CASE STUDY: Should stand-by equipment be depreciated?

14/09/13 23:06

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CASE STUDY: Should stand-by equipment

be depreciated? Follow 516,485

CASE STUDY: Should stand-by equipment be depreciated? If

yes, what determines the useful life (that will inform the
depreciation rate) of the stand-by equipment?

Case Study
An entity installed two specialized electrical devices in its water treatment plant. The first of the
two devices functions together with other electrical gadgets in the plant to produce energy that
is required for the water treatment process. The second specialized electrical device is
installed as stand-by/backup equipment in case the first one suddenly fails, or is rendered out
of service. From experience it has been established that the likelihood that such stand-
by/backup equipment will ever be used is very low. However, the installation of the backup is
highly necessary to ensure continuity in the treatment process at all times.

Question
Should the second device which serves as stand-by equipment be depreciated? If yes, what is
the useful life of the equipment?

Solution
The standby/backup equipment should be depreciated. IAS 16 requires that depreciation of an
asset commences when it is available for use i.e. when it is in the condition and location
necessary for it to be capable of operating in the manner intended by management. Therefore,
the moment the second device is installed to serve as backup to ensure continuity of the water
treatment process, depreciation has to commence. One may be tempted to argue against this
treatment since the second device is actually not working like the first device but only on stand-

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CASE STUDY: Should stand-by equipment be depreciated? 14/09/13 23:06

by incase of failure of the latter. However, the answer lies in the fact that the device is already
performing the function intended by management which is to provide BACKUP. Therefore,
since it is contributing to the operations of the entity, its cost must be charged/recognised
appropriately.

The stand-by equipment's useful life will be determined by the useful life of the first specialized
device for which it serves as a backup. The useful life may also be the useful life of the
treatment plant (of which the specialized device is part of) if this is shorter.

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CASE STUDY: Should stand-by equipment be depreciated? 14/09/13 23:06

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