Component depreciation

What it means

Component depreciation is a method of accounting depreciation in which one asset is split into significant parts, or components, with different useful lives, and each is depreciated separately. The classic example is a building, whose structure lasts decades, the roof and facade less, and lifts or ventilation even less.

Slovak accounting procedures allow component depreciation but do not require it. A company can choose it in its accounting policy and depreciation plan, deciding which components are significant and what their useful lives are. Under IFRS the component approach is standard.

Component depreciation does not apply to tax depreciation. For tax the asset is depreciated as a whole according to its depreciation group, and the difference between accounting and tax depreciation goes into the tax base and, where relevant, deferred tax.

How it works in practice

Component depreciation is most useful for buildings and large production lines. When the roof is replaced after fifteen years, under the component approach its original value has already been depreciated and the new roof is recognised as a new component. Without it, the replacement would have to be treated as a repair or a capital improvement of the whole building.

When the asset is put into use we split its cost into components using the construction budget or suppliers’ invoices. Each component has its own asset card, depreciation period and accumulated depreciation. The breakdown is best done at acquisition, as the data are hard to gather later.

The component approach improves the true and fair view: results are not distorted by one-off costs of replacing major parts, and the balance sheet better reflects the real condition of the assets. For banks and investors it is an argument when assessing an asset-heavy company.

What to watch out for

The most common mistake is splitting assets into dozens of components, which only adds administration. A component should be a part that is significant in value and has a markedly different life. Minor parts are depreciated together with the main asset.

The second risk is a mismatch with tax records. As tax depreciation treats the asset as a whole, two sets of records are needed, and when a component is replaced it must be correctly assessed whether for tax it is a repair or a capital improvement. Otherwise there is a risk of an incorrect tax base.