2 May 2025

Reading the accounting standards, depreciation is clearly regarded as an estimate. Yet in many of our audit files this is ignored. Why?

I suspect this is because if we have come from a tax accounting background where depreciation rates are prescribed, we forget that accounting depreciation is something that management and governance can exercise a lot of leeway on, which can significantly influence the financial results.

The international standard on Property, Plant and Equipment says:

The depreciation method applied to an asset shall be reviewed at least at each financial year-end and, if there has been a significant change in the expected pattern of consumption of the future economic benefits embodied in the asset, the method shall be changed to reflect the changed pattern. Such a change shall be accounted for as a change in an accounting estimate in accordance with NZ IAS 8. (NZ ISA 16, 60)

Depreciation is clearly regarded as an estimate, and any change must be accounted for as a change in estimate, rather than a change in policy.

The NZ Tier 3 NFP reporting standard (table 3) says:

Record depreciation: spread the cost of the asset over the expected useful life of the asset, using a structured method such as straight line or diminishing value. Note that land is not depreciated.

While not explicitly stating that this is an estimate, it obviously requires estimation of useful life and depreciation method on the part of the preparers.

Similarly, the auditing standard clearly lists depreciation as an estimate which must be considered according to the standard (ISA (NZ) 540 (Revised) A1).

Paragraph 3 says:

For certain accounting estimates, estimation uncertainty may be very low, based on their nature, and the complexity and subjectivity involved in making them may also be very low. For such accounting estimates, the risk assessment procedures and further audit procedures required by this ISA (NZ) would not be expected to be extensive.

So does this mean that we should be completing the accounting estimates workpaper for every job that includes depreciation? If the assets are standard things like computer and vehicles, there is unlikely to be any material risk. But for complex plant, equipment or buildings the complexity and subjectivity is much higher.

So the bottom line is – treat depreciation as an accounting estimate unless you can clearly justify that it is both non-material and there is no uncertainty.