Intermediate Accounting II Chapter 11 Accounting for Property, Plant and Equipment and Intangible Assets Utilization and Impairment – Part I Intermediate Accounting II Chapter 11

COST ALLOCATION: PROPERTY, PLANT & EQUIPMENT AND INTANGIBLE ASSETS The usefulness of most long-lived, revenue-producing assets is consumed as the assets are applied to the production of goods or services. The matching principle requires that the net cost of these assets (cost less residual value) be allocated to the years of asset use in direct proportion to the role the asset plays in revenue production. Cost allocation for assets is known as depreciation for plant and equipment, depletion for natural resources, and amortization for intangibles. Depreciation, depletion, and amortization are processes of cost allocation, not valuation.

MEASURING COST ALLOCATION The process of cost allocation for an asset requires that three factors be established at the time the asset is put into use: (1) service life, (2) allocation base, and (3) allocation method. The service life, or useful life, of an asset is the amount of use that the company expects to obtain from the asset before disposing of it. Service life can be expressed in units of time or in units of activity. Expected obsolescence can shorten service life below physical life. Allocation base is the difference between the cost of the asset and its anticipated residual value. The allocation method used should be systematic and rational and correspond to the pattern of asset use. Time-based methods Activity-based methods 

TIME-BASED ALLOCATION METHODS Time-based depreciation methods allocate the depreciable base according to the passage of time. Straight-line Sum-of-the-years-digits Declining balance

ACTIVITY-BASED ALLOCATION METHODS Activity-based depreciation methods estimate service life in terms of some measure of productivity. Productivity could be measured in terms of output (for example, the number of units a machine will produce) or input (for example, the number of hours a machine will operate). Units-of-production

SELECTING A DEPRECIATION METHOD All methods provide the same total depreciation over an asset's life. Activity-based methods are theoretically superior to time-based methods, but often are infeasible or too costly to use. Most companies use the straight-line method. Different depreciation methods may be used for different classes of assets. Different depreciation methods may be used for financial and income tax reporting.

STRAIGHT-LINE DEPRECIATION The straight-line depreciation method allocates an equal amount of depreciable base to each year of the asset's service life. Cost – Residual Value = Base Base/Useful Life = Annual Depreciation Annual Depreciation/12 = Monthly Depreciation If the period covered is less than a year, multiply the monthly depreciation by the number of months covered in the period.

(h) Exercise 11–3 #1, page 624 $115,000 – 5,000 10 years = $11,000 per year   2016 $11,000 x 3/12 = $ 2,750 2017 $11,000 x 12/12 = $11,000 The asset was held for 3 months in 2016, so depreciation is calculated as 3/12 of a year. The asset was held for the entire year of 2017, or 12/12 months. Annual depreciation will continue to be taken for 9 years until 2025. In 2026, depreciation will only be taken for 9/12 of a year. Journal Entry Dec 31, 2017 Depreciation Expense 11,000 Accumulated Depreciation

ACCELERATED METHODS Accelerated depreciation methods allocate more depreciable base to the earlier years of an asset's life and less to the later years. Sum-of-the-years-digits Declining Balance

SUM-OF-THE-YEARS-DIGITS The sum-of-the-years'-digits method multiplies the depreciable base by a declining fraction whose denominator is the constant sum of the digits from one to n where n is the number of years in the asset's service life. sum-of-the-years-digits = n(n+1) 2

Brief Exercise 11–2 (b), page 622 (h) Brief Exercise 11–2 (b), page 622 Sum-of-the-digits is ([4 (4 + 1)] ÷ 2) = 10 Depreciable base is $30,000 - $2,000 = $28,000   2016 $28,000 x 4/10 = $11,200 2017 $28,000 x 3/10 = $ 8,400

SUM-OF-THE-YEARS-DIGITS – PARTIAL YEARS With sum-of-the-years-digits, each depreciation fraction must be taken for 12 consecutive months. When partial years are involved, this fraction is split between two fiscal periods. For instance, an asset purchased in the beginning of August with a three year life will have the sum-of-the-years digits of 6. The first twelve month’s depreciation fraction is 3/6. 3/6 of the base will be taken for 5/12 months (August – December). In the second fiscal year, 3/6 depreciation fraction will be used for 7/12 (the number of months remaining to complete 12 consecutive months) and 2/6 will be taken for 5/12 months. The process will continue until the depreciation has been applied to 36 months of service.

