An analyst is comparing two companies, 'Global Tech' and 'Local Innovate,' operating in the same industry. Global Tech reports under IFRS, while Local Innovate reports under U.S. GAAP. Both companies use the cost model for their property, plant, and equipment (PP&E). The analyst notes that Global Tech reports significantly higher depreciation expense than Local Innovate, despite having similar asset bases and useful lives. Which of the following differences in accounting standards is the most likely reason for this observation?
- AIFRS requires depreciation to begin when an asset is available for use, while U.S. GAAP may delay until actual use.
- BU.S. GAAP requires component depreciation, while IFRS does not.
- CIFRS permits the revaluation model for PP&E, which leads to higher depreciation.
- DIFRS requires a review of residual value and useful life annually, potentially leading to more frequent upward revisions.
Show answer & explanationAnswer & explanation
Correct answer: D. IFRS requires a review of residual value and useful life annually, potentially leading to more frequent upward revisions.
Under IFRS, companies are required to review the residual value and useful life of an asset at least at each financial year-end. This frequent review can lead to more timely adjustments. If residual values are revised downwards or useful lives shortened, depreciation expense would increase. U.S. GAAP does not mandate such an annual review, making adjustments less frequent. Option A is incorrect because both use the cost model. Option B is incorrect as IFRS *requires* component depreciation while U.S. GAAP permits it. Option D is incorrect as IFRS typically starts depreciation when available for use, which might lead to *earlier* depreciation, but not necessarily higher annual expense unless useful life or residual value changes.
Why the other options are wrong
- A. Incorrect. IFRS typically requires depreciation to begin when an asset is available for use, which might lead to *earlier* depreciation recognition compared to U.S. GAAP, but not necessarily a *higher annual* depreciation expense given similar useful lives and asset bases, unless other factors (like residual value) are also changing.
- B. Incorrect. This statement is reversed. IFRS *requires* component depreciation, while U.S. GAAP *permits* it. If IFRS is applying component depreciation, it could potentially lead to higher total depreciation if components have shorter lives, but it's not the annual review aspect.
- C. Incorrect. Both companies use the cost model, so the revaluation model is not applicable here. Even if it were, revaluation typically leads to higher carrying values and thus higher depreciation, but it's not the primary or required difference for higher depreciation under IFRS when using the cost model.
Depreciation Differences (IFRS vs. U.S. GAAP)
Differences in depreciation expense between IFRS and U.S. GAAP can arise from variations in rules regarding residual value, useful life reviews, component depreciation, and the point at which depreciation commences.
- Residual Value/Useful Life Review: IFRS requires annual review; U.S. GAAP does not mandate annual review.
- Component Depreciation: IFRS requires; U.S. GAAP permits.
- Revaluation Model: IFRS permits (not for cost model); U.S. GAAP does not permit for most PP&E.
- Depreciation Start: IFRS when available for use; U.S. GAAP generally when placed in service.
Memory trick: IFRS reviews life annually, components are required; GAAP is more 'set it and forget it'.