Operational Assets: Utilization and Impairment Sid Glandon, DBA, CPA Assistant Professor of Accounting

Depreciation, Depletion and Amortization Means of cost allocation Not a method of valuation Matching Principle Allocation of cost in systematic and rational manner to the accounting periods expected to benefit from use of the asset

Measuring Cost Allocation Estimated service life Depreciable base Original cost less salvage value Allocation method Time-based methods Activity-based methods

Time-Based: Straight-Line Method Calculate depreciable base Original cost Less: salvage or disposal value Determine estimated service life Divide depreciable base by number of years in estimated service life Equals annual depreciation expense

Time-Based: Declining Balance Multiply the straight-line rate by factor (2 Xs = double declining) Current year depreciation Multiply the result times the beginning book value of the asset Reduce book value by current year depreciation Repeat the process

Time-Based: Sum of the Years Digits Sum the years Create fraction Numerator-declining number with first year as the largest number Denominator-the sum of the years Multiply the declining fraction by the depreciable base

Example: Fact Pattern

Straight Line Depreciation

Double Declining Balance

Sum of the Years Digits

Activity-Based Output based Input based Units of production Number of hours of service Number of miles of service

Activity-Based Methods Determine depreciable base Determine units of measurement Divide depreciable base by units of measurement Equals depreciation per unit Determine number of units in year Multiply number of units in year by depreciation per unit

Activity Based Depreciation

Depletion of Natural Resources Cost basis expensing of natural resources Natural resources Complete removal of asset Replacement only by an act of nature

Depletion Activity-based method Divide depletion base by estimated number of units to be extracted Equals, depletion per unit

Amortization of Intangible Assets Finite useful life intangible assets Useful life Legal, regulatory, or contractual Residual value Usually zero Allocation method Usually straight line Exception-software development costs

Intangible Assets Not Subject to Amortization Indefinite life intangible assets Goodwill

Partial Year Depreciation If asset is placed in service during year Calculate depreciation for full year Allocate between years Half-year convention

Revision of Depreciation Estimates Initial estimates change Life Salvage value Apply prospectively Recompute current year depreciation Changes do not affect prior periods

Change in Depreciation Method Change in accounting principle resulting in a change in estimate Apply prospectively Recompute current year depreciation Changes do not affect prior periods

Correction of an Error Restate all prior periods presented in the financial statements Prior period adjustment to retained earnings for the earliest period reported

Impairment of Value Carrying value of asset is not recoverable Operational assets held and used in operations Operational assets held for sale Intangibles with finite life

Tangible Operational Assets Finite Life Intangible Assets Recovery Test If undiscounted sum of future cash flows is less than book value an impairment loss is indicated Fair Value Test The measurement of the impairment loss is the book value less the fair value

Fair Value Market value if there is a market Fair value estimate if there is no market Present value of the estimated future cash flows

Indefinite Life Intangible Assets Should be tested for impairment at least annually Impairment loss Book value exceeds fair value

Goodwill Should be tested for impairment at least annually Impairment loss Book value of the reporting unit exceeds its implied fair value

Operational Assets Held for Sale Impairment when classified as held for sale Impairment loss Book value exceeds fair value less cost of disposal

Expenditures Subsequent to Acquisition Repairs and Maintenance Expensed as incurred Additions Capitalized and depreciated over remaining service life Improvements Rearrangements Capitalized if they increase future benefits

Cost of Defending Intangible Rights Successful defense is capitalized and amortized over remaining service life Unsuccessful defense is expensed