How Revenue-Based Depreciation Methods Are Evaluated under IFRS and US GAAP

Depreciation allocates the cost of an asset over the period in which it generates economic benefits. While most entities use straight-line or units-of-production methods, some industries—especially mining, oil and gas, and entertainment—attempt to link depreciation directly to revenue. Both IFRS (IAS 16 and IAS 38) and US GAAP (ASC 360) restrict the use of revenue-based depreciation, emphasizing that revenue reflects output performance, not asset consumption.

The key principle under both standards is that depreciation must reflect the pattern in which the asset’s future economic benefits are consumed, not the income generated by its use.

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How depreciation methods are determined under IFRS and US GAAP

IFRS (IAS 16.60):An entity must select a method that most closely reflects the pattern of consumption of the asset’s future economic benefits. Acceptable methods include:

• Straight-line (constant consumption),

• Diminishing balance (accelerated), or

• Units of production (based on output or usage).

Revenue-based methods are prohibited, except in rare cases where revenue and consumption are directly correlated, such as for rights linked to production volumes or royalties.

US GAAP (ASC 360-10-35):Similar principle—depreciation must reflect the asset’s pattern of economic consumption. Revenue-based methods are generally not acceptable, as they are considered a measure of output performance, not consumption.

Example:A power plant operates under a 20-year supply contract with fixed annual capacity but variable electricity prices. Revenue fluctuates with market prices, not with the physical use of the plant. Therefore, depreciation based on revenue would distort cost allocation.

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Why revenue-based methods are discouraged

Under both frameworks, the logic is clear:

• Revenue volatility reflects market demand, pricing, and inflation—not the physical wear or efficiency loss of an asset.

• Linking depreciation to revenue can delay expense recognition in low-revenue periods and overstate profit volatility.

• The method violates the matching principle when revenue and asset use diverge.

IFRS Clarification (Amendments to IAS 16 and IAS 38, 2014):The IASB explicitly stated that “a revenue-based method cannot be used to depreciate property, plant and equipment” because revenue is influenced by other factors unrelated to asset consumption.

US GAAP Enforcement (SEC guidance):Revenue-based depreciation is rarely accepted except for assets whose consumption is directly tied to the revenue stream (e.g., film rights recognized on a revenue-sharing basis).

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When revenue-based methods may still apply

Permitted exceptions under IFRS and GAAP include:

• Intangible assets whose economic benefits are consumed in direct proportion to revenue (e.g., licenses, royalties, or mineral rights).

• Production-based assets where revenue volume equals physical depletion (e.g., units extracted from a mine).

Example — royalty-based license:A media company acquires distribution rights costing 2,000,000, expected to generate total lifetime revenue of 10,000,000.In Year 1, revenue = 2,500,000 → 25% of total.Depreciation expense = 25% × 2,000,000 = 500,000.

Entry:

• Debit: Amortization Expense 500,000

• Credit: Accumulated Amortization – Intangible Asset 500,000

Here, the pattern of consumption (license use) is clearly aligned with revenue generation.

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Comparative framework between IFRS and US GAAP

Aspect	IFRS (IAS 16 / IAS 38)	US GAAP (ASC 360)
Principle	Reflect pattern of consumption of benefits	Same principle
Revenue-based depreciation	Generally prohibited (2014 amendment)	Generally prohibited
Permitted exceptions	Intangibles tied to revenue (royalty or license)	Intangibles or natural resources
Review frequency	Method reviewed annually	Method reviewed when circumstances change
Residual value reassessment	At least annually	When significant changes occur
Disclosure	Method, useful life, rate, and justification	Same requirement

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Worked example — depreciation comparison

Scenario:An oil extraction platform costs 10,000,000 with an estimated output capacity of 1,000,000 barrels. Total expected revenue = 100,000,000.

Case 1 – Units-of-production (IFRS/GAAP accepted):If 100,000 barrels extracted in Year 1 → 10% of total → depreciation = 1,000,000.

Entry:

• Debit: Depreciation Expense 1,000,000

• Credit: Accumulated Depreciation 1,000,000

Case 2 – Revenue-based (not acceptable):If Year 1 revenue = 12,000,000 → 12% of total → depreciation = 1,200,000.This method reflects price changes, not resource depletion—therefore, inconsistent with both standards.

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Disclosure requirements

Entities must disclose:

• Depreciation method used and rationale.

• Useful lives or rates.

• Gross carrying amount and accumulated depreciation.

• Any changes in method or estimates, with quantitative impact.

Example disclosure excerpt:

Asset Class	Method	Useful Life	Depreciation Expense (USD)
Production Equipment	Units-of-Production	10 years / output-based	1,000,000
Licenses	Revenue-Based (justified)	5 years	500,000

If a revenue-based approach is used for an intangible, detailed explanation and sensitivity analysis must be provided under IAS 38.126 and ASC 350-30-50.

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Journal entries summary

1) Recognition of PPE:

• Debit: PPE / Intangible Asset xx

• Credit: Cash / Payables xx

2) Annual depreciation – straight-line:

• Debit: Depreciation Expense xx

• Credit: Accumulated Depreciation xx

3) Annual depreciation – units-of-production:

• Debit: Depreciation Expense xx

• Credit: Accumulated Depreciation xx

4) Amortization of revenue-tied intangible:

• Debit: Amortization Expense xx

• Credit: Accumulated Amortization xx

5) Change in method (if justified):

• Disclosure only; no retrospective adjustment unless prior method was inappropriate.

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Impact on financial performance and ratios

• EBITDA: unaffected, as depreciation is below EBITDA.

• Net profit: can fluctuate significantly if revenue-based methods were previously used and replaced.

• ROA and ROCE: improve with smoother expense recognition.

• Cash flow: unaffected by depreciation method choice.

• Comparability: enhanced when all entities use consumption-based, not performance-based, depreciation.

Eliminating revenue-linked depreciation improves period-to-period comparability and aligns expense recognition with asset usage rather than market factors.

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Operational considerations

Companies must:

• Reassess depreciation methods at least annually for consistency with asset use.

• Justify any exception for intangible or royalty-linked assets in disclosure notes.

• Coordinate with tax reporting if fiscal depreciation differs.

• Ensure alignment between operational output data and accounting records.

Under IFRS and US GAAP, depreciation policy is not a revenue recognition tool but a consumption measurement principle. Consistent application ensures that asset cost allocation reflects real economic usage rather than fluctuating revenue cycles.

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