Question

Recently Sea Eagle Ltd experienced a strike that affected a number of its operating plants. The group accountant of Sea Eagle Ltd indicated that it was not appropriate to report depreciation expense during this period as the equipment was not used during the strike. She stated that during the strike the equipment did not depreciate and an inappropriate matching of costs and revenues would result if depreciation were charged. She based her position on the following points.

1. It is inappropriate to charge the period with costs for which there are no related revenues arising from production.
2. The basic factor of depreciation in this instance is wear and tear, and because the equipment was idle, no wear and tear occurred.

Required

1. Summarise the requirements of AASB 116 in relation to depreciation of property, plant and equipment

assets.

2. You are a part of the auditing team that analyses the accounts of Sea Eagle Ltd. Write a report to your supervisor in relation to the views of the group accountant of Sea Eagle Ltd.

Answer 1

The relevant portion for this case from AASB 116 reads as :

“Therefore, depreciation does not cease when the asset becomes idle or is retired from active use unless the asset is fully depreciated. However, under usage methods of depreciation the depreciation charge can be zero while there is depreciation”

Depreciation is the means of allocation of cost of asset over number of accounting periods. It does not measure movement in fair value or use of property, plant and equipment unless a special method of depreciation i.e. based on usage is applied. Depreciation continues to be levied. It does not stop if asset gets idle or retired from the active use. Depreciation shall be charged till the asset is fully depreciated. This does not happen under the case of usage method of depreciation. Under usage method, if assets are not used for particular accounting period, the total depreciation shall be NIL in such scenario. Hence as per AASB 116, the usage would impact the estimation of useful life. The strike period if long enough may change the expected useful life of property, plant and equipment. This would impact expected residual value as well. If method of depreciation is determined, the factors for measurement will be affected by the economic events, in the present case, being strikes. The strike does not suspend depreciation allocation process as depreciation is not based on accounting principle of matching. Hence, depreciation is not to be matched with revenues in a particular accounting period.