ch11_Fixed asset II - Depreciation, Impairments, and...

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Unformatted text preview: Depreciation, Impairments, and Depreciation, Depletion Depletion Chapter 11 Chapter 11 Intermediate Accounting 12th Edition Update Kieso, Weygandt, and Warfield Chapter 11-1 Prepared by Coby Harmon, University of California, Santa Barbara Learning Objectives 1. 2. 3. Explain the concept of depreciation. Identify the factors involved in the depreciation process. Identify factors Compare activity, straight-line, and decreasing-charge Compare activity straight-line and methods of depreciation. methods Explain special depreciation methods. Explain the accounting issues related to asset impairment. Explain asset Explain the accounting procedures for depletion of natural Explain resources. resources Explain how to report and analyze property, plant, equipment, Explain and natural resources. and 4. 5. 6. 7. Chapter 11-2 D epr eci a ti on, I mpa i r ments, a nd D epl eti on Depreciation Factors involved Methods of Methods depreciation depreciation Special methods Special issues Impairments Recognizing Recognizing impairments impairments Measuring Measuring Impairments Impairments Restoration of Restoration loss loss Assets to be Assets disposed of disposed Depletion Establishing a Establishing base base Write-off of Write-off resource cost resource Continuing Continuing controversy controversy Special problems Presentation and Presentation Analysis Analysis Presentation Analysis Chapter 11-3 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 11-4 LO 1 Explain the concept of depreciation. 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 asset’s useful life? (3) What method of cost allocation is best? Chapter 11-5 LO 2 Identify the factors involved in the depreciation process. Depreciation - Method of Cost Allocation Methods of Depreciation The profession requires the method employed be “systematic and rational.” Examples include: (1) (2) (3) (4) (5) (6) Activity method (units of use or production). Straight-line method. Sum-of-the-years’-digits (SYD). Declining-balance method. Group and composite methods. Hybrid or combination methods. Accelerated methods Special methods Chapter 11-6 LO 3 Compare activity, straight-line, and decreasing-charge LO methods of depreciation. methods Depreciation - Method of Cost Allocation Exercise (Depreciation Computations—Four Methods) Robert Parish Corporation purchased a new machine for its assembly process on September 30, 2007. The cost of this machine was $117,900. The company estimated that the machine would have a salvage value of $12,900 at the end of its service life. Its life is estimated at 5 years and its working hours are estimated at 1,000 hours. Year-end is December 31. Instructions: Compute the depreciation expense under the following methods. (a) Straight-line depreciation. (b) Activity method. (c) Sum-of-the-years’-digits (SYD). (d) Double-declining balance (DDB). Chapter 11-7 LO 3 Compare activity, straight-line, and decreasing-charge LO methods of depreciation. methods Depreciation - Method of Cost Allocation Exercise (Straight-line Method) Year 2007 2008 2009 2010 2011 2012 Depreciable Base $ 105,000 105,000 105,000 105,000 105,000 105,000 Years 5 5 5 5 5 5 Annual Expense $ 21,000 21,000 21,000 21,000 21,000 21,000 Partial Year 3/12 Current Year Accum. Expense Deprec. =$ 5,250 $ 5,250 21,000 26,250 21,000 47,250 21,000 68,250 21,000 89,250 = 15,750 105,000 $ 105,000 / / / / / / = = = = = = x x 9/12 Journal entry: 2007 Depreciation expense Accumultated depreciation 5,250 5,250 Chapter 11-8 LO 3 Compare activity, straight-line, and decreasing-charge LO methods of depreciation. methods Depreciation - Method of Cost Allocation Exercise (Activity Method) ($105,000 / 1,000 hours = $105 per hour) Year 2007 2008 2009 2010 2011 (Given) Hours Used 200 150 250 300 100 1,000 Rate per Hours $105 105 105 105 105 Annual Expense $ 21,000 15,750 26,250 31,500 10,500 Partial Year Current Year Expense $ 21,000 15,750 26,250 31,500 10,500 $ 105,000 Accum. Deprec. $ 21,000 36,750 63,000 94,500 105,000 x x x x x = = = = = Journal entry: 2007 Depreciation expense Accumultated depreciation 21,000 21,000 Chapter 11-9 LO 3 Compare activity, straight-line, and decreasing-charge LO methods of depreciation. methods Depreciation - Method of Cost Allocation Exercise (Sum-of-the-years’-digits Method) Year 