IAS 16 and IAS 38 — Revenue-based depreciation method
The Committee previously considered a request to clarify the meaning of the term ‘consumption of the expected future economic benefits embodied in the asset´ in paragraphs 97 and 98 of IAS 38 Intangible Assets when determining the appropriate amortisation method for intangible assets of service concession arrangements. The request included a specific fact pattern where the tariff chargeable to users is contracted in the agreement and a lower tariff is imposed at the beginning of the concession and increases periodically in line with the grantor´s practice so as not to burden consumers.
At its November 2011 meeting, the Committee considered whether a revenue-based or time-based amortisation method better reflects the economic reality of the underlying contractual terms. The Committee noted that the principle in IAS 38 is that an amortisation method should reflect the pattern of consumption of the expected future economic benefits and not the pattern of generation of expected future economic benefits. Consequently, the Committee decided that amortisation methods based on revenue are not an appropriate reflection of the pattern of consumption of the expected future economic benefits embodied in an intangible asset. The Committee requested that the staff draft the proposed annual improvement for discussion at a future meeting.
At this meeting, the staff presented its proposed amendment to IAS 38 and IAS 16 as part of the annual improvements project (2011-2013 cycle) which noted that a revenue-based method is not considered to be an appropriate method of amortisation. In reviewing the proposed amendment wording, several Committee members expressed reservations with conclusions reached in earlier meetings. This consternation was whether the proposed amendments would eliminate the ability to apply a diminishing balance method of depreciation which is allowable in paragraphs 62 of IAS 16 and 98 of IAS 38.
Specifically, one Committee member outlined an example of a computer chip manufacturer where the consumption of the expected future economic benefits embodied in the manufacturing equipment is subject to significant technical or commercial obsolescence. As a result, price competition results in declining revenue per unit over time. The Committee member questioned whether the proposed amendment, given the influence of a pricing factor, would limit the ability to apply a declining balance depreciation method to the manufacturing equipment. Several Committee members believed that pricing factors (or revenue) could be a proxy for selection of an amortisation / depreciation methodology (i.e., a declining balance depreciation method would not be prohibited). However, the amortisation method should not reflect a pattern of generation of the expected future economic benefits embodied in the asset.
From this general concern, several Committee members suggested that the amendment should specify that an amortisation method should reflect the pattern of consumption of future economic benefits embodied in an asset rather than stating that a revenue-based amortisation method is not appropriate. Therefore, a model that reflects a pattern of generation of the expected future economic benefits embodied in the asset (i.e., a model based on generation of economic benefits from operating the business) would not be acceptable. The Committee tentatively agreed with this view, and thus, they asked the staff to revise the proposed amendments accordingly for presentation to the Board.