ACCT2014

Depreciation, Impairments and

Depletion
By the end of the session students should be able
to:
Apply different types of depreciation methods
 activity
 straight line
 diminishing charge
Explain accounting issues relating to
asset impairment
depletion of mineral resources
 Depreciation is defined as the accounting process of allocating the cost
of plant, property and equipment in a systematic way over the useful
life of the asset.
 Previously depreciation was based solely on initial estimates, however
IRFS requires that these estimates are reviewed annually. E.g. residual
value when revisited can increase or decrease and this would have to
be taken into consideration when calculating annual depreciation
expense depending on the depreciation method used.
 Depreciable Base
 Asset’s useful life
 Method of Depreciation
 Depreciable Base - Original cost minus Residual value or
salvage value (the amount the company wishes to sell the
asset for in the future when it is removed from service)
 Useful life - The period in which the asset will be useful, used
in the business. Companies usually stop using an asset for
physical, economic ad internal reasons. IFRS have identified
the following factors that need to be considered when
determining the useful life of an asset: expected usage,
physical wear and tear and technical and commercial
obsolescence
Methods of depreciation - The depreciation method should
reflect the pattern in which the asset’s future economic benefits
are expected to be consumed by the company. There are
several methods of depreciation.
 Activity Method
 Straight-Line Method
 Diminishing Charge Method
 Sum-of-the-Year’s-Digits
 Double Declining Balance
 The activity method is also referred to as the variable charge or unit of
production method.
 This method is based on the assumption that depreciation is a function of use,
or productivity rather than the passage of time.
 The life of the asset is considered in terms of unit of output or number of
hours of hours worked
 Limitations:
 This method is inappropriate in situations where depreciation is a
function of time and not activity.
 In instances where economic or functional factors affect an asset,
independent of use this method loses its significance.
 It is difficult to estimate units of output or service hours received.
Formula
Depreciation per unit = Cost - Residual value
Total units of output

Depreciation charge = Units of output * Depreciation

for period per unit
Depreciation is considered as a function of time rather
than a function of usage.
Most commonly used method.
Simplest method to calculate depreciation charge.
Most conceptually appropriate method
However, this method is inappropriate for assets which decline in
value over time
Formula:
Depreciation charge = Cost - Residual Value
Useful life

Or
= (Cost – Residual Value) x SL Rate
SL Rate (as a %) = 100/n, where n = years of useful life
E.g. if n =5; SL Rate = 100/5 = 20%
Depreciation charge is higher in earlier years
and becomes lower in later years

The main justification for this method is an

asset is more functional in earlier years and
require more maintenance and repairs as it
ages.
 Two main methods of Diminishing Charge
are:
▪Sum-of-the-year’s-digits
▪Declining balance method
This method results in a decreasing depreciation based
on a decreasing fraction of the depreciable base.
 Each fraction uses the sum of the years as the
denominator and the estimating useful life remaining
as the numerator.
The numerator decreases year by year but the
denominator remains constant.
At the end of the assets useful life the asset balance
should equal the residual value.
 Components of the Sum-of-Year’s-Digits method

 Depreciable Base - Cost of the asset minus residual value

 Numerator - The remaining life in years as of the beginning of that year

 Denominator - The sum of the remaining life in years during the life of the asset.

E.g. if an asset is 5 years. This is calculated by adding the remaining life each year

(5+4+3+2+1)= 15

or [n(n + 1)]/2 hence, [5(5 + 1)]/2 =15

 Depreciation Fraction - The remaining life in years ➗ the
sum of the years of remaining useful life.
▪E.g. in Year 1 the depreciation fraction for an asset with a
useful life of 5 years is 5/15.

 Deprecation expense = depreciable * depreciation

base fraction
 Tech Co purchased a delivery van on January 1, 2018 for $400,000
with a useful life of 5 years and zero residual value . Prepare the
Sum of the Year’s Digit Depreciation Schedule
Solution: Depreciation
Depreciable Remaining Life Depreciation Expense
Year Base in Years Fraction (figures
$ rounded) $
1 400,000 5 5/15 133,333
2 400,000 4 4/15 106,666
3 400,000 3 3/15 80,000
4 400,000 2 2/15 53,333
5 400,000 1 1/15 26,668*
* Rounding discrepancy 15 15/15 400,000
 This method charges a higher
depreciation in earlier years and
reduces the depreciation charge in
later years.
 The justification is that the asset will
require more maintenance and repair
in later years.
The residual value is ignored when using
this method.

The depreciation rate is double the

straight line depreciation rate
Formula
Depreciation rate =
Straight Line Rate x 2

Depreciation charge=
Net Book Value x Depreciation rate

 Net Book Value = Cost – Accum. Dep’n

Tom Door Corp. purchased machinery for $300,000 on May 1, 2017.
It is estimated that it would have a useful life of 10 years, residual
value of $20,000, production of 290,000 units. During period May
2017 to April 2018, Tom Door Corp uses the machinery to produce
30,000 units. The financial ends April 30. Depreciation is calculated
on the basis of the nearest full month.

