If you work in auditing I bet you got the worst tasks and assignments during your first year at work!
Just as I did. I remember taking part in numerous inventory counts, including those who should be avoided at all cost.
What can happen in the warehouse?
Once I had to visit cold stores and count the stock of frozen veggies and fruits in the deep-freezer.
What’s so bad about it? Hmmm, try to imagine holding your pen and paper when the air temperature around you is about minus 20 degrees. Brrr! Then coming outside was like a tropical breeze, even when the temperature outside was about minus 1.
Another day my audit senior sent me to participate on the count of fixed asset in a big state-owned company. A part of its equipment was stored in a separate warehouse – these were all assets that were acquired back in the past and not used for years.
So, while I was paddling through ancient dirty machines in my rubber boots, followed by vicious smiles of the company’s employees (they did not like auditors), I spotted something interesting.
Back in the deepest tiny corner, there was one piece covered by some plastic blanket. It immediately dragged my attention. And I had an interesting conversation with a storekeeper:
Me: What is that?
Storekeeper: Ehmmm, hmmm, weeelll, it’s a new machine.
Me: Why is it here?
Storekeeper: Errrrr, hmmmm, well, we did not want to put it into use. Yet.
After some discussions with the company’s staff I found out that they invested in this expensive machine to improve some production process, but they wanted to start using it in 6 months.
They planned to keep a machine in the warehouse to avoid depreciation charges. In other words, they wanted to start depreciation at the moment of putting the machine into use.
That’s not what IAS 16 requires
I shared my story above with you to make you realize that IFRS do not use the concept of “put into use”.
The standard IAS 16, paragraph 55 states that depreciation of an asset begins when it is available for use, or when it is in the desired location and condition.
In the situation described above, the machine was available for use, as has been in the company’s premises, did not require additional installation and was capable of operations.
You can argue that it was in the warehouse of company’s antiques and not in the actual place of production, but I’m not sure this argument would be good enough for approval of your tax authorities or auditors.
Let me give you a few more examples when “available for use” is not the same as “put into use”:
Example 1 – investment property
Imagine you bought an apartment complex in January 20X1 and you wish to rent it to some tenants.
During February and March 20X1, you paint the walls, make a few repairs and clean the house. At the end of March 20X1, the house is ready for the new tenants.
You start placing ads and negotiate rental contracts. The first tenants move in in June 20X1.
In this example:
Available-for-use date is the end of March 20X1, as the house was ready for the new tenants.
Put-into-use date is in June 20X1, when the first tenants move in and start to use the house.
Under IFRS, you start depreciating this property at the end of March 20X1 (unless you use the fair value model).
Example 2 – specialized machinery
ABC company acquired a machine for its new production line.
The machine was delivered in February 20X1. Before putting it into use, an installation and testing performed by certified technician is required.
All the work including tests were completed in April 20X1 and ABC launched the new production line in July 20X1.
In this example:
Available-for-use date is in April 20X1, as all the necessary works on the machine were completed.
Put-into-use date is in July 20X1 when the new production line was launched.
ABC starts depreciating the machine in April 20X1.
Fit in the depreciation charges
OK, so now we now that “available for use” matters.
But here’s a problem:
You start depreciating an asset when it’s available for use, but as there are no revenues produced yet (e.g. new production line has not been launched yet), the matching principle is in trouble.
In other words, you have expenses (depreciation), but not the revenues.
Many accountants automatically think about the straight-line depreciation, just as no other methods would have been allowed.
This is what I call a “fixed” thinking.
In fact, IAS 16 does permit using several depreciation methods, such as number of units, diminishing balance, or simply any method that reflects the pattern in which the asset is consumed.
Therefore, you can have zero depreciation charges in a non-production (or idle) period. Simple as that.
What about taxation?
Here, you need to look deeply in the tax rules of your country.
Many tax laws present only limited options for your depreciation methods. As a result, you might be able to choose, for example, either straight-line or accelerated depreciation method.
Or, you might not be permitted to apply zero depreciation charge in a non-production period.
As a result, tax depreciation method might not correspond with the depreciation method selected under IAS 16 and tax depreciation will be different from accounting depreciation.
What’s the outcome?
You guessed it – a deferred tax arises. But that’s another story.