002: How to deal with different useful lives of PPE within the group?
IFRS Question 002: Different useful life of PPE within the same group
We have a head office in Singapore and subsidiaries in various countries.
The headquarters of the parent company set the useful lives of the property, plant and equipment (PPE) for the whole group and subsidiaries have to depreciate their PPE over these useful lives set by the parent.
But individual countries have their own laws or rules on the useful lives that are not the same as what the parent company prescribes. Also, auditors of the subsidiary insist on using useful lives in line with the parent’s policy.
How can this be handled in the financial statements?
IFRS Answer 002
This is a great question because it happens on a regular basis and many companies within the same group use different useful lives of their assets. And, auditors insist on depreciating these assets over the uniform useful lives throughout the group.
I personally don’t like it. Yes, it is very practical – no dispute on it.
But, the standard IAS 16 says that the useful life of an asset is determined based on expected utility of that asset to an entity.
According to IAS 16 par. 6, the useful life is either:
- 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 by that entity.
So, the useful life is specific to the individual asset and individual entity.
It is quite possible that the parent can use the same type of asset for a longer period than its subsidiary and as a result, both can apply different useful lives.
Just imagine one subsidiary operating in northern Canada and one operating in India. Totally different climates – one is cold, one is warm.
They bought the same drilling machine that will operate outside. It is quite probable that the subsidiary in Canada will use the same machine for the shorter time that the company in India just because the temperatures are much lower, the ground is harder and the drilling machine would be consumed earlier than the one in Indian warm weather.
So it’s normal in this case to have different useful lives for the same assets.
Now I can hear you saying – but, when you consolidate, IFRS 10 says that the companies within the group MUST apply the same accounting policies!
Yes, that’s true, but the useful life is NOT an accounting policy, but an accounting estimate and it is specific for each company and each asset I would say. So it’s permitted to apply different accounting estimates based on the specifics of that company.
However, in practice, it is very common that the parent prescribes the useful lives of all assets within the group and although it might not fully reflect the reality, it is widely accepted.
So what to do when the local useful lives or depreciation rates are different for tax purposes than the group rate?
There are several solutions possible:
- Subsidiary depreciates its PPE over the same useful lives as its parent in its own local accounting records. Here, if the tax depreciation rules are different, subsidiary must recognize deferred tax.
- In its local accounting books, the subsidiary depreciates its PPE over the useful life as prescribed by the local legislation. When the subsidiary prepares the reporting package for the consolidation purposes, it will make the adjustment to align useful lives with the group’s policy and again, the deferred tax would be required in that consolidation package.
- The parent can make the adjustment when consolidating all subsidiaries, but if the parent owns number of subsidiaries, it would be extremely demanding to keep track on adjustments of every single subsidiary.
The easiest approach is probably the first one, when the subsidiary just applies the group’s rates in its own local accounting books and makes the adjustment for the deferred taxation.
Yes, it is true that in this case, PPE might not reflect the subsidiary’s reality, but if the subsidiary does not need to submit the financial statements to some public market like stock exchange and reports just to tax office and to the parent, it would be acceptable.
If the subsidiary is big enough and it’s shares or other instruments are traded publicly on the stock exchange or needs to share its individual financial statements with the wide range of users, then I would go for the second option and make adjustment in the consolidation package.
Example: Handling different useful lives within the group
Subsidiary acquired a building with cost of CU 120 000. Local tax legislation prescribes to depreciate buildings straight-line over 40 years, but the group’s policy is to use the buildings for 30 years and then sell them. Tax rate in subsidiary’s country is 20%.
The first approach: The same useful lives
Subsidiary depreciates the building over 30 years exactly as its parent.
The annual depreciation is then CU 120 000/30 = CU 4 000. The carrying amount at the end of year 1 = CU 116 000 (120 000 – 4 000).
For tax purposes, it is possible to deduct CU 120 000/40 = CU 3 000. The tax base at the end of year 1 = CU 117 000 (120 000 – 3 000).
As the tax base is different than the carrying amount, the deferred tax must be recognized: 20%*(117 000-116 000) = 200 (deferred tax asset).
Journal entries – in subsidiary’s individual financial statements:
- Depreciation: Debit P/L Depreciation: CU 4 000 / Credit PPE – Accumulated depreciation: CU 4 000
- Deferred tax: Debit Deferred tax asset: CU 200 / Credit P/L – Deferred income tax: CU 200
There is NO need to make any consolidation adjustment.
The second approach: Adjustment in the reporting package
Subsidiary depreciates the building in line with the local legislation.
The annual depreciation is then CU 120 000/40 = CU 3 000. The carrying amount at the end of year 1 = CU 117 000 (120 000 – 4 000).
Tax depreciation is the same, therefore no deferred tax arises in the local books.
Journal entry – in the subsidiary’s individual financial statements:
- Depreciation: Debit P/L Depreciation: CU 3 000
- Credit PPE – Accumulated depreciation: CU 3 000
When making consolidation, consolidating adjustment will be made in the group’s financial statements:
- Aligning the depreciation:
- Debit P/L Depreciation: CU 1 000
- Credit PPE – Accumulated depreciation: CU 1 000 (difference between the group’s policy and local tax rules)
- Deferred tax on adjustment:
- Debit Deferred tax asset: CU 200
- Credit P/L – Deferred income tax: CU 200 (CU 1 000*20%)
From the above examples it’s clear that from the group’s view, it’s easier to use the same accounting estimates (approach 1) to reduce the amount of adjustments and journal entries.
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