Unformatted text preview: Intermediate Accounting
Depreciation, Impairments, and Depletion Learning Objectives
Learning Describe the concept of depreciation
Identify the factors involved in the depreciation process
Compare activity, straightline, and decreasingcharge methods of depreciation
Explain special depreciation methods
Explain the accounting issues related to asset impairment
Explain the accounting procedures for depletion of natural resources
Explain how to report property, plant, equipment and natural resources 2 Depreciation – Method of Cost Allocation
Depreciation is the accounting process of allocating the cost of tangible assets to expense in a systematic rational manner to those periods expected to benefit from the use of the asset.
Allocating costs of longterm assets: 3 Fixed assets = Depreciation expense Intangibles = Amortization expense Natural resources = Depletion expense 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? 4 LO 2: Identify the factors involved in the depreciation process. Depreciation – Method of Cost Allocation
Factors Involved in the Depreciation Process
Depreciable Base Original Cost
Less: Salvage Value
Depreciable Base 5 $ 10,000 1,000 9,000 LO 2: Identify the factors involved in the depreciation process. Depreciation – Method of Cost Allocation
Factors Involved in the Depreciation Process
Estimation of Service Lives 6 Service life of an asset often differs from its physical life. Companies retire assets for two reasons:
(1) physical factors (such as casualty or expiration physical life) and
(2) economic factors (obsolescence). LO 2: Identify the factors involved in the depreciation process. of 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) Straightline method.
(3) Sumoftheyears’digits. Accelerated methods
(4) Decliningbalance method.
(5) Group and composite methods. Special methods
(6) Hybrid or combination methods } 7 } LO 3: Compare activity, straightline, and decreasingcharge methods of depreciation. Depreciation – Method of Cost Allocation
Special Depreciation Methods
The choice of method depends on the nature of the assets involved: 8 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 tailormade depreciation methods, provided the method results in the allocation of an asset’s cost in a systematic and rational manner (Hybrid or Combination Methods). 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? NO
• Funds for the replacement of the assets come from the revenues
(3) How should companies handle revisions in depreciation rates? 9 LO 4: Explain special depreciation methods. Depreciation – Method of Cost Allocation
Changes in Depreciation Rate 10 Accounted for in the period of change and future periods (Change in Estimate)
Not handled retrospectively
Not considered errors or extraordinary items LO 4: Explain special depreciation methods. Change in Estimate Example
Arcadia HS, purchased equipment for $510,000 which was estimated 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 straightline basis. In 2010 (year 8), it is determined that the total estimated life should be 15 years with a salvage value of $5,000 at the end of that time.
Questions: What is the journal entry to correct the prior years’ depreciation? 11 Calculate the depreciation expense for 2010. LO 4: Explain special depreciation methods. No Entry Required Change in Estimate Example (After 7 Years)
Useful Life (original)
Annual depreciation $510,000
First, establish NBV at 10,000
date of change in estimate. 500,000 10 years
$ 50,000 x 7 years = $350,000 Balance Sheet (Dec. 31, 2009)
Fixed Assets: Equipment $510,000 Accumulated depreciation 350,000 Net book value (NBV) $160,000
12 LO 4: Explain how to report irregular items. Change in Estimate Example (After 7 Years)
Net book value
Salvage value (new)
Useful life remaining
Annual depreciation $160,000 5,000 155,000 8 years
$ 19,375 Depreciation Expense calculation for 2010 Journal entry for 2010 Depreciation expense 19,375 Accumulated depreciation 19,375 13 LO 4: Explain how to report irregular items. Impairments
When the carrying amount of an asset is not recoverable, a company records a writeoff 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.
14 LO 5: Explain the accounting issues related to asset impairment. 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 longlived 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.
See Illustration 11-16 15 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 Depletion is the process of allocating the cost of natural resources.
16 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. 17 LO 6: Explain the accounting procedures for depletion of natural resources. Depletion
Write-off of Resource Cost
Normally, companies compute depletion on a units-of-production
method (an activity approach). Thus, depletion is a function of the method
number of units extracted during the period.
Total cost – Salvage value = Depletion cost per unit Total estimated units available
Units extracted x Depletion cost per unit= Depletion
18 LO 6: Explain the accounting procedures for depletion of natural resources. Depletion
Estimating Recoverable Reserves Same as accounting for changes in estimates Revise the depletion rate on a prospective basis Divide the remaining cost by the new estimate of the recoverable reserves 19 LO 6: Explain the accounting procedures for depletion of natural resources. Liquidating Dividends
Liquidating Dividends – Dividends greater than the Liquidating
Dividends greater than the amount of accumulated net income. Illustration: Callahan Mining had a retained earnings balance of Illustration: Callahan Mining had a retained earnings balance of $1,650,000 and paidin capital in excess of par of $5,435,493. Callahan’s board declared a dividend of $3 a share on the 1,000,000 shares outstanding. It records the $3,000,000 cash dividend as follows.
Paidin Capital in Excess of Par
Cash 20 1,650,000
3,000,000 LO 6: Explain the accounting procedures for depletion of natural resources. Depletion
• Oil and gas Industry: • Full cost concept
• Successful efforts concept 21 LO 6: Explain the accounting procedures for depletion of natural resources. Presentation and Analysis
Presentation of Property, Plant, Equipment, and
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
22 LO 7: Explain how to report and analyze property, plant, equipment, and natural resources. Appendix 11A
Appendix Income Tax Depreciation Modified Accelerated Cost Recovery System
MACRS differs from GAAP in three respects:
1. a mandated tax life, which is generally shorter than the economic life;
2. cost recovery on an accelerated basis; and 3. an assigned salvage value of zero. 23 LO 8: Describe income tax methods of depreciation. ...
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