Chapter 11 Notes

Chapter 11 Notes - Chapter 11: Depreciation, Impairments,...

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Chapter 11: Depreciation, Impairments, and Depletion Depreciation – A Method of Cost Allocation - Depreciation is a means of cost allocation - Depreciation - 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 - Employed because the value of the asset may fluctuate between the time the asset is purchased and the time it is sold or junked - Companies use the cost allocation approach because it matches costs with revenues and because fluctuations in market value are uncertain and difficult to measure - Depletion - the reduction in the cost of natural resources over a period of time - Amortization - expiration of intangible assets Factors Involved in the Depreciation Process - Before establishing a pattern of charges to revenue, a company must answer 3 basic questions: o What depreciable base is to be used for the asset? o What is the asset’s useful life? o What method of cost apportionment is best for this asset? - Answers to these questions involve combining several estimates into one single figure - Calculations assume perfect knowledge of the future, which is never attainable - Depreciable Base for the Asset o The base established for depreciation is a function of 2 factors: Original cost Salvage or disposal value o Salvage Value - the estimated amount that a company will receive when it sells the asset or removes it from service o Depreciation Base - the difference from the cost of the asset and the salvage value
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- Estimation of Service Lives o Service life of an asset often differs from its physical life o Companies retire assets for 2 reasons: Physical factors Economic factors o Physical factors set the outside limit for the service life of an asset o Classify economic or functional factors into 3 categories: Inadequacy - results when an asset ceases to be useful to a company because the demands of the firm have changed Supersession - the replacement of one asset with another more efficient and economical asset Obsolescence - the catchall for situations not involving inadequacy and supersession o In most cases, a company estimates the useful life of an asset based on its past experience with the same or similar assets o Other uses sophisticated statistical methods to establish a useful life o Some cases, companies select arbitrary service lives o In a highly industrial economy, technological factors have as much effect, if not more, on service lives of tangible plant assets as physical factors do Methods of Depreciation - 3 rd factor involved in the depreciation process is the method of cost apportionment - Profession requires that the depreciation method employed be “systematic and rational.” - Companies may use a number of methods: o Activity method o Straight-line method o Decreasing charge methods Sum-of-the-years’-digits Declining-balance method Page 2 of 12
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o Special depreciation method
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This note was uploaded on 02/22/2011 for the course BUAD 362 taught by Professor Frazer during the Spring '10 term at Millersville.

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Chapter 11 Notes - Chapter 11: Depreciation, Impairments,...

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