Canada: Clarifying Depreciation And Amortization (At The Margins…)

Last Updated: May 23 2014
Article by John Hughes

The IASB recently issued Clarification of Acceptable Methods of Depreciation and Amortization (Amendments to IAS 16 and IAS 38), effective for annual periods beginning on or after January 1, 2016.

IAS 16 and 38 both require depreciating or amortizing an asset using a method reflecting "the pattern in which the asset's future economic benefits are expected to be consumed by the entity." The amendments address the question of whether this might ever allow using a revenue-based method – one that "allocates an asset's depreciable / amortizable amount based on revenues generated in an accounting period as a proportion of the total revenues expected to be generated over the asset's useful economic life." They conclude that such a method isn't appropriate, "because it reflects a pattern of economic benefits being generated from operating the business (of which the asset is part) rather than the economic benefits being consumed through the use of the asset."

This seems reasonable enough as a general premise – the revenue generated from an asset might clearly vary for a range of market-related factors having nothing inherently to do with the rate at which its economic benefits are being consumed. It's possible though to identify cases where the two would usually track each other closely, and the amendments to IAS 38 provide some illustrations:

"In the circumstance in which the predominant limiting factor that is inherent in an intangible asset is the achievement of a revenue threshold, the revenue to be generated can be an appropriate basis for amortization. For example, an entity could acquire a concession to explore and extract gold from a gold mine. The expiry of the contract might be based on a fixed amount of total revenue to be generated from the extraction (for example, a contract may allow the extraction of gold from the mine until total cumulative revenue from the sale of gold reaches CU2 billion) and not be based on time or on the amount of gold extracted. In another example, the right to operate a toll road could be based on a fixed total amount of revenue to be generated from cumulative tolls charged (for example, a contract could allow operation of the toll road until the cumulative amount of tolls generated from operating the road reaches CU100 million). In the case in which revenue has been established as the predominant limiting factor in the contract for the use of the intangible asset, the revenue that is to be generated might be an appropriate basis for amortizing the intangible asset, provided that the contract specifies a fixed total amount of revenue to be generated on which amortization is to be determined."

This won't have a specific impact on too many entities – revenue-based methods are most likely applied only to major assets in specialized industries, and it's hard to think of many other cases where the asset monetizes itself as directly as described above. For the population at large, the value of the exposure draft is most likely as a general reminder that IFRS requires assessing depreciation rates and methods – both when an asset is acquired and at regular periods after that – more specifically than old Canadian GAAP did. CICA 3061 for instance talked about applying a "rational and systematic manner appropriate to the nature of an item of property, plant and equipment with a limited life and its use by the enterprise," but a particular depreciation policy could be rational and systematic without actually being the best representation of how economic benefits were being used up. And although CICA 3061 did say that the "method and estimates of the life and useful life of an item of property, plant and equipment should be reviewed on a regular basis," this was a bit less prescriptive than the IFRS requirement of reviewing these matters at least at each financial year-end.

The best example of the difference, of course, is the notorious "componentization" issue, which flows directly out of the greater precision in how IFRS sets out the concept. Taken as a whole, there are likely still plenty of Canadian companies applying a very broad policy in this area without worrying about it too much. At the same time of course, any adjustments they might theoretically make to their policies often wouldn't be material by any measure, especially given that changes in the amount of reported depreciation usually carry very low information content for investors, if any. In particular, as we know, analysts and others – rightly or wrongly – often focus on EBITDA or other adjusted measures that exclude depreciation and similar charges.

The amendments acknowledge that expected future reductions in the selling price of an item that was produced using an asset might provide an indicator of technical or commercial obsolescence, and therefore of a reduction in the future economic benefits embodied in the asset, affecting the depreciation policy in turn. This only bolsters the broader point though, that IFRS requires being alert to all factors that indicate changes in how the asset's economic benefits are being consumed.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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John Hughes
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