FRS 102 section 17 requires that all fixed assets are depreciated using a method that “reflects the pattern in which it expects to consume the asset’s future economic benefits” [FRS 102 17.22]. This could be the straight-line method, the reducing-balance method or another method, such as usage based on units of production. The depreciation charge should reduce the value of the asset in a systematic way from its initial carrying value to its residual value, over its expected useful life.
Often, it is reasonable to depreciate the total value of the asset using one method, one rate and one useful life. For example, it may be reasonable to depreciate a €1,000 laptop using a reducing-balance method over an estimated useful life of four years.
However, there may be instances where a fixed asset of significant size or value does not have one single useful life, or where elements of the asset will lose value sooner than others. An example would be a large building, where the overall structure – the walls, foundations, roof and so on – may be estimated to last 100 years, but the heating system may need complete replacement after 20 years. Where such differences in useful lives are material, component accounting should be used to reflect the true values of the asset in the financial statements.
When using component accounting, the fixed asset is accounted for as if it was multiple assets. In the example above, the building itself would be recognised as one asset and depreciated over a period of 100 years, and the heating system would be recognised as a separate asset, depreciated over 20 years. This allows for the financial statements to reflect the “significantly different patterns of consumption of economic benefits” [FRS 102 17.16].
An example of component accounting is given below.
Question:
A company purchases a machine for €100,000, and it expects it to be used for 10 years. However, there are two components of the machine that the directors expect to need to replace sooner – part X, that cost €35k, and part Y, that cost €50k. It is anticipated that part X will need replaced in three years, and part Y in five years.
Answer:
The entity has identified two components – X, that cost €35,000, and Y, that cost €50,000 – that have individually significantly different patterns of consumption of economic benefits. In this situation, cost attributable to the remainder of the asset that is not individually significant is €15,000. The entity will depreciate components X and Y over their useful lives of three and five years respectively. The remainder of the machine, which is treated as a single asset, should be depreciated over 10 years.
