Depreciation or amortization of a long-lived asset begins when the asset is available for its intended use. That is, depreciation or amortization begins when the asset is in the location and condition necessary for it to operate in the manner intended by management.
As noted in ASC 835-20-25-5
and ASC 350-40-25-14
, interest capitalization should cease and depreciation should begin when the long-lived asset is substantially complete and ready for its intended use. The proposed PPE SOP (see PPE 1.1
) describes “ready for its intended use” as follows.
Excerpt from paragraph 28(b) of the proposed PPE SOP
PP&E is considered ready for its intended use when it is first capable of producing a unit of product that is either saleable or usable internally by the entity.
The date on which a long-lived asset is considered ready for its intended use should not be delayed by activities undertaken by the entity in pursuit of efficiency, productivity, or quality enhancements. Similarly, depreciation or amortization of an asset that is available for its intended use should not be delayed simply because the entity has not started operating the asset (e.g., sufficient capacity exists with current production assets).
Certain conditions may prevent a long-lived asset from being considered available for its intended use. For example, if FDA approval is required before a pharmaceutical company can start to manufacture a new drug for sale, depreciation of the manufacturing equipment will generally not commence until the relevant FDA approval is obtained.
Reporting entities often purchase additional spare parts for key pieces of equipment to ensure downtime is minimized in the event of equipment failure. As discussed in PPE 1.5.3
and FSP 8.6.6
, depending on the facts and circumstances associated with the spare parts, companies classify spare parts either as long-lived assets or as inventory. When treated as inventory, the spare parts are not depreciated and are expensed when placed in service, similar to maintenance expense. When considered to be long-lived assets, the spare parts are depreciated over their useful lives or the remaining service lives of the related equipment. Determining when to start depreciating a spare part that meets the definition of long-lived asset will depend on its expected use. If the spare part is expected to be used only if there is an unexpected breakdown or equipment failure, it may be appropriate to start depreciation at the point when the spare part is available for installation. On the other hand, if that spare part is expected to be routinely used as a replacement part, it may be appropriate to start depreciation when the spare part is installed.
Example PPE 4-2 illustrates when to begin depreciation of a newly installed asset.
EXAMPLE PPE 4-2
When to begin depreciation of a newly installed asset
PPE Corp installs a new production line to produce plastic containers. Commercial production cannot begin until PPE Corp receives routine quality approval from its key customer.
Does PPE Corp need to defer the commencement of depreciation until the quality approval is obtained?
Depreciation should commence when the production line is substantially complete and ready for its intended use. Because the quality approval is considered to be routine in nature, PPE Corp should not defer recognition of depreciation until approval is received from the customer. If, however, the plastic containers are highly customized (e.g., requiring specialized technology or engineering) and the customer delays granting approval pending a significant modification to the asset or related process, the asset may not be ready for its intended use until customer approval is obtained.
Depreciation ceases when an asset is derecognized or when the asset is classified as held for sale in accordance with ASC 360-10-35-43
. Therefore, depreciation generally does not stop when an asset is temporarily idled. However, if an asset or component of an asset remains idle for more than a short period of time, it may indicate a potential impairment or demonstrate the need to reassess the asset’s useful life. For further details regarding held for sale accounting, see PPE 5.3
. See PPE 4.4
for further discussion of component depreciation.
Judgment is required to determine whether a productive asset is temporarily idled or permanently abandoned. See PPE 6.3.1
for further information regarding assets abandoned or to be abandoned.
Depreciation would also cease when an asset’s accumulated depreciation equals its cost minus salvage value, if any. A reporting entity will often continue to record a fully depreciated asset on the balance sheet and disclose the asset in the footnotes to the financial statements at its cost along with its accumulated depreciation (i.e., at a net carrying amount of zero) until such time that the asset is physically disposed of or sold.
When a reporting entity expects to sell an asset significantly before the end of its previously estimated useful life and the asset does not meet the held for sale criteria, the reporting entity should continue to depreciate the asset, even if it expects to sell it at a gain. Although fair value may be higher than book value, depreciation should continue until the asset either is disposed of (or meets the held for sale criteria) or is depreciated to its salvage value. Long-lived assets should not be written up to reflect appraisal, market, or current values above the book value. As noted in ASC 360-10-35-4
, depreciation is “a process of allocation, not of valuation.” Unless an asset is disposed of (or meets the held for sale criteria), ceasing depreciation would distort the allocation of the initial cost of the asset over its useful life (see Example PPE 4-1 in PPE 4.2.3