Depreciation Policy Change at a Machine Shop
Metaalwerk De Wilde NV has used straight-line depreciation for its CNC machines over 10 years with no residual value. At the start of year 5, management concludes that the machines are being used more intensively and that a remaining useful life of 4 years (instead of 6) better reflects reality; residual value is still nil. One machine was bought for €240,000 at the start of year 1 and has been depreciated for 4 full years. The financial director proposes to treat the change as a change in accounting policy, restate prior years, and book the whole catch-up through retained earnings. The auditor disagrees. Separately, a new machine bought on 1 October of year 5 for €96,000 will be depreciated for a full year in year 5 under the current spreadsheet, which the controller questions.
1. Is the revision of useful life a change in accounting policy or a change in accounting estimate? What is the correct accounting treatment?
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A revision of the estimated useful life is a change in accounting estimate, not a change in accounting policy (IAS 8). It is applied prospectively from the date of change; prior periods are not restated and no catch-up is booked to retained earnings. The financial director's proposal is therefore wrong. The carrying amount at the start of year 5 is spread over the revised remaining life. This distinction matters because policy changes are rare and require restatement, whereas estimate changes are the normal consequence of new information and are handled going forward.
2. Calculate the depreciation charge for year 5 on the existing machine and explain the effect on the financial statements.
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Annual depreciation in years 1–4 was €240,000 / 10 = €24,000, so accumulated depreciation is €96,000 and carrying amount at the start of year 5 is €144,000. With a revised remaining life of 4 years, the year-5 charge is €144,000 / 4 = €36,000. Compared with the old charge of €24,000, profit before tax falls by €12,000 in year 5 and each following year. The change is disclosed as a change in estimate, with a description and, where practicable, the amount of the effect. No prior-year adjustment is made.
3. How should the machine bought on 1 October of year 5 be depreciated, and what is the year-5 charge if it also has a 4-year life and nil residual value?
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Depreciation starts when the asset is available for use, i.e. 1 October, so only 3 months of depreciation belong to year 5, not a full year. The charge is €96,000 / 4 × 3/12 = €6,000. Depreciating a full year would overstate the expense by €18,000 and understate the carrying amount. The spreadsheet error is a timing error, not a policy issue, and should be corrected before the accounts are finalised.