Whether an asset is carried under the cost model or the revaluation model (Part 2 of this series), its carrying amount still has to be depreciated over its useful life. This part covers the core mechanics of depreciation under IAS 16 — depreciable amount, useful life, and residual value — and walks through all three depreciation methods the standard recognizes, with worked numeric examples for each. Part 5 of this series turns these formulas into a free interactive Fixed Asset Schedule Generator that builds the full year-by-year schedule from your own numbers.

Depreciation: Depreciable Amount, Useful Life and Residual Value

Depreciation is the systematic allocation of an asset’s depreciable amount over its useful life — it is an allocation mechanism, not a valuation exercise, and it continues even if the asset’s fair value exceeds its carrying amount, as long as the asset’s residual value does not exceed its carrying amount.

Each part of an item of PP&E with a cost that is significant in relation to the total cost of the item is depreciated separately — component depreciation is covered in Part 4. Depreciation of an asset begins when it is available for use — when it is in the location and condition necessary for it to operate in the manner intended by management — not when it is actually brought into use. Depreciation does not cease when the asset becomes idle or is retired from active use unless it is fully depreciated, and it does not cease when an asset is classified as held for sale (at which point IFRS 5 takes over instead).

The residual value and the useful life of an asset must be reviewed at least at each financial year-end, and if expectations differ from previous estimates, the change is accounted for as a change in accounting estimate under IAS 8 — applied prospectively, not retrospectively, and never by restating prior periods. Useful life is defined as the period over which an asset is expected to be available for use, or the number of production or similar units expected to be obtained from it; it is an entity-specific measure that need not correspond to the asset’s physical or economic life. Factors to consider when estimating it include expected usage assessed by reference to expected capacity or physical output, expected physical wear and tear, technical or commercial obsolescence, and legal or similar limits on use such as the expiry of a related lease.

Depreciation Methods: Straight-Line, Declining Balance, and Units of Production

IAS 16 requires that the depreciation method used reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the entity — it is reviewed at least annually alongside useful life and residual value, and a change in expected pattern of consumption is accounted for, again, as a change in accounting estimate rather than a restatement. Three methods are named in the standard.

Straight-line method: results in a constant charge over the useful life, as long as the residual value does not change. Annual depreciation = (Cost − Residual Value) ÷ Useful Life. This is the most widely used method in practice because it is simple, predictable, and easy to budget against, and it suits assets whose economic benefit is consumed evenly over time, such as buildings and office furniture.

Diminishing (declining) balance method: results in a decreasing charge over the useful life — more expense is recognized in earlier years and less in later years, which can better reflect assets that lose economic value or productive efficiency faster when new, such as vehicles, computers, and other technology-driven equipment. Annual depreciation = Opening Book Value × Depreciation Rate, where the rate is commonly set as a multiple of the straight-line rate — 200% of straight-line is the well-known “double-declining balance” variant. Under this method the residual value acts only as a floor: the book value is never depreciated below it, so the final period or two is typically a smaller, plugged amount rather than a full rate-based charge.

Units of production method: results in a charge based on the expected use or output of the asset, allocating depreciation in proportion to the units produced (or hours used) in a period relative to total estimated lifetime units. Depreciation for the period = Depreciable Amount × (Units Produced in Period ÷ Total Estimated Lifetime Units). This method suits assets whose wear is driven by usage rather than time — manufacturing equipment, mining machinery, or aircraft depreciated by flight hours.

Worked example (straight-line): a company buys a machine for $50,000, expects a residual value of $5,000, and a useful life of 9 years. Annual depreciation = ($50,000 − $5,000) ÷ 9 = $5,000 per year, charged evenly until the machine’s book value reaches $5,000 at the end of year 9.

Worked example (declining balance): the same $50,000 machine depreciated at a 20% declining-balance rate charges $10,000 in year 1 (20% of $50,000), $8,000 in year 2 (20% of the $40,000 opening balance), $6,400 in year 3, and so on — front-loading the expense and slowing down each year, but never depreciating below the $5,000 residual floor.

Worked example (units of production): the same $50,000 machine (depreciable amount $45,000) is instead expected to produce 900,000 units over its life. In a year it produces 120,000 units, depreciation = $45,000 × (120,000 ÷ 900,000) = $6,000 for that year. A slower production year of only 60,000 units would charge just $3,000 — the expense moves directly with output rather than the calendar.

Straight-line and declining balance both depend only on the passage of time, which is exactly what the Fixed Asset Schedule Generator in Part 5 of this series automates — including properly prorating the first and last periods when an asset is purchased partway through a financial year, which is where most manually-built spreadsheets get the math wrong.