Change of Method of Depreciation (by both Current and Retrospective effect)

Changing the method of depreciation for assets involves considering both the accounting implications and the practical aspects of applying a new method.

Change in Depreciation Method:

Accounting Standards Overview:

Under AS-6 (Revised), a change in the method of depreciation is permissible but should be approached with caution. The change should reflect a more accurate allocation of the asset’s cost over its useful life, and it must be justified by a change in the expected pattern of economic benefits.

Current Effect:

1. Justification: The change in depreciation method should be based on a valid reason. For instance, if the new method better matches the pattern of asset usage or revenue generation, it may be appropriate to switch methods.
2. Application: The new method is applied prospectively, meaning it will affect depreciation expense from the date of the change onward. The depreciation expense for the current period and future periods will be calculated using the new method.
3. Disclosure: The entity must disclose the change in method, the reason for the change, and the financial impact of the change in the financial statements. This helps users understand how the change affects the financial results.

Retrospective Effect:

1. Restating Financial Statements: For retrospective changes, the entity must adjust the financial statements of prior periods as if the new method had always been used. This involves recalculating the depreciation for prior periods and restating comparative figures to reflect the new method.
2. Impact on Comparative Periods: The financial statements for the previous periods (comparative periods) will need to be restated to reflect the change. This allows for a more accurate comparison between the current and prior periods.
3. Disclosure: The entity must disclose the nature of the change, the reason for the retrospective application, and the impact on financial statements. This includes restating the financial results of previous periods and explaining how the new method affects the financial statements.

Process for Changing Depreciation Method

Assessment:

• Review the Existing Method: Evaluate the effectiveness and appropriateness of the current depreciation method.
• Determine the New Method: Choose a new method that better reflects the asset’s consumption pattern or provides more accurate financial reporting.
• Quantify the Impact: Assess the financial impact of the change on current and future depreciation expenses.

Implementation:

• Prospective Application: Start applying the new method from the date of change. Adjust the depreciation calculation based on the new method for all future periods.
• Retrospective Adjustment: If applying retrospectively, adjust prior period financial statements. This involves recalculating depreciation for prior periods and restating the figures accordingly.

Disclosure:

• Nature of Change: Clearly state the nature of the change in the depreciation method.
• Reason for Change: Explain why the new method is more appropriate than the previous one.
• Financial Impact: Provide details on the financial impact of the change, including adjustments to prior periods if applicable.
• Comparative Information: Restate comparative information for prior periods to reflect the new depreciation method, if necessary.

Example:

Scenario:

An entity has been using the Straight-Line Method for a machine but decides to change to the Diminishing Balance Method because the machine is expected to be used more intensively in the earlier years.

Current Effect:

• New Depreciation Expense: Calculate the depreciation for the current period using the Diminishing Balance Method.
• Disclosure: Include a note in the financial statements explaining the change and its impact on the current year’s depreciation expense.

Retrospective Effect:

• Restate Prior Periods: Recalculate depreciation for prior periods using the Diminishing Balance Method and adjust the opening balance of retained earnings or other appropriate equity accounts if the cumulative effect of the change is material.
• Comparative Statements: Present restated comparative figures in the financial statements.

Disclosure:

• Change Details: Include details of the change in depreciation method and the reasons behind it.
• Impact: Describe how the change affects financial results and the restatement of prior periods.