Instructions:
From the information given, compute the depreciation charge for
year to April 30, 2018 under each of the following methods. (Round
to the nearest dollar.)
a) Straight-line
b) Units-of-output
c) Sum-of-the-years’-digits
d) Double-declining-balance
a)Straight-line = (original cost-residual value)/estimated
useful life
= ($300,000-$20,000)/10 years
= $280,000/10
= $28,000

b)Unit Depreciation= (Original Cost - Residual Value)

Total Units Produced
Depreciation per unit = ($300,000 - $20,000)
290,000
= $0.97

Depreciation charge = 30,000*$0.97

= $29,100
c)
Sum-of–the-years’-digits = (Original Cost –Residual Value) *
Remaining life in years ➗ sum of remaining life in years
Depreciable base
= $300,000 - $20,000
= $280,000

Denominator
= 10+9+8+7+6+5+4+3+2+1
= 55

or [10(10 + 1)]/2 = [10 x 11] /2 = 55

Numerator in 2018 = 10
Formula = $280,000 * 10/55
= $50,909
d)
Double Declining Balance Method
= Original cost * double declining rate

Original cost = $300,000

Double declining rate = [100 /10] * 2= 20%

Dep’n = $300,000*20%
= $55,800

•Double declining rate is twice the straight line

rate, in this instance the asset had a 10 year useful
life, therefore the straight line rate is 100/10=10%.
The double declining rate is 10%*2= 20%
Tom Door Corp. purchased machinery for $300,000 on May 1, 2017.
It is estimated that it would have a useful life of 10 years, residual
value of $20,000, production of 290,000 units. During 2018, Tom
Door Corp uses the machinery to produce 30,000 units. The
financial ends December 31. Depreciation is calculated on the basis
of the nearest full month.

Instructions:
From the information given, compute the depreciation charge for
2017 and 2018 under each of the following methods. (Round to the
nearest dollar.)
a) Straight-line
b) Units-of-output
c) Sum-of-the-years’-digits
d) Double-declining-balance
A long-lived tangible asset is impaired when a
company is not able to recover carrying amount of
the asset either by using or selling it.

A company determines if an asset is impaired on an

annual basis by reviewing the asset for indicators of
impairments, i.e. a decline in the asset’s cash-
generating ability through use or sale.
The review considers both internal (adverse
changes in performance)and external sources
(adverse changes in the business or regulatory
environment) of information.

IAS 36 identifies signs of impairment, these are

outlined on the next slide.
INTERNAL INDICATORS
 Obsolescence
 Physical damage
 Significant changes in how
the asset is used (E.g. excess
capacity)
 Worse economic
performance than expected
EXTERNAL INDICATORS
 Observable indication of a
decline in value
 Changes in technology
 Adverse market conditions
(E.g. recession and changes
in demand)
 Carrying value of the
business’ net assets is
greater than its
capitalization.
 Once impairment indicators are present, then an
impairment test MUST be done on the asset.

 An impairment test compares the asset’s

recoverable amount with its carrying amount.
▪ If the carrying amount is higher than the recoverable
amount, the difference is an impairment loss.
▪ If the carrying amount is lower than the recoverable
amount, no impairment is recorded.
 Recoverable amount is the higher of fair value less
cost to sell or value-in use.

 Fair value less cost to sell refers to what the asset

could be sold for after deducting costs of disposal.

 Value-in-use is the present value of cash flows

expected from the future use and eventual sale of the
asset at the end of the useful life.
To record the impairment loss:
Dr. Loss on Impairment xx
Cr. Accum. Dep’n – Asset xx
 After recording the impairment loss, the recoverable amount
becomes the carrying amount of the impaired asset.
 In a subsequent period when the asset is reviewed and the
recoverable amount is higher than the carrying amount, the
impairment loss may be reversed.
 The entry to illustrate the reversal is as follows:
Accumulated Depreciation - Asset XX
Recovery of Impairment Loss XX
 The general rule relating to reversals of impairment
loss is that the amount of recovery of the loss is limited
to the carrying amount of that would result if the
impairment had not occurred.

 Recovery of impairment loss is reported in the “other

income and expense” section of the Income
Statement.
 It is sometimes impossible to assess a single asset for
impairment because the asset generates cash flows only in
combination with other assets.

 Cash-generating-unit (CGU) is a smallest group of assets that

can be identified that generates cash flows independently of
the cash flows from other assets.