(h) Exercise 11–3 #2, page 624 Sum-of-the-digits is {[10 (10 + 1)]/2} = 55 Depreciable base is $115,000 - $5,000 = $110,000   2016 $110,000 x 10/55 x 3/12 = $ 5,000 2017 $110,000 x 10/55 x 9/12 = $15,000 +$110,000 x 9/55 x 3/12 = 4,500 $19,500

DECLINING BALANCE METHODS Declining balance depreciation methods multiply beginning of year book value, not depreciable base, by an annual rate that is a multiple of the straight-line rate. Residual value is ignored at the beginning of the depreciation process, but the asset may not depreciate below residual value. When 200% is used as the multiplier, the method is known as the double-declining-balance method. Straight-line rate = 1/n Book Value = Cost – Accumulated Depreciation

(h) Exercise 11–3 #3, page 624 Straight-line rate is 10% (1 ÷ 10 years) x 2 = 20% DDB rate   2016 $115,000 x 20% x 3/12 = $ 5,750 2017 ($115,000 – 5,750) x 20% = $21,850

Accumulated Depreciation (h) Exercise 11–1 #3, page 623 Straight-line rate of 20% (1 ÷ 5 years) x 2 = 40% DDB rate. Year Beg Book Value Rate Depreciation Accumulated Depreciation End Book Value 2016 40% 2017 2018 2019 2020

Accumulated Depreciation (h) Exercise 11–1 #3, page 623 Year Beg Book Value Rate Depreciation Accumulated Depreciation End Book Value 2016 $33,000 40% $13,200 $19,800 2017 2018 2019 2020

Accumulated Depreciation (h) Exercise 11–1 #3, page 623 Year Beg Book Value Rate Depreciation Accumulated Depreciation End Book Value 2016 $33,000 40% $13,200 $19,800 2017 7,920 21,120 11,880 2018 2019 2020

Accumulated Depreciation (h) Exercise 11–1 #3, page 623 Year Beg Book Value Rate Depreciation Accumulated Depreciation End Book Value 2016 $33,000 40% $13,200 $19,800 2017 7,920 21,120 11,880 2018 4,752 25,872 7,128 2019 2020

Accumulated Depreciation (h) Exercise 11–1 #3, page 623 Year Beg Book Value Rate Depreciation Accumulated Depreciation End Book Value 2016 $33,000 40% $13,200 $19,800 2017 7,920 21,120 11,880 2018 4,752 25,872 7,128 2019 2,851 28,723 4,277 2020

Accumulated Depreciation (h) Exercise 11–1 #3, page 623 Year Beg Book Value Rate Depreciation Accumulated Depreciation End Book Value 2016 $33,000 40% $13,200 $19,800 2017 7,920 21,120 11,880 2018 4,752 25,872 7,128 2019 2,851 28,723 4,277 2020 3,000 Recall that the ending book value cannot be below the asset’s estimated residual value. In the last year of service, the depreciation is calculated backwards from ending book value and the amount is “plugged”.

Accumulated Depreciation (h) Exercise 11–1 #3, page 623 Year Beg Book Value Rate Depreciation Accumulated Depreciation End Book Value 2016 $33,000 40% $13,200 $19,800 2017 7,920 21,120 11,880 2018 4,752 25,872 7,128 2019 2,851 28,723 4,277 2020 -------- 1,277 30,000 3,000 Recall that the ending book value cannot be below the asset’s estimated residual value. In the last year of service, the depreciation is calculated backwards from ending book value and the amount is “plugged”.

Accumulated Depreciation (h) Exercise 11–1 #3, page 623 Assume the van was purchased July 1, 2016. The first year’s depreciation would be $33,000 X .4 X 6/12 = $9,900 Year Beg Book Value Rate Depreciation Accumulated Depreciation End Book Value 2016 $33,000 40% ($13,200 X 6/12) $9,900 $23,100 2017 2018 2019 2020

Accumulated Depreciation (h) Exercise 11–1 #3, page 623 Assume the van was purchased July 1, 2016. The first year’s depreciation would be $33,000 X .4 X 6/12 = $9,900 Year Beg Book Value Rate Depreciation Accumulated Depreciation End Book Value 2016 $33,000 40% ($13,200 X 6/12) $9,900 $23,100 2017 23,100 9,240 19,140 13,860 2018 5,544 24,684 8,316 2019 3,326 28,010 4,990 2020 -------- 1,990 30,000 3,000

UNITS-OF-PRODUCTION METHOD The units-of-production method computes a depreciation rate per measure of output and then multiplies this rate by actual output to determine periodic depreciation. Cost/Estimated Output = Depreciation Rate/Unit of Output

(h) Exercise 11–3 #5, page 624   $115,000 – 5,000 220,000 units = $.50 per unit depreciation rate 2016 10,000 units x $.50 = $ 5,000 2017 25,000 units x $.50 = $12,500

Intermediate Accounting II – Chapter 11 END OF PRESENTATION – PART 1 Accounting for Property, Plant and Equipment and Intangible Assets Utilization and Impairment – Part I Intermediate Accounting II – Chapter 11 END OF PRESENTATION – PART 1