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.
