Accounting (equipment/depreciation)?

Question

Explain the accounting treatment required when a change is made to the estimated service life of a machine?

Answer 1

When you change your estimate of an asset's useful life, that's a change in accounting estimate (as opposed to a change in a/cg policy) and prospective application applies ( as opposed to retrospective application for changes in a/cg policies). This is an extract from IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors:

32. As a result of the uncertainties inherent in business activities, many items in financial statements cannot be measured with precision but can only be estimated. Estimation involves judgements based on the latest available, reliable information. For example, estimates may be required of:
(a) bad debts;
(b) inventory obsolescence;
(c) the fair value of financial assets or financial liabilities;
(d) the useful lives of, or expected pattern of consumption of the future economic benefits embodied in, depreciable assets; and
(e) warranty obligations.

33. The use of reasonable estimates is an essential part of the preparation of financial statements and does not undermine their reliability.

34. An estimate may need revision if changes occur in the circumstances on which the estimate was based or as a result of new information or more experience. By its nature, the revision of an estimate does not relate to prior periods and is not the correction of an error.

38. Prospective recognition of the effect of a change in an accounting estimate means that the change is applied to transactions, other events and conditions from the date of the change in estimate. A change in an accounting estimate may affect only the current period’s profit or loss, or the profit or loss of both the current period and future periods. For example, a change in the estimate of the amount of bad debts affects only the current period’s profit or loss and therefore is recognised in the current period. However, a change in the estimated useful life of, or the expected pattern of consumption of the future economic benefits embodied in, a depreciable asset affects depreciation expense for the current period and for each future period during the asset’s remaining useful life. In both cases, the effect of the change relating to the current period is recognised as income or expense in the current period. The effect, if any, on future periods is recognised as income or expense in those future periods.

Disclosure

39. An entity shall disclose the nature and amount of a change in an accounting estimate that has an effect in the current period or is expected to have an effect in future periods, except for the disclosure of the effect on future periods when it is impracticable to estimate that effect.

40. If the amount of the effect in future periods is not disclosed because estimating it is impracticable, an entity shall disclose that fact.

Answer 2

If the current carrying amount is a good approximation of the recoverable amount of the asset, then divide the carrying amount by the remaining useful life.

For example:

Machine's original cost was $100,000 with an original 10 year useful life

After eight years, you had already depreciated $80,000, leaving a carrying amount of $20,000 and you estimated now that there are actually a further five years useful life.

Carrying amount = $100,000 - $80,000 = $20,000/5 = $4,000 depreciation per year.