Depreciating right-of-use assets may commence before owned property, plant and equipment
Depreciating right-of-use assets may commence before owned property, plant and equipment
Many preparers are unaware that the start dates for depreciating property, plant and equipment and right-of-use (leased) assets are different. Our article highlights a subtle but important difference between the depreciation requirements in IAS 16 Property, Plant and Equipment and IFRS 16 Leases.
IAS 16 Property, Plant and Equipment
Property, plant and equipment (PPE) must be depreciated on a systematic basis over its useful life.
Depreciation of an item of PPE begins when the asset is available for use, i.e. when it is in the location and condition necessary for it to be capable of operating in the manner intended by management.
PPE may, therefore, be available for use when it is first purchased or may only become available for use at a later date when the item is in the location and condition necessary for management to use the asset as intended.
Example
Entity A purchased a new machine for its production facility on 1 January 20X1. It will take three months to install the machine and test it to ensure that it is properly integrated with Entity A’s existing manufacturing processes.
Depreciation for the new machine will commence on 1 April 20X1 when it is fully installed, and in the location and condition necessary for management to use the asset as intended.
IFRS 16 Leases
IFRS 16 directs lessees to the depreciation requirements in IAS 16 for right-of-use (ROU) assets. However, there is a proviso that depreciation starts from the commencement date of the lease.
IFRS 16 defines the ‘commencement date of the lease’ as follows (emphasis added):
‘The date on which a lessor makes an underlying asset available for use by a lessee.’
Definition of ‘commencement date of the lease’ in IFRS 16
In some instances, ROU assets may be ‘available for use by a lessee’ under IFRS 16 earlier than when items of PPE are ‘available for use’ under IAS 16 (which is when they are in the location and condition necessary for it to be capable of operating in the manner intended by management).
Example
Entity B enters into a five-year lease for a retail store in the Shopping Centre Mall. The commencement date for the lease is 1 January 20X1. Entity B spends four months installing leasehold improvements in the store.
Depreciation for the ROU asset (retail store lease) will commence on 1 January 20X1 when the store is available for use by Entity B. This applies despite the store not yet operating in the manner intended by management, which only occurred on 1 May 20X1.
However, depreciation for the leasehold improvements will start on 1 May 20X1 when the store fit-out becomes available for use, i.e., when it is in the location and condition necessary for it to be capable of operating in the manner intended by management.
Entities with material leases should ensure that ROU assets are depreciated from the commencement date of the lease.
More information
Our publication contains in-depth discussion and examples to help you apply IFRS 16 to your organisation.
Need help?
BDO offers comprehensive support for your lease accounting needs. Our cloud-based system, BDO Lead simplifies the complexities of implementing IFRS 16. We also provide outsourced leased management services, handling your lease accounting using BDO Lead.
For assistance, please contact BDO’s IFRS & Corporate Reporting team.