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IAS 16 and IAS 38 — Clarification of acceptable methods of depreciation and amortisation

Date recorded:

In December 2012, the IASB published for comments the Exposure Draft Clarification of Acceptable Methods of Depreciation and Amortisation (ED/2012/5), which contains a proposal to amend IAS 16 Property, Plant and Equipment and IAS 38 Intangible Assets. More specifically, the IASB proposes to prohibit a depreciation or amortisation method that uses revenue generated from an activity that includes the use of an asset.

Around half of the respondents expressed conditional agreement on the proposal however issues were raised around the following:

  • the guidance in the standards,
  • use of revenue as a proxy for consumption,
  • the meaning of the term “consumption of economic benefits” being unclear,
  • the proposed guidance in regards to the application of the diminishing balance method is confusing,
  • the proposed guidance should not be applied on a retrospective basis, the statement “when it was acquired” in paragraph 62A of IAS 16 and in paragraph 98A of IAS 38 should be deleted.

Less than a third disagreed as they found the proposals too prescriptive and rules based rather than principles. They also found the current guidance banning the use of revenue based methods as revenue is measure of output as opposed to a measure of consumption of economic benefits and prices changes within revenue are not directly linked with the consumption of related assets.

Less than a quarter agreed as they thought the proposal clarified the requirements in IAS 16 and IAS 38.

At the July 2013 meeting staff recommended that the use of a revenue based method should be prohibited in all circumstances thereby removing the description included in the BC of the limited circumstances in which revenue dates would be correlated with production date.

Certain members agreed with the recommendation but wanted to understand why the use of revenue as a basis should be discontinued. Other members disagreed with the recommendation and concerns were raised about particular situations where revenue may be a proxy and the outright banning of it may cause problems, examples given included cinemas. A Committee member also highlighted that this was a shift away from “Accounting Principles”, and by deleting the paragraph a rule was effectively made which is definitive and therefore unsuitable. Members suggested allowing limited use of such a basis within given circumstances and therefore emphasised focusing on the underlying principle (that depreciation/amortisation is an estimate and a measure of the consumption of benefits as opposed to the generation of economic benefits). In addition, preparers of financial statements should exercise professional judgement around decisions that are appropriate in the calculation of amortisation when using revenue as a proxy.

Staff recommended that the Committee should recommend to the IASB that it should:

  1. state in the proposed amendment to IAS 16 and in IAS 38 (paragraphs 60A and 97A, respectively) that paragraph 60 and paragraph 97 (respectively) establish the consumption of the benefits inherent in the asset as the principle for depreciation and amortisation and that the resulting depreciation and/or amortisation charge results from an estimation process and represents a measure of the consumption of the economic benefits inherent in the asset;
  2. state in the proposed amendment to IAS 38 that in cases in which the right implicit in an intangible asset is expressed as a measure of the amount of revenue generated, the amortisation of an intangible asset should be based on the expected pattern of revenue generated;
  3. state in the proposed amendment to IAS 38 that in choosing an amortisation method an entity could determine what the limiting factor is for the intangible asset; for example a contract could be limited by a number of years (i.e. time) or a number of units produced or an amount of revenue earned;
  4. include guidance in IAS 38 on circumstances in which an intangible asset is used in multiple activities, such as a proposal to:
    1. segment the asset into separate identifiable components based on the way the asset is used or is expected to be used in the business (this could be done, for example, by allocating the cost of the intangible asset based on the relative fair value of the identifiable components); and
    2. amortise the separately different components of the intangible asset that are used in different activities using amortisation methods and useful economic lives appropriate to each component;
  5. remove the proposed guidance with regard to the diminishing balance method that was included in paragraph 62B of IAS 16 and paragraph 98B of IAS 38 in the ED and instead:
    1. amend paragraph 56(c) of IAS 16 to state that technical or commercial obsolescence could also arise from a change in the market demand as indicated by a future expected reduction in the unit selling price for the product or service output of the asset; and
    2. amend paragraph 92 of IAS 38 to explain that a future expected reduction of the selling price of an intangible asset could indicate the existence of commercial obsolescence; and
  6. apply the proposed amendments to IAS 16 and IAS 38 prospectively.

Staff presented their recommended changes to the draft wording in the appendix to their staff papers.

In the September 2013 meeting, a majority of members disagreed with the staff proposal to make an outright prohibition of the use of revenue as a proxy. A member highlighted that the method adopted should eliminate the effect of inflation and the asset’s expected capacity is reflected by looking at the pattern of revenue generated in some cases. This member also opposed to Staff’s recommendation of splitting intangible assets as shown in the staff paper, as it would diverge from US GAAP and also lead to a very complex calculation. The member suggested clarifying in both standards (IAS 16 and 38) the explicit and implicit effect of inflation when looking at the pattern of consumption. The member also had difficulty in understanding the limiting factor within the staff proposal.

Another member spoke about the principle of depreciation being to estimate the economic consumption of benefits and suggested not to add paragraph 62A and 92A. A few other members highlighted that there is inconsistency between the two paragraphs. Members went on to explain that the use of output in terms of physical output was a reasonable approach but the use of monetary output should not be used due to price effects. Also, prices could change without any effect on output. In addition, one member disagreed with separating the components of intangible assets as it a fundamental change in the standard and would lead to complex calculations and it would involve a material level of judgement.

A few other members disagreed with staff, as the proposal takes on a rule based approach, whereas the standard is principle based. Members suggested staff should focus on the principle and explaining the idea of consumption in a better manner by clarifying the wording around use of revenue as a proxy. Certain members raised concern on the idea of componentisation because it may result in unintended consequences.

There was a member who agreed with staff’s proposal and said the guidance on the limiting factor within the Staff paper flowed from the determination of the principle. The member went further to explain by using the film industry as an example where revenue is used as a proxy to calculate amortisation of intangible assets.

Members discussed that generally a revenue based calculation of amortisation does not work and therefore agreed with staff but reiterated that adopting a rule based approach may not be appropriate. Members suggested having a basis of conclusions on this, clarifying the issue or using illustrations or examples of when this would and would not be appropriate.

Members found paragraph 98D as it currently is created more issues and suggested Staff should clarify the wording in this paragraph. Rather than focusing on using words such as “revenue based method” where the emphasis is on revenue, Staff should use “a method” which would make it more principle based.

The Committee concluded on this matter by disagreeing with staff on prohibiting the use of revenue as a proxy for the determination of amortisation. Staff are to reword the various parts of paragraph 98. The paper will then be presented to the Board along the reservations certain members had, as discussed above.

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