The depreciation period for right-of-use assets may be different to owned property, plant and equipment

In many cases, the types of assets accounted for as owned assets under IAS 16 Property, Plant and Equipment and leased right-of-use (ROU) assets under IFRS 16 Leases are the same – for example, motor vehicles, computers, printers, etc. However, depreciation may not always commence on the same date.

In addition, the depreciation period may differ because IFRS 16 has special rules for depreciating ROU assets. This article explains why entities may have to depreciate ROU assets over a different period than they would for owned property, plant and equipment.

IAS 16 Property, Plant and Equipment

IAS 16, paragraph 50, requires the depreciable amount of an asset (i.e. cost or revalued amount less residual value) to be allocated on a systematic basis over its ‘useful life’. An asset’s ‘useful life’ is usually the period that it is expected to be available for use by an entity.

Useful life is:

  • the period over which an asset is expected to be available for use by an entity; or
  • the number of production or similar units expected to be obtained from the asset by an entity.

Definition of ‘useful life’ of an entity in IAS 16, paragraph 6 (emphasis added)

Example

Entity A purchased a new motor vehicle on 1 January 20X1 for $50,000.

Entity A replaces its vehicles every three years (i.e. useful life is three years).

Entity A estimates that the residual value of the vehicle on 31 December 20X3 will be $20,000.

Entity A uses a straight-line method of depreciation for motor vehicles.

The depreciable amount of the vehicle is $30,000 ($50,000 cost less $20,000 residual value).

Applying paragraph 50, Entity A depreciates the vehicle by $10,000 in each of the years ending 31 December 20X1, 31 December 20X2 and 31 December 20X3.

IFRS 16 Leases

IFRS 16 directs lessees to the depreciation requirements in IAS 16 for ROU assets. However, paragraph 32 of IFRS 16 alters the IAS 16 principle of depreciating assets over their useful lives as follows:

  1. If the lease transfers ownership of the underlying asset to the lessee by the end of the lease term or if the cost of the ROU asset reflects that the lessee will exercise a purchase option, the lessee shall depreciate the ROU asset from the commencement date to the end of the useful life of the underlying asset.
  2. Otherwise, the lessee shall depreciate the ROU asset from the commencement date of the lease to the earlier of the end of the useful life of the ROU asset or the end of the lease term.

Note: Under IAS 16, depreciation on owned property, plant and equipment only starts when the asset is available for use.

Earlier of the end of the useful life and the end of the lease term

In general, the maximum period for depreciating ROU assets is the lease term because this reflects the period over which the lessee has the right to use the underlying leased asset.

The non-cancellable period for which a lessee has the right to use an underlying asset, together with both:

  1. periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option; and
  2. periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that option.

Definition of ‘lease term’ in IFRS 16, Appendix A

Our bulletin provides guidance and examples for determining the lease term.

However, if the asset’s useful life is expected to be shorter than the lease term, the carrying amount of the ROU asset is depreciated over a shorter period.

Note: the definition of ‘useful life’ in IFRS 16 is the same as the IAS 16 definition noted above.

Example 1 – Useful life and lease term equal five years

Entity B enters into a lease for a new motor vehicle on 1 January 20X1. The carrying amount of the ROU asset at the commencement date of the lease is $50,000.

The lease is for a five-year period.

Entity B estimates the useful life of the vehicle to be five years.

Entity B uses a straight-line method of depreciation for ROU motor vehicle assets.

Applying the IAS 16 depreciation requirements, the vehicle’s depreciable amount is $50,000. The residual value is Nil because there is no purchase option, and the vehicle will have to be returned to the lessor at the end of the five-year lease term.

Applying paragraph 32 of IFRS 16, Entity B depreciates the ROU vehicle asset by $10,000 for each of the five years of the lease. This results in a similar depreciation expense on an annual basis to that incurred for the owned asset in the IAS 16 example above. However, the accumulated depreciation in this example is $50,0000 at the end of three years, whereas in the IAS 16 example above it is only $30,000.

Example 2 – Useful life shorter than the lease term

Entity C enters into a lease for a new motor vehicle on 1 January 20X1. The carrying amount of the ROU asset at the commencement date of the lease is $50,000.

The lease is for a five-year period with no early termination option.

Based on anticipated mileage, Entity C estimates the useful life of the vehicle to be only three years.

Entity C uses a straight-line method of depreciation for ROU motor vehicle assets.

Applying the IAS 16 depreciation requirements, the vehicle’s depreciable amount is $50,000. The residual value is Nil because there is no purchase option, and the vehicle will have to be returned to the lessor at the end of the five-year lease term.

Applying paragraph 32 of IFRS 16, Entity C depreciates the ROU vehicle asset by $16,667 in each of the years ending 31 December 20X1, 31 December 20X2 and 31 December 20X3. There is no depreciation expense for the years ending 31 December 20X4 and 20X5.

Entities should not automatically assume that the depreciation period equals the lease term. ROU assets consumed before the end of the lease term must be depreciated at a faster rate than those that are available for use throughout the lease term.

Transfer of ownership and purchase options

Lease agreements may provide for the transfer of ownership of the underlying ROU asset to the lessee at the end of the lease term. They may also allow the lessee to exercise a purchase option for the ROU asset by making additional lease payments that are factored into the lease liability, and therefore the carrying amount of the ROU asset.

In both instances, it’s as if the lessee has an owned asset, and the lessee depreciates the ROU asset from the commencement date of the lease to the end of the useful life of the underlying asset.

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.