30 January 2013

FRC: Response to exposure draft clarification of acceptable methods of depreciation and amortisation

FRC published its comment letter to the IFRS ED, "Clarification of Acceptable Methods of Depreciation and Amortisation: Proposed amendments to IAS 16 and IAS 38". FRC agrees that depreciation should reflect the consumption of economic benefits.

The ED proposes to clarify that a method that uses revenue generated from an activity that includes the use of an asset is not an appropriate depreciation method. FRC disagrees with that principle. In FRC´s view, an economic perspective of the consumption of economic benefits may, in some cases, requires consideration of the value of those benefits—and revenue will often be the best available evidence of that value. The consumption of benefits cannot always be quantified simply by reference to the passage of time or the amount of use made by the asset. FRC notes that IAS 38 states that the benefits flowing from an asset may include revenue from the sale of products or services.

The ED discusses two cases where the value of future revenues is relevant to depreciation.

(i) The Basis for Conclusions gives the example of rights to broadcast a film where depreciation would reflect the value obtained on each transmission. The ED claims that this gives the same result as the units of production method, but this is unconvincing as it is more plausible to use as the ‘unit’ each transmission, rather than the number of viewers attracted. The licence would presumably specify the number of transmissions: it cannot regulate the number of viewers.

(ii) The ED acknowledges that an expected future reduction in unit selling price due to obsolescence may be relevant to depreciation. (It suggests that this is only the case where a diminishing balance method is used, but FRC does not agree that obsolescence is irrelevant if another method, such as straight-line, is used).

It seems that revenue-based methods are acceptable in these circumstances because they result in earlier rather than later amortisation, as noted in the last sentence of BC4. It therefore seems that the aim of the ED is to ensure that depreciation and amortisation are not unduly deferred. FRC supports that objective.

Depreciation and amortisation necessarily entail the making of estimates of uncertain future events, including changes in market prices for both costs and output. The approach adopted for depreciation therefore needs to be prudent. Before its revision in 2010, the Framework described prudence as ‘the inclusion of a degree of caution in the exercise of the judgements needed in making the estimates required under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated.’ FRC agrees with IASB´s recent observation at the FEE Conference on Corporate Reporting of the Future in Brussels that this is ‘spot on’.

There is therefore a case for standards to ensure that the lack of reliability of estimates of the future is reflected in a prudent approach to depreciation. The proposals in the ED are one way of addressing one particular aspect of this issue, and might therefore be acceptable as a short-term solution if there is evidence of a pressing problem. However, they have the drawback of adding a rule, which is not founded on a clear principle and, in FRC´s view, incorrect. FRC therefore suggests that the IASB consider alternative approaches, such a complete prohibition of depreciation and amortisation that is less prudent than a given bench mark, or creating a rebuttable presumption that the method used should be at least as prudent as straight-line, with disclosure of the reasons and effect in cases where that presumption is rebutted.

FRC supports the approach of working on standards and Framework at the same time so that work on one can inform the other. The issues raised in the ED provide a clear demonstration of the importance of the concepts of reliability and prudence. FRC hopes therefore that work on this project will be considered in the development and completion of the Framework and result in appropriate treatment on these concepts.

Full comment letter

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