Agreed with component depreciation.
But when we are not using component depreciation, is it fundamentally correct to present an expense, which is not at all existing physically, as part of asset and continue depreciating the old replaced part?
I feel it is fundamentally incorrect to include that part of expense relating to a replaced item and continue presenting it as asset while on the contrary that expense is no more an asset.
Moreover, just to substantiate, we also have standards to impair the asset if the book value exceeds recoverable amount which is also the case here.
Now you see why companies choose component depreciation: so that they can do just what you feel is fundamentally correct and not do what you feel is fundamentally incorrect.
Part of the problem is that this example is artificial; the cutter in a milling machine is not going to be 20% of the cost. (And, to be honest, you’re hardly going to get an industrial milling machine for $10,000. When I was a warhead designer we bought a computer numerically controlled (CNC) milling machine that probably cost a few hundred thousand dollars (in the 1980s); cutters were a few hundred dollars at most.) So, in this example, we’re depreciating the original cutter over 8 years even though we throw it away after 2 years. C’est la vie.
A more appropriate example might be buying a delivery truck. It costs you, say, $100,000 and will last for, say, 150,000 miles. When you buy the truck it comes with tires, which you’re going to have to replace more than once during the life of the truck. But when you depreciate the truck you will likely do it as a single asset; i.e., you won’t separate out the value of the original set of tires and depreciate those over their, say, 30,000-mile life. And, to be honest, when you replace them, you’ll likely expense the new tires, rather than depreciating them. (Of course, they may not last more than one year, depending on how many miles you put on the truck each year.)
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Wao… I must say, you really have great grasp over the topic. You literally made my doubt fly away.
Example of delivery truck and tires is a more appropriate example and the way you blended that example in our discussion is just awesome level of solving doubt. Tires are replaced to maintain the operating of truck at the same level and tires by themselves do not increase the value of the asset and thereby expensed off. (moreover it does not constitute a significant part of cost)
Thank you for giving such a good explanation.
My pleasure.
I knew that eventually I’d hit the Aha! combination.
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