 If a company is reviewing the plant assets for indicators of

impairment, and the assets are dependant on each other to
generate cash flows, they should be evaluated together as a
cash-generating unit in the impairment assessment.
The management of Tom Door Corp is contemplating whether certain equipment should
be written off as a charge to current operations because of obsolescence. The equipment
has a cost of $1,000,000 with depreciation to date of $500,000 as of December 31, 2018. On
December 31, 2018, management projected the present value of future net cash flows from
this equipment to be $300,000 and its fair value lest cost of disposal to be $270,000. The
Company intends to use the equipment in the future. The remaining useful life of the
equipment is 4 years.
Required:
a) Prepare the journal entry (if any) to record the impairment at December 31, 2018.
b) Where should the gain or loss (if any) on the write–down be reported in the income
statement.
c) At December 31, 2019, the equipment’s recoverable amount is $250,000. Prepare the
journal entry (if any).
d) What accounting issues did management face in accounting for this impairment?
a)
December 31, 2018
Loss on Impairment $200,000
Accum. Dep’n (Equipment) $200,000

Working: $
Cost 1,000,000
Accum. Dep’n (Equipment) (500,000)
500,000
Recoverable Cost (300,000)
Impairment loss 200,000

NB
Recoverable cost = value in use of $300,000 because it is
greater than the fair value less cost of disposal of $270,000
b) It should be reported in the other income and expense section in
the income statement.

c)
December 31, 2019
Accum. Dep’n—Equipment 25,000
Recovery of Impairment Loss 25,000

Working:
Recoverable Amt. at Dec 31, 2019 $250,000
Recoverable Amt. at Dec 31, 2018 300,000
Dep’n Expense ($300,000/4 yrs) (75,000)
Carrying Value at Dec 31, 2019 225,000

Recovery of Impairment loss 25,000*

d)
To determine whether an asset is impaired, companies review the
asset annually for indicators of impairment, a decline in the asset’s
cash-generating ability through use or sale. If impairment
indicators are present, then the company compares the asset’s
recoverable amount with its carrying amount.

 If the carrying amount is higher than the recoverable

amount, the difference is an impairment loss.
 Recoverable amount is defined as the higher of fair value
less costs to sell or value-in-use.
Depletion is the process of allocating the cost of
mineral resources.
Mineral resources have two main features:
▪The complete removal (consumption) of an
asset;
▪Replacement of an asset only by act of nature.
 Determining the depletion base involves properly
accounting for the following three types of
expenditure:
▪Pre-exploratory costs
▪Exploratory and evaluation costs
▪Development costs

 Depletion is usually computed using the unit of

production method.
Formula used to compute the depletion rate
= Total cost - Residual Value
Total estimated units available

In instances where companies change the estimate

of recoverable reserves, the procedure is to revise
the depletion rate on a prospective basis. (Divide
the remaining cost by the new estimate of the
recoverable reserves).
Presentation on the Financial Statements

Companies should disclose the following related to the E &

E expenditures.
1. The accounting policies for exploration and evaluation
expenditures, including the recognition of E&E assets.
2.The amounts of assets, liabilities, income, expenses and
operating cash flow arising from the exploration for and
evaluation of mineral resources.
Gozak Mining Company purchased land on March 1, 2018, at a cost of $1,000,000. It estimated a total
of 60,000 tons of mineral was available for mining. After it has removed all the mineral resources, the
company is required to restore the property to its previous state because of strict environmental
protection laws.
It estimates the fair value of this restoration obligation at $90,000. It believes it will be able to sell the
property afterwards for $280,000. It incurred development costs of $200,000 before it was able to do
any mining. During 2018, resources removed totalled 30,000 tons. The company sold 24,000 tons.
Required:
Compute the following information for 2018:
a) Per unit mineral cost.
b) Depletion cost for 2018. Prepare the necessary journal entry.
c) Total material cost of December 31, 2018, inventory.
d) Total materials cost in cost of goods sold at December 31, 2018. Prepare the necessary journal
entry.
a)
Per Unit Mineral Cost = Depletion Rate
Depletion Rate = $1,010,000 ÷ 60,000
= $16.83/ton

Working:
Depletion Base:
$1,000,000 + $90,000 – $280,000 + $200,000
= $1,010,000
b)
Depletion cost for 2018. Prepare the necessary journal
entry.
Units Removed = 30,000 tons
Depletion cost = 30,000 x $16.83
= $504,900

Journal Entry:
Inventory $504,900
Accumulated Depletion $504,900
c)
Total Material cost inventory at December 31, 2018:
Removed Sold
Inventory = 30,000 tons – 24,000 tons
= 6,000 tons

Inventory Cost = $16.83 X 6,000 tons

= $100,980
d)
Total materials cost in cost of goods sold at December
31,2018:
Units Sold = 24,000 tons

$16.83 X 24,000 tons

= $403,920

Journal Entry:
Cost of Goods Sold $403,920
Inventory $403,920
Kieso et al, 2014 (Intermediate Accounting,(IFRS Edition) 2nd
Edition), Wiley, USA
Arnold G & Kyle S (Intermediate Financial Accounting, Volume 1)