, whether BOL (Bill of Lading Rate) or transaction date (date of Purchase Order Rate). And in our company we accumulate all Profit and Losses that arises to the Asset account. And then on capitalization any difference between Bill of lading amount and Actual amount realized is allocated to Other Comprehensive Income (Forex Profit/Loss) account.
Kindly assist to ensure that we are following the correct IFRS procedure. Thanks
hiSilvia, how do you recognise the proceeds from a sale of fully depreciated assets, what are the accounting steps
Silvia, you are a great lecturer. Will definitely join your course. Any discount available?
Hi Pil, thanks for your feedback! 🙂 Please contact me via contact form. 🙂
hi. what if the equipment was already fully depreciated or was sold but the equipment was still recorded as an asset.
Hmmm, that’s a BIG trouble 🙂
1) If it’s fully depreciated => read the article above;
2) If it’s sold => there’s an accounting error if an asset has not been disposed of. You need to correct it. S.