Full explanation
Overview
Picture the single most valuable thing a company owns. Not its logo. Not its clever ideas. Its stuff — the factory, the machines, the fleet of trucks. Now look closer… because from the second it switches on, it begins to die. Slowly. Silently. And the way a company records that quiet death can turn one firm's profit into another firm's loss — using the very same machine.
Let me prove it. Two companies buy the identical machine — same day, same price. One year on, one posts a profit, the other a loss. How can the same machine tell two opposite stories?
Often more than half of everything owned
That standard is IAS 16 — Property, Plant and Equipment. For the companies that build, make, and move things, it's often more than half of everything they own. Misread this one line… and you misread the entire business.
Here's the deal. In the next few minutes you'll crack that mystery — what an asset really costs, how a building's value can rise, and what happens the day you finally sell. Let's open it up.
Part one. What counts as an asset — and what it costs to put it on the books.
Tangible · held to use
First, definitions. Property, plant and equipment are tangible items — things you can physically touch — that a business holds to use in production, supply, or admin, and expects to use for more than one period. Not to sell. To use. Keep that word 'use' — it's the whole game. And our map for the episode is four steps: Recognise, Measure, Present, Disclose.
So what's in, and what belongs to a neighbour? Held to use goes to IAS 16. Held to sell as your trade — that's inventory, IAS 2. Held to rent out or for capital gain — investment property, IAS 40. No physical substance, like a patent or software — intangibles, IAS 38. Leased in — a right-of-use asset under IFRS 16. Living plants or animals — IAS 41. And once it's up for sale — IFRS 5. The same brick building can sit in three different standards depending on why you hold it.
Think of a car you own
Before the mechanics, hold one everyday picture in your head: a car you own. The moment you drive it off the forecourt, it's worth less — that's depreciation, in real life. Pay for an oil change? That's a repair — an expense. Drop in a brand-new engine? That adds value, so you capitalise it, and scrap the old part. And the day you sell the car, you make a gain or a loss on disposal. One car — and you've just met most of IAS 16. The one twist: a car only falls in value, but a house can rise — and that's the revaluation model we'll come to.
Two tests to recognise
When do you actually put an item on the balance sheet? Two tests. One — it's probable the item will bring future economic benefit. Two — its cost can be measured reliably. Pass both, and it's recognised as an asset. Fail, and it's just an expense.
Not the invoice — the full cost
Meet Meridian Limited. It buys a new production machine. The invoice says four hundred thousand euros — but that's not what goes on the books. IAS 16 says measure it at cost: everything needed to get the asset to its location and working — including import duties and non-refundable taxes. So we add delivery, ten thousand. Installation, twenty thousand. Testing that it runs properly, ten thousand.
One more, and it surprises people: the estimated cost to dismantle and restore the site at the end — say thirty thousand — is capitalised into the asset today, with the other side sitting as a provision under IAS 37. Total cost so far: four hundred and seventy thousand euros. But not everything counts. Staff training, launch marketing, and early operating losses — around fifteen thousand — are expensed, never part of the asset.
Proceeds before intended use
Now a recent rule change worth knowing. While testing the machine, Meridian sold five thousand euros of sample output. The old habit was to deduct those proceeds from the asset's cost. But an IAS 16 amendment, effective January twenty twenty-two, stopped that. Now, proceeds from items produced while getting the asset ready — and their cost — go straight to profit and loss. The asset's cost stays at four hundred and seventy thousand; it isn't quietly reduced. A small change that hit testing-heavy industries like mining, oil and gas hard.
Not the invoice — the full cost
So that's Recognise, and the start of Measure — Meridian's machine sits on the books at four hundred and seventy thousand. But an asset you use wears out. And that's the piece that solves our two-company puzzle: depreciation.
Part two. Spreading the cost — and why the method changes the profit.
Depreciable amount & three methods
Depreciation is simply spreading an asset's cost over the years it's used — matching the cost to the benefit. Two ingredients. Useful life: how long this business will use it — say ten years. Residual value: what you could sell it for at the very end of its life, its scrap or trade-in value — say twenty thousand. Subtract residual from cost — four hundred and seventy thousand minus twenty thousand — and you get the depreciable amount: four hundred and fifty thousand euros. That's what we spread.
How you spread it is a choice — and IAS 16 allows several patterns. Straight-line: the same each year — four hundred and fifty thousand over ten, so forty-five thousand a year. Reducing balance: say twenty percent of the value each year — front-loaded, so year one is ninety-four thousand. Units of production: by output — heavy use, heavy charge. Same machine. Same cost. Three completely different year-one expenses.
Same machine · two profits
And there's our two-company mystery. Company A picks straight-line — forty-five thousand hits its profit. Company B picks reducing balance — ninety-four thousand hits its profit. Same machine, same day, same price — but a forty-nine thousand euro difference in year-one profit. One shows a gain, the other a loss, and both are correct. Depreciation policy isn't a footnote — it shapes the profit.
20% of the shrinking balance
Let's see that reducing balance in action. Year one: twenty percent of the full four hundred and seventy thousand — ninety-four thousand. That leaves a carrying value of three hundred and seventy-six thousand. Year two: twenty percent of that — seventy-five thousand, two hundred. Year three: twenty percent again — about sixty thousand. See the pattern? The charge shrinks every single year — heavy at the start, lighter later. That is what front-loaded means.
Land, timing & idle assets
Three quick rules that catch people out. First, land is special — it has an unlimited life, so land itself is never depreciated, only the building on it. Second, depreciation starts when the asset is ready for use, not when you first switch it on. And it keeps running even while the asset sits idle — stopping only when you sell it, or classify it as held for sale.
One aircraft — parts on different clocks
Now a subtlety that trips people up: component accounting. If a significant part of an asset has a different useful life, IAS 16 says you depreciate it separately. And the textbook example flies — an aircraft.
Picture a passenger jet, built from its major parts. The engines get overhauled and replaced far sooner than the airframe. The cabin interior is refitted every few years. But the fuselage and wings last for decades. So an airline never depreciates the whole plane as one lump — it splits it into components, and depreciates each over its own life: the engines fast, the airframe slow. Same asset, several different clocks. That is component accounting.
Estimates change — prospectively
Useful life, residual value, and method aren't set in stone. IAS 16 says review them at least every year-end. If reality changes — the machine's tiring faster than expected — you don't rewrite history. Under IAS 8, it's a change in estimate: you take the current carrying amount and spread it over the new remaining life, from now on. Prospective, never a restatement.
So — recognised, measured at cost, and depreciated by method and component. But the asset's story isn't over. In Part two, it can rise in value, get sold, and land on the statements. See you there.