What is the ‘component approach’?

Property, plant and equipment (PPE) is often composed of various parts with varying useful lives or consumption patterns. These parts are (individually) replaced during the useful life of an asset.

Therefore:

  • Each part of an item of PPE with a cost that is significant in relation to the total cost of the item is depreciated separately (except where one significant part has a useful life and a depreciation method that is the same as those of another part of that same item of PPE; in which case, the two parts may be grouped together for depreciation purposes [IAS 16.45]; and
  • The cost of a replacement of a part is recognised under the recognition principle [IAS 16.7]
  • and the entity derecognises the carrying amount of the replaced part.

Under the ‘component approach’, the entity does not recognise in the carrying amount of an item of PPE the costs of the day-to-day servicing of the item. These costs are recognised in the income statement as incurred.

One of the objectives of the ‘component approach’ is therefore to reflect more precisely the pattern in which the asset’s future economic benefits are expected to be consumed by the entity. The IASB did not believe that an entity’s use of approximation techniques, such as a weighted average useful life for the item as a whole, resulted in depreciation that faithfully represents an entity’s varying expectations for the significant parts of the asset [IAS 16, BC 26].

The above method achieves a more appropriate calculation of the depreciation, as well as the derecognition of the costs of a replacement of a part to allow the recognition of the new part.

The standard requires separate depreciation only for significant parts of an item of PPE with different useful lives or consumption patterns; however, the

principles regarding replacement of parts (that is, subsequent cost of replaced part) apply generally to all identified parts, regardless whether they are significant or not.

Every item of PPE is split into parts to the extent possible in a first step to ensure that the recognition and derecognition requirements can be applied. The identified parts can then be grouped together if they have the same useful life; they can therefore form a (combined) component for depreciation purposes. Insignificant parts can be depreciated together in the remainder of the asset.

Component accounting

  • Significant parts/components are required to be depreciated over their estimated useful life
  • Costs of replacing components are required to be capitalised
  • Continued operation of an item of property, plant and equipment (PPE) may require regular major inspections for faults regardless of whether parts of the item are replaced. When each major inspection is performed, its cost is recognised in the carrying amount of the item of PPE as a replacement if the recognition criteria are satisfied.

Property, plant and equipment (PPE) is often composed of various parts with varying useful lives or consumption patterns. These parts are (individually) replaced during the useful life of an asset.

Therefore:

  • Each part of an item of PPE with a cost that is significant in relation to the total cost of the item is depreciated separately (except where one significant part has a useful life and a depreciation method that is the same as those of another part of that same item of PPE; in which case, the two parts may be grouped together for depreciation purposes [IAS 16.45]; and
  • The cost of a replacement of a part is recognised under the recognition principle [IAS 16.7] and the entity derecognises the carrying amount of the replaced part.

Under the ‘component approach’, the entity does not recognise in the carrying amount of an item of PPE the costs of the day-to-day servicing of the item. These costs are recognised in the income statement as incurred.

One of the objectives of the ‘component approach’ is therefore to reflect more precisely the pattern in which the asset’s future economic benefits are expected to be consumed by the entity. The IASB did not believe that an entity’s use of approximation techniques, such as a weighted average useful life for the item as a whole, resulted in depreciation that faithfully represents an entity’s varying expectations for the significant parts of the asset [IAS 16, BC 26].

The above method achieves a more appropriate calculation of the depreciation, as well as the derecognition of the costs of a replacement of a part to allow the recognition of the new part.

The standard requires separate depreciation only for significant parts of an item of PPE with different useful lives or consumption patterns; however, the principles regarding replacement of parts (that is, subsequent cost of replaced part) apply generally to all identified parts, regardless whether they are significant or not.

Every item of PPE is split into parts to the extent possible in a first step to ensure that the recognition and derecognition requirements can be applied. The identified parts can then be grouped together if they have the same useful life; they can therefore form a (combined) component for depreciation purposes. Insignificant parts can be depreciated together in the remainder of the asset.

Component accounting

  • Significant parts/components are required to be depreciated over their estimated useful life
  • Costs of replacing components are required to be capitalised
  • Continued operation of an item of property, plant and equipment (PPE) may require regular major inspections for faults regardless of whether parts of the item are replaced. When each major inspection is performed, its cost is recognised in the carrying amount of the item of PPE as a replacement if the recognition criteria are satisfied.

Spare parts, stand-by or servicing equipment

  • Are classified as PPE when they meet the definition of PPE, and are classified as inventory when definition is not met.

Disposals

  • Remove the asset from the statement of financial position on disposal or when withdrawn from use and no future economic benefits are expected from its disposal
  • The gain or loss on disposal is the difference between the proceeds and the carrying amount and is recognised in profit or loss
  • When a revalued asset is disposed of, any revaluation surplus may be transferred directly to retained earnings. The transfer to retained earnings is not made through profit or loss.

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