Depreciation, Impairments, and Depletion Chapter 11 Depreciation, Impairments, and Depletion ACCT-3030

1. Theory of Depreciation Definition the systematic and rational allocation of the cost of a fixed asset Depreciation is an allocation method – not a valuation method Justification matching fluctuations in market value too difficult to determine ACCT-3030

2. Depreciation Factors Cost – covered in Chapter 10 Salvage value – estimated Useful life useful life vs. physical life functional factors changes in environment, asset inadequate for intended purpose, obsolescence, supersession physical factors routine wear and tear, deterioration, effects of continual usage, etc. ACCT-3030

3. Selecting Appropriate Method Factors expected use, expected obsolescence, expected pattern of decline in usefulness of asset, expected contribution of asset to revenue, etc. Conceptually method that most clearly reflects net income Practically method that minimizes bookkeeping expenses method that reports highest net income Consistency ACCT-3030

4. Depreciation Methods Activity method can be based on output (e.g., units produced) can be based on inputs (e.g., operating hours or miles) Depr = Cost – Salvage x Productive Service Exp Life in Units ACCT-3030

4. Depreciation Methods ACCT-3030

4. Depreciation Methods ACCT-3030

4. Depreciation Methods Straight Line most commonly used method easy to use ACCT-3030

4. Depreciation Methods ACCT-3030

4. Depreciation Methods Sum-of-the-years’ digits (cost – savage) x declining fraction numerator of fraction years in life of asset in reverse order denominator of fraction sum of the years compute denominator of fraction as n (n + 1) 2 ACCT-3030

4. Depreciation Methods ACCT-3030

4. Depreciation Methods Declining balance remaining BV x fixed rate rate is a multiple of the straight line rate compute straight line rate as: 100% / life in years rates commonly used: 125%, 150%, 200% ACCT-3030

4. Depreciation Methods ACCT-3030

4. Depreciation Methods Group and Composite methods Composite Group assets grouped by common characteristics average depreciation rate used as if a single unit depreciation expense = group cost x average rate Composite refers to collection of dissimilar assets Group refers to collection of similar assets Use straight line depreciation method No gain or loss recorded on disposals until entire group disposed of debit accumulated depreciation for difference between asset’s cost and the proceeds Example BE 11-6 ACCT-3030

4. Depreciation Methods BRIEF EXERCISE 11-6 Asset Depreciation Expense $202,000 $16,000 $21,800 Composite rate = $21,800/$202,000 = 10.8% Composite life = ($202,000 – 16,000) / $21,800 = 8.53 years   ACCT-3030

4. Depreciation Methods BRIEF EXERCISE 11-6 Extension Asset A was sold for $60,000 on the first day of year 2. Prepare entry to record sale. Cash 60,000 Accumulated Depreciation 10,000 Equipment 70,000 ACCT-3030

4. Depreciation Methods BRIEF EXERCISE 11-6 Extension Calculate depreciation expense for year 2 for the group. 132,000 x 10.8% = 14,256 Depreciation Expense 14,256 Accumulated Depreciation 14,256 ACCT-3030

4. Depreciation Methods Other methods Inventory method sometimes used for large numbers of low cost assets Retirement and Replacement methods sometimes used if have large number of similar assets replaced on constant schedule Retirement method FIFO approach Replacement method LIFO approach Examples ACCT-3030

4. Depreciation Methods Partial years conventions – must be used consistently half year in first and last year full year in first year and none in last year none in first year and full year in last year nearest month SYD prorate 12-month blocks of depreciation between years DB use partial year fraction in first year only Example ACCT-3030

5. Changes in Depreciation Change in accounting estimate method, salvage, or life Depreciate remaining BV over remaining life Example Cost = $11,000 Salvage = $1,000 Life = 5 years Date Acquired = January 1, 2012 ACCT-3030

5. Changes in Depreciation SL depreciation: 11,000 – 1,000 / 5 = 2,000 During 2015, changed life from 5 years to 7 New depreciation used for 2015 and forward BV on 1/1/2015 Cost $ 11,000 Accum Depr (2000 x 3) $ 6,000 BV $ 5,000 New Depreciation Amount 5,000 - 1000 / 4 = 1,000 ACCT-3030

6. Depletion Depreciable assets retain their physical characteristics as used Natural resources (coal, gas, oil) are used up as natural resources used up cost of natural resources allocated to units extracted Use the units-of-production method determine depletion base (acquisition cost, development cost, carrying cost) estimate recoverable units calculate depletion rate: Cost of Natural Resource – Residual Value Estimated Recoverable Units ACCT-3030

6. Depletion Example ABC Mining acquired a tract of land containing ore deposits. Total costs of acquisition and development were $1,100,000. ABC estimated the land contained 40,000 tons of ore, and that the land will be sold for $100,000 after the coal is mined. What is ABC’s depletion rate? ACCT-3030

6. Depletion Solution Depletion rate = 1,000,000 ÷ 40,000 Tons = $25 Per Ton Assume ABC mined 13,000 tons this year. What is the total amount of depletion for the year? Depletion = 13,000 tons × $25per ton = $325,000 What is the amount of CGS for the year? ACCT-3030

7. Impairments An impairment occurs when expected future net cash flows (undiscounted) of an asset are less than the asset’s carrying amount ACCT-3030

7. Impairments Test for impairment review events for possible impairment apply recoverability test to determine if impairment has occurred impairment occurs if sum of expected future net cash flows (undiscounted) is less than asset’s carrying amount if impairment has occurred recognize impairment loss for amount by which the carrying amount of the asset exceeds fair value of asset fair value is market price if active market exists if no market, use present value of expected future net cash flows ACCT-3030

7. Impairments if impaired asset is held for use new cost basis of asset is the reduced carrying amount depreciation is taken on new cost basis over asset’s remaining useful life write-ups of asset’s value are not allowed if impaired asset is intended to be disposed of reported at the lower-of cost-or-net realizable value recovery of impairment loss is allowed but write-up cannot exceed carrying amount of asset before impairment ACCT-3030

7. Impairments ACCT-3030