2007 2008 2009 2010 2011 2012 Depreciable Base $ 105,000 105,000 105,000 105,000 105,000 105,000 Years 5/15 4.75/15 3.75/15 2.75/15 1.75/15 .75/15 Annual Expense $ 35,000 33,250 26,250 19,250 12,250 5,250 Partial Year 3/12 Current Year Accum. Expense Deprec. $ 8,750 $ 8,750 33,250 42,000 26,250 68,250 19,250 87,500 12,250 99,750 5,250 105,000 $ 105,000 x x x x x x = = = = = = x Journal entry: 2007 Depreciation expense Accumultated depreciation 8,750 8,750 Chapter 11-10 LO 3 Compare activity, straight-line, and decreasing-charge LO methods of depreciation. methods Depreciation - Method of Cost Allocation Exercise (Double-Declining Balance Method) Year 2007 2008 2009 2010 2011 2012 Depreciable Base $ 117,900 106,110 63,666 38,200 22,920 13,752 Rate per Year 40% 40% 40% 40% 40% 40% Annual Expense $ 47,160 x 42,444 25,466 15,280 9,168 5,501 Partial Year 3/12 Current Year Expense =$ 11,790 42,444 25,466 15,280 9,168 852 $ 105,000 Accum. Deprec. $ 11,790 54,234 79,700 94,980 104,148 105,000 x x x x x x = = = = = = Plug Journal entry: 2007 Depreciation expense Accumulated depreciation 11,790 11,790 Chapter 11-11 LO 3 Compare activity, straight-line, and decreasing-charge LO methods of depreciation. methods Depreciation - Method of Cost Allocation Special Depreciation Methods The choice of method depends on the nature of the assets involved: 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. Companies are also free to develop tailor-made depreciation methods, provided the method results in the allocation of an asset’s cost in a systematic and rational manner (Hybrid or Combination Methods). Chapter 11-12 LO 4 Explain special depreciation methods. Depreciation - Method of Cost Allocation Composite method (p. 528) Mooney Motors established the composite depreciation rate for its cars, trucks, and campers as shown below: Original cost Cars Trucks Campers $145,000 44,000 35,000 $224,000 Residual value $25,000 4,000 5,000 Depreciable cost $120,000 40,000 30,000 $190,000 Life 3 4 5 Depreciation Per year $40,000 10,000 6,000 $56,000 Composite depreciation rate = $56,000/ $224,000 = 25% Composite life = 3.39 years ($190,000/ $56,000) Chapter 11-13 LO 4 Explain special depreciation methods. Depreciation - Method of Cost Allocation Special Depreciation Issues (1) How should companies compute depreciation for partial periods? Companies normally compute depreciation on the basis of the nearest full month. (2) Does depreciation provide for the replacement of assets? Funds for the replacement of the assets come from the revenues (3) How should companies handle revisions in depreciation rates? Chapter 11-14 LO 4 Explain special depreciation methods. Depreciation - Method of Cost Allocation Changes in Depreciation Rate Accounted for in the period of change and future periods (Change in Estimate) Not handled retrospectively Not considered errors or extraordinary items Chapter 11-15 LO 4 Explain special depreciation methods. Change in Estimate Example Arcadia HS, purchased equipment for $510,000 which was estimated Arcadia to have a useful life of 10 years with a salvage value of $10,000 at the end of that time. Depreciation has been recorded for 7 years on a straight-line basis. In 2005 (year 8), it is determined that the total estimated life should be 15 years with a salvage value of $5,000 at the 15 $5,000 end of that time. end Questions: What is the journal entry to correct What the prior years’ depreciation? the Calculate the depreciation expense Calculate for 2005. for Chapter 11-16 No Entry No Required Required LO 4 Explain special depreciation methods. Change in Estimate Example Equipment cost Equipment Salvage value Depreciable base Useful life (original) Annual depreciation After 7 years $510,000 $510,000 First, establish NBV - 10,000 at date of change in estimate. 500,000 estimate. 10 years years $350,000 $ 50,000 x 7 years = $350,000 Balance Sheet (Dec. 31, 2004) (Dec. Fixed Assets: Equipment Accumulated depreciation Net book value (NBV) Net Chapter 11-17 $510,000 350,000 350,000 $160,000 LO 4 Explain special depreciation methods. Change in Estimate Example Net book value Net Salvage value (new) Salvage Depreciable base Useful life remaining Annual depreciation Journal entry for 2005 Depreciation expense Accumulated depreciation Chapter 11-18 After 7 years Depreciation Depreciation Expense calculation for 2005. for $160,000 $160,000 5,000 5,000 155,000 8 years $ 19,375 19,375 19,375 19,375 LO 4 Explain special depreciation methods. Impairments When the carrying amount of an asset is not recoverable, a company records a write-off referred to as an impairment. Events leading to an impairment: a. Decrease in the market value of an asset. b. Change in the manner in which an asset is used. c. Adverse change in legal factors or in the business climate. 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 11-19 LO 5 Explain the accounting issues related to asset impairment. Impairments Measuring Impairments 1. Review events for possible impairment. 2. If the review indicates impairment, apply the recoverability test. 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 11-20 LO 5 Explain the accounting issues related to asset impairment. Impairments Illustration 11-16 Accounting for Impairments Chapter 11-21 LO 5 Explain the accounting issues related to asset impairment. Impairments Impairments E11-16 (Impairment) Presented below is information related to equipment owned by Suarez Company at December 31, 2007. Assume that Suarez will continue to use this asset in the future. As of December 31, 2007, the equipment has a remaining useful life of 4 years. Cost Accumulated depreciation to date Expected future net cash flows Fair value $ 9,000,000 1,000,000 7,000,000 4,800,000 Instructions: (a) Prepare the journal entry (if any) to record the impairment of the asset at December 31, 2007. (b) Prepare the journal entry to record depreciation expense for 2008. (c) The fair value of the equipment at December 31, 2008, is $5,100,000. Prepare the journal entry (if any) necessary to record this increase in fair value. Chapter 11-22 LO 5 Explain the accounting issues related to asset impairment. Impairments (a). Cost Accumulated depreciation Carrying amount Fair value Loss on impairment $9,000,000 1,000,000 8,000,000 4,800,000 $3,200,000 12/31/07 Loss on impairment Accumulated depreciation Chapter 11-23 3,200,000 3,200,000 LO 5 Explain the accounting issues related to asset impairment. Impairments (b) Net carrying amount Useful life Depreciation per year $4,800,000 4 years $1,200,000 12/31/08 Depreciation expense Accumulated depreciation 1,200,000 1,200,000 (c) Restoration of any impairment loss is not permitted. Chapter 11-24 LO 5 Explain the accounting issues related to asset impairment. Depletion Natural resources, often called wasting assets, include petroleum, minerals, and timber. They have two main features: 1. complete removal (consumption) of the asset, and 2. replacement of the asset only by an act of nature. Depletion is the process of allocating the cost of natural resources. Chapter 11-25 LO 6 Explain the accounting procedures for depletion of natural resources. Depletion Establishing a Depletion Base Computation of the depletion base involves four factors: (1) Acquisition cost of the deposit, (2) Exploration costs, (3) Development costs, and (4) Restoration costs. Chapter 11-26 LO 6 Explain the accounting procedures for depletion of natural resources. Depletion Write-off of Resource Cost Normally, companies compute depletion on a units-ofproduction method (an activity approach). Thus, depletion is a function of the number of units extracted during the period. Calculation: Total cost – Salvage value Total estimated units available Units extracted x Cost per unit Chapter 11-27 = Depletion cost per unit = Depletion LO 6 Explain the accounting procedures for depletion of natural resources. Depletion E11-19 (Depletion Computations—Timber) Stanislaw Timber Company owns 9,000 acres of timberland purchased in 1996 at a cost of $1,400 per acre. At the time of purchase the land without the timber was valued at $400 per acre. In 1997, Stanislaw built fire lanes and roads, with a life of 30 years, at a cost of $84,000. Every year Stanislaw sprays to prevent disease at a cost of $3,000 per year and spends $7,000 to maintain the fire lanes and roads. During 1998, Stanislaw selectively logged and sold 700,000 board feet of timber, of the estimated 3,500,000 board feet. In 1999, Stanislaw planted new seedlings to replace the trees cut at a cost of $100,000. Instructions: Determine the depreciation expense and the cost of timber sold related to depletion for 1998. Chapter 11-28 LO 6 Explain the accounting procedures for depletion of natural resources. Depletion E11-19 (Depletion Computations—Timber) Depreciation Expense: Fire lanes and roads Useful life Depreciation expense per year $ $ 84,000 30 2,800 Chapter 11-29 LO 6 Explain the accounting procedures for depletion of natural resources. Depletion E11-19 (Depletion Computations—Timber) Depletion: Cost of timberland per acre Cost of land per acre Cost of timber only per acre Total acres Value of timber Estimated total board feet Cost per board foot Board feet of timber sold Cost of timber sold related to depletion $ $ $ $ $ 1,400 (400) 1,000 9,000 9,000,000 3,500,000 2.57 700,000 1,800,000 Chapter 11-30 LO 6 Explain the accounting procedures for depletion of natural resources. Depletion Continuing Controversy Oil and Gas Industry: Full cost concept Successful efforts concept Special Problems in Depletion Accounting 1. Difficulty of estimating recoverable reserves. 2. Problems of discovery value. 3. Tax aspects of natural resources. 4. Accounting for liquidating dividends. Chapter 11-31 LO 6 Explain the accounting procedures for depletion of natural resources. Presentation and Analysis 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 Disclosures Depreciation expense for the period. Balances of major classes of depreciable assets. Accumulated depreciation. A description of the depreciation methods used. Chapter 11-32 LO 7 Explain how to report and analyze property, plant, LO equipment, and natural resources. equipment, Presentation and Analysis Presentation Rate of Return on Assets measures a firm’s success in using assets to generate earnings. Net Income ROA = Average Total Assets $56,200 6.56% = ($1,030,400 + 682,400) / 2 Chapter 11-33 LO 7 Explain how to report and analyze property, plant, LO equipment, and natural resources. equipment, Presentation and Analysis Presentation The analyst obtains further insight into the behavior of ROA by disaggregating it into components of profit margin on sales and asset turnover as follows: Rate of Return on Assets Net Income = Average Total Assets Sales = Profit Margin on Sales Net Income x Average Total Assets x Asset Turnover Sales Chapter 11-34 LO 7 Explain how to report and analyze property, plant, LO equipment, and natural resources. equipment, Presentation and Analysis Presentation The analyst obtains further insight into the behavior of ROA by disaggregating it into components of profit margin on sales and asset turnover as follows: Rate of Return on Assets $56,200 = ($1,030,400 + 682,400) / 2 6.56% Chapter 11-35 = Profit Margin on Sales $56,200 x Asset Turnover $300,000 x $300,000 18.73% x ($1,030,400 + 682,400) / 2 = .3503 LO 7 Explain how to report and analyze property, plant, LO equipment, and natural resources. equipment, Presentation and Analysis Presentation The profit margin on sales is a measure of the ability of a The firm to generate operating income from a particular level of sales. sales. Rate of Return on Assets Net Income = Average Total Assets 6.56% Chapter 11-36 = Profit Margin on Sales Net Income x Asset Turnover Sales x Sales Average Total Assets x .3503 = 18.73% LO 7 Explain how to report and analyze property, plant, equipment, and natural resources. equipment, Presentation and Analysis Presentation The profit margin on sales is a measure of the ability of a The firm to generate operating income from a particular level of sales. sales. Rate of Return on Assets Net Income = Average Total Assets Sales = Profit Margin on Sales Net Income x Average Total Assets x Asset Turnover Sales Differences in the profit margin on sales (from year to year) can be studied by analyzing individual revenues and expenses. Chapter 11-37 LO 7 Explain how to report and analyze property, plant, LO equipment, and natural resources. equipment, Presentation and Analysis Presentation The assets turnover is a measure of a firm’s ability to The generate sales from a particular investment in assets. Rate of Return on Assets Net Income = Profit Margin on Sales Net Income x Asset Turnover Sales = Average Total Assets 6.56% Chapter 11-38 x Sales Average Total Assets x .3503 = 18.73% LO 7 Explain how to report and analyze property, plant, equipment, and natural resources. equipment, The end Questions? Chapter 11-39 ...
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This note was uploaded on 03/29/2010 for the course FINANCE 0011100110 taught by Professor Shentingchun during the Spring '10 term at Nashville State Community College.

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