1. