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Plain‑English explainer of HKAS 16 / IAS 16 for students, junior accountants and non‑specialists who find official standards too dense to read.
This article is based on Hong Kong Accounting Standards (HKAS / HKFRS), which are fully aligned with IAS / IFRS except for minor local tweaks, so the same principles generally apply under IAS / IFRS unless noted otherwise. The goal is to unpack HKAS 16 Property, Plant and Equipment (equivalent to IAS 16) using plain English and practical, real‑life examples instead of technical jargon. It is written for students, junior accountants, audit juniors and finance professionals who want to understand not just “what the standard says” but how to actually read and prepare financial statements in line with it.
When you see “the company” or “the entity” below, you can think of any entity that prepares general purpose financial statements under HKFRS / IFRS.
The asset is on the books – now what?
Many people learn how to recognise PPE and measure its initial cost, then immediately ask: “Once the asset is on the balance sheet, how do we handle it year by year?” Typical follow‑up questions include:
- How do we choose between the cost model and the revaluation model for property?
- When fair value goes up or down, what goes to profit or loss and what goes to other comprehensive income (OCI)?
- If a machine sits idle for a few years, can we stop depreciating it?
- If we change the depreciation method from straight‑line to something else, is that a change in accounting policy?
These all connect to one main theme: during the asset’s useful life, how should its carrying amount move over time so that it reflects economic reality and still fits within the accounting framework?
What You Should Be Able To Do After Reading?
By the end, you should be able to:
- Distinguish clearly between the cost model and the revaluation model, and know when each is more appropriate.
- Explain how revaluation increases and decreases are split between OCI and profit or loss, and how revaluation affects the future depreciation base.
- Understand the core principles of depreciation, including when it starts and stops, and why assets are depreciated even when idle.
- Use the component depreciation idea for assets like aircraft (body vs engines), and explain why revenue‑based depreciation is usually not acceptable.
- See how changes in useful life, residual value or depreciation method are treated as changes in estimates (not policies), and how all this links to impairment testing under HKAS 36.
1. Choosing a subsequent measurement model – cost vs revaluation
Once PPE is recognised initially, the entity must choose a subsequent measurement policy. HKAS 16 (equivalent to IAS 16) allows two models:
- Cost model
- Revaluation model
Cost model: simple and commonly used
The cost model is the most common choice, especially in Hong Kong. The basic approach is:
- Carry PPE at cost less accumulated depreciation and accumulated impairment losses.
- Do not adjust the carrying amount for short‑term market price fluctuations, unless there is an indication of impairment and you have to apply HKAS 36 Impairment of Assets.
For assets without an active market, or those whose fair value cannot be measured reliably (for example certain specialised machinery), the cost model is usually more practical and less costly to implement.
Revaluation model: keeping the carrying amount close to fair value
Under the revaluation model, the entity carries an entire class of PPE at revalued amounts, being fair value at the date of revaluation less subsequent accumulated depreciation and accumulated impairment losses.
Key requirements include:
- Consistency within a class: the entity cannot cherry‑pick only some high‑value assets to revalue; it must apply the same model to the whole class (for example all office buildings, or all land).
- Reliable fair value: if fair value for that class cannot be measured reliably, the revaluation model is not appropriate.
- Revaluation frequency: revaluations must be frequent enough that the carrying amount does not differ materially from fair value; the more volatile the market, the more often revaluation is needed.
In practice, many Hong Kong entities use the fair value model for investment property, while for owner‑occupied property they choose cost or revaluation depending on industry practice and management’s strategy.
Changing models: usually a change in accounting policy
When the entity first chooses a model, it considers factors such as:
- Industry norms and peer practice
- Cost and availability of fair value information
- Impact on key ratios and earnings volatility
If the entity later changes from the cost model to the revaluation model (or the other way round), this is generally treated as a change in accounting policy under HKAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. That means additional disclosures are required to explain the reasons and effects of the change.
2. Accounting for revaluation movements and future depreciation
The tricky part of the revaluation model is not deciding “whether to revalue”, but understanding how to present revaluation gains and losses between profit or loss and OCI, and how to adjust depreciation afterwards.
Revaluation increases: normally go to OCI
When a revaluation increases an asset’s carrying amount, the increase is generally recognised in other comprehensive income and accumulated in equity under a “revaluation surplus”.
However, if there was a past revaluation decrease for the same asset that was recognised in profit or loss, the current increase is first recognised in profit or loss to reverse that previous loss. Only any excess above that reversal goes to OCI.
In simplified steps:
- First “replenish” any past revaluation loss previously expensed in profit or loss.
- Then take the remaining upward revaluation to OCI as revaluation surplus.
This keeps the treatment symmetrical, so that increases and decreases are handled consistently across profit or loss and OCI.
Revaluation decreases: usually hit profit or loss first
When revaluation reduces an asset’s carrying amount, the decrease is generally recognised in profit or loss as a revaluation loss.
But if there is an existing revaluation surplus in equity relating to that asset, the entity uses that surplus first to absorb the decrease. Only the excess beyond the available surplus is recognised in profit or loss.
In other words:
- Use previously accumulated “upward revaluation” in equity to cover the drop.
- Any remaining decrease reduces current‑period profit.
Again, this helps maintain a symmetric and transparent pattern of recognition over time.
Depreciation after revaluation: updated base, same principles
Revaluation does not change the basic idea of depreciation, but it changes the depreciation base. After revaluation:
- The revalued carrying amount (after the revaluation adjustment) is depreciated over the asset’s remaining useful life.
- If residual value is also updated, future depreciation charges must be recalculated accordingly.
Example: a building originally costs 100m; after accumulated depreciation, its carrying amount is 80m. It is revalued to a fair value of 120m. If the remaining useful life is 20 years and residual value is zero, annual depreciation becomes 120m / 20 = 6m, based on the revalued amount, not the pre‑revaluation carrying amount.
From a mechanics perspective, the entity can choose either a “gross” or “net” approach to restate accumulated depreciation at the revaluation date, but the end result is simply to reset the asset and accumulated depreciation to align with the new revalued amount.
3. Core depreciation principles – when and how to depreciate
Depreciation is more than “spreading cost”. Its purpose is to reflect the pattern in which the asset’s economic benefits are consumed.
Basic rules: depreciable amount and method
HKAS 16 states that depreciation allocates the depreciable amount of an asset on a systematic basis over its useful life. The depreciable amount is normally cost or revalued amount, less residual value.
The choice of depreciation method and useful life should reflect how the asset’s economic benefits are actually consumed, not just a convenient pattern. For example, some machinery delivers more output or utility in earlier years and requires more repairs later; an accelerated method might then better reflect consumption of economic benefits.
When depreciation starts and stops
Timing rules that often cause confusion:
- Start date: depreciation starts when the asset is available for use, meaning it is in the location and condition necessary for it to operate as intended by management. This can be before full‑scale production begins.
- Stop date: depreciation stops when the asset is derecognised (for example, disposed of) or when it is classified as held for sale. Depreciation does not stop just because the asset is temporarily idle.
A common misconception is: “If the asset is not being used, we should not depreciate it.” The standard’s view is that as long as the entity still holds the asset and it remains capable of providing economic benefits, the passage of time continues to consume its useful life, so depreciation should continue.
4. Component depreciation and choosing a method
In many industries, a single item of PPE is made up of significant components that have different useful lives. HKAS 16 requires component depreciation for significant parts.
Component depreciation: breaking assets into meaningful parts
The classic example is an aircraft:
- The airframe might have a useful life of 20–25 years.
- The engines or interior fittings may need replacement much earlier.
If the entity depreciates the whole aircraft on one single useful life, the pattern of expense will not reflect how different parts actually wear out. Therefore, the standard requires that:
- Components that are significant in cost relative to the total asset and that have distinct useful lives are identified and depreciated separately.
- When a component is replaced, the carrying amount of the old component is derecognised, and the cost of the new component is capitalised and depreciated over its own useful life.
In Hong Kong practice, the same logic can apply to large pieces of equipment with replaceable cores, or to buildings where the main structure and certain major fit‑out elements have different useful lives.
Depreciation methods: straight‑line, diminishing balance, units of production
Common methods include:
- Straight‑line: the same depreciation expense each year; suitable when benefits are consumed evenly.
- Diminishing balance: higher charge in early years, lower later; useful when assets lose utility faster early on or face higher obsolescence risk.
- Units‑of‑production: based on usage or output; useful when benefits are mainly driven by usage volume rather than time.
HKAS 16 specifically states that revenue‑based depreciation is generally inappropriate for PPE. Revenue is influenced by many factors (selling prices, demand, sales strategy) that may not correlate with how the asset itself is consumed.
For example, some older practices assumed: “This machine exists to generate revenue. The more revenue we earn, the more economic benefits are consumed, so let’s depreciate based on revenue proportion.” A typical approach would be:
- Estimate total lifetime revenue of 100m.
- If this year’s revenue is 10m, charge 10% of the depreciable amount as depreciation.
But revenue can grow simply because prices increase, even if the machine runs the same hours; or revenue may fall because of discounts, while the machine works harder than before. Because of this weak link, the standard setters clarified that:
- For PPE (HKAS 16 / IAS 16), revenue‑based depreciation is not permitted.
- For intangible assets (HKAS 38 / IAS 38), revenue‑based amortisation is also presumed inappropriate, except in rare cases where revenue truly reflects the consumption of economic benefits.
5. Residual value, useful life and impairment – how they interact
Depreciation is based on estimates, and estimates change. HKAS 16 therefore requires entities to review residual value and useful life regularly, and treat changes as changes in accounting estimates.
Changing residual value and useful life: forward‑looking only
When market conditions or usage patterns change, the residual value and useful life of an asset may need updating. Examples:
- A stronger second‑hand market develops for a specific machine type, increasing its expected residual value.
- Management decides to retire equipment earlier due to a new technology rollout, shortening its useful life.
HKAS 16 requires that:
- Changes in residual value and useful life are treated prospectively as changes in estimates.
- Future depreciation is recalculated based on the revised estimates, but past reported numbers are not restated.
This reflects the reality that estimates are inherently uncertain and are updated as better information arises.
When estimated residual value ≥ carrying amount
If at some point the estimated residual value is equal to or exceeds an asset’s carrying amount, the depreciable amount becomes zero, so depreciation stops until the estimate changes again.
For example, a prime‑location property may see land and building values rise significantly, so that the estimated residual value (what would be recovered at end of life) is higher than the current carrying amount. In such cases, depreciation may be suspended, but management must still review this estimate regularly to ensure it remains supportable.
High fair value does not cancel depreciation
Another source of confusion: “If fair value is much higher than carrying amount, can we stop depreciating?” The answer is no. Even if fair value is high, HKAS 16 still requires systematic allocation of depreciable amount over the asset’s remaining useful life.
Revaluation updates the base amount; it does not remove the fact that the asset’s service potential is consumed over time. So you may recognise a revaluation surplus in OCI, but afterwards you continue depreciating the revalued amount.
Link with HKAS 36 Impairment of Assets
When there are indicators that an asset may be impaired, such as:
- Rapid technological change making equipment obsolete
- A significant drop in market demand
- Physical damage or prolonged idle status
the entity must perform an impairment test under HKAS 36. If the carrying amount exceeds the recoverable amount, an impairment loss is recognised.
The interaction with depreciation is:
- Impairment reduces the carrying amount immediately.
- Future depreciation is then based on the lower, post‑impairment carrying amount and any updated useful life.
6. Depreciation‑related changes – estimate vs policy
A very common exam and audit question is: “If we change the depreciation method, is this a change of accounting policy or a change of estimate?”
HKAS 8 Accounting Policies, Changes in Accounting Estimates and Errors provides the answer.
Depreciation method, residual value and useful life: changes in estimate
HKAS 8 makes it clear that changes in:
- Depreciation method
- Residual value
- Useful life
are treated as changes in accounting estimates, not changes in accounting policies.
Why?
- These items reflect management’s latest expectations about how economic benefits will be consumed.
- As circumstances and usage patterns evolve, revising these estimates is normal, not a “policy switch”.
The accounting treatment is therefore:
- Apply the change prospectively from the date of change.
- Do not restate prior period figures.
Simple example: moving from diminishing balance to straight‑line
Suppose a company has been depreciating a machine using the diminishing balance method. Later, it concludes that actual usage is more even over time and decides that straight‑line better reflects the consumption pattern.
This is a change in estimate. In the financial statements:
- Current and future depreciation charges are adjusted based on the new method.
- Comparative figures are not restated; the notes explain the nature of the change and its financial effect.
By contrast, switching from the cost model to the revaluation model for an entire class of assets affects the underlying measurement basis and is normally treated as a change in accounting policy under HKAS 8, with the related disclosure requirements.
Key takeaways for students and junior accountants
- When you see PPE on a file, ask three questions in order: (1) Which model is used for subsequent measurement – cost or revaluation? (2) How are revaluation gains and losses split between OCI and profit or loss? (3) How are depreciation, useful life and residual value justified?
- In both exams and real work, explain clearly whether a change relates to the measurement model (usually a policy change) or to estimates like useful life, residual value or method (always treated as a change in estimate, applied prospectively).
- Do not stop depreciating just because an asset is idle or because fair value is high; only stop when the asset is derecognised, classified as held for sale, or when revised estimates give a residual value equal to or above the carrying amount.
- Avoid revenue‑based depreciation for PPE; if you see it in client records, that is a red flag that you should challenge and reconcile with HKAS 16 / IAS 16 requirements.
- In working papers, document for each significant class of PPE: the chosen model (cost or revaluation), the depreciation method and key assumptions, any revaluation movements and how they were split between OCI and profit or loss, and whether there are any impairment indicators requiring HKAS 36 testing.
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