Depreciation, Impairments, and Depletion

Chapter

11

Chapter 11-1

Depreciation - Method of Cost Allocation

Depreciation is the accounting process of allocating the cost of tangible assets to expense in a systematic and rational manner to those periods expected to benefit from the use of the asset.
Allocating costs of long-term assets:
Fixed assets = Depreciation expense Intangibles = Amortization expense Natural resources = Depletion expense

Chapter 11-2

Depreciation - Method of Cost Allocation

Factors Involved in the Depreciation Process
Three basic questions:
(1) What depreciable base is to be used? (2) What is the assets useful life?

(3) What method of cost allocation is best?

Chapter 11-3

Depreciation - Method of Cost Allocation

Methods of Depreciation
The profession requires the method employed be systematic and rational. Examples include:
(1) Activity method (units of use or production). (2) Straight-line method. (3) Sum-of-the-years-digits. (4) Declining-balance method. (5) Group and composite methods. (6) Hybrid or combination methods. Accelerated methods

Special methods

Chapter 11-4

Depreciation - Method of Cost Allocation

E11-5 (Depreciation ComputationsFour Methods): Maserati Corporation purchased a new machine for its assembly process on August 1, 2012. The cost of this machine was $150,000. The company estimated that the machine would have a salvage value of $24,000 at the end of its service life. Its life is estimated at 5 years and its working hours are estimated at 21,000 hours. Year-end is December 31. Instructions: Compute the depreciation expense under the following methods.

(a) Straight-line depreciation.

(b) Activity method
Chapter 11-5

(c) Sum-of-the-years-digits.
(d) Double-declining balance.

Depreciation - Method of Cost Allocation

Straight-line Method
Current Year 2012 2013 2014 2015 2016 2017 Depreciable Base $ 126,000 126,000 126,000 126,000 126,000 126,000 Years 5 = 5 5 5 5 5 = = = = = Annual Expense $ 25,200 25,200 25,200 25,200 25,200 25,200 x 7/12 = Partial Year 5/12 Year Expense = $ 10,500 25,200 25,200 25,200 25,200 14,700 $ 126,000 Accum. Deprec. $ 10,500 35,700 60,900 86,100 111,300 126,000

/ / / / / /

Journal entry: 2012 Depreciation expense Accumultated depreciation 10,500 10,500

Chapter 11-6

Depreciation - Method of Cost Allocation

Exercise (Activity Method):
Depreciation expense= Estimated cost per unit * actual units used in period
Where, Estimated cost per unit = (depreciable base/estimated total units of use)

Chapter 11-7

Depreciation - Method of Cost Allocation

Exercise (Sum-of-the-years-digits Method)
Depreciation Exp =
[Number of years left/ Sum of (years digits in Useful life)] * Depreciable base

Chapter 11-8

Depreciation - Method of Cost Allocation

# Declining Balance Method
Depreciation Exp = # * 1/Useful life * Book Value
Where # = the desired speed of the decline

Chapter 11-9

Depreciation - Method of Cost Allocation

See Exercise 11-1 for similar example

Chapter 11-10

Depreciation Other Issues

Changes in Depreciation Rate
Accounted for in the period of change and future periods (Change in Estimate) Not handled retrospectively First, establish NBV at date of change in estimate. (Requires calculation of past depreciation based on old assumptions) Second, use NBV and new assumptions to calculate depreciation from date of change
Example of change in estimate in Chapter 4 and Ex 11-11
Chapter 11-11

Impairments
When the carrying amount of an asset is not recoverable, a company records a write-off referred to as an impairment.
Examples of events that may lead to an impairment:
a. c. Decrease in the market value of an asset. Adverse change in legal factors or in the business climate. b. Change in the manner in which an asset is used. d. An accumulation of costs in excess of the amount originally expected to acquire or construct an asset. e. A projection or forecast that demonstrates continuing losses associated with an asset.

Chapter 11-12

Impairments
Measuring Impairments (BE 11-8)
1. Review events for possible impairment.
2. If the review indicates impairment, apply the recoverability test. i) If the sum of the expected future net cash flows from the long-lived asset is less than the carrying amount of the asset, an impairment has occurred. 3. Assuming an impairment, the impairment loss is the amount by which the carrying amount of the asset exceeds the fair value of the asset. The fair value is the market value or the present value of expected future net cash flows.
Chapter 11-13

Impairments
Illustration 11-16 Accounting for Impairments

Chapter 11-14

Impairments
Ex 11-16 is example of impairment for asset used in operations

Ex 11-17 is example of impairment for asset held for resale

Chapter 11-15

Depreciation - Method of Cost Allocation

Group/Composite Depreciation Methods
Large corporations owning many long-term assets have a choice as to whether to record depreciation on an asset-by-asset basis, or on a group basis using composite/group methods. Group method used when the assets are similar in nature and have approximately the same useful lives. Composite approach used when the assets are dissimilar and have different lives.
Chapter 11-16

Depreciation - Method of Cost Allocation

Group/Composite Depreciation Methods
1. 2.

Record original assets as Asset Group Compute depreciation rate based on original group
i) ii)

Calculate and sum straight line depreciation for each individual asset in original group Divide result by total cost of group of assets

3. 4.

Depreciation expense is total cost * depreciation rate. If group has dissimilar assets with differing useful lives, calculate composite life by dividing depreciable base of group by the annual depreciation expense calculated See BE 11-6 and extension for future purchases and sales

5.

Chapter 11-17

Presentation
Presentation of Property, Plant, Equipment, and Natural Resources
Depreciating assets, use Accumulated Depreciation. Depleting assets may include use of Accumulated Depletion account, or the direct reduction of asset.
Basis of valuation (cost) Pledges, liens, and other commitments Depreciation expense for the period. Balances of major classes of depreciable assets. Accumulated depreciation. A description of the depreciation methods used.

Disclosures

Chapter 11-18

Under both iGAAP and U.S. GAAP, interest costs incurred during construction must be capitalized. iGAAP, like U.S. GAAP, capitalizes all direct costs in selfconstructed assets. The accounting for exchanges of nonmonetary assets has recently converged between iGAAP and U.S. GAAP. iGAAP permits the same depreciation methods (straight-line, accelerated, units-of-production) as U.S. GAAP.

Chapter 11-19

As discussed in the Chapter 4 Convergence Corner, iGAAP permits asset revaluations (which are not permitted in U.S. GAAP). Consequently, companies that use the revaluation framework must follow revaluation depreciation procedures.

iGAAP also uses a fair value test to measure the impairment loss. However, iGAAP does not use the first-stage recoverability test used under U.S. GAAPcomparing the undiscounted cash flows to the carrying amount. Thus, the iGAAP test is more strict than U.S. GAAP.

Chapter 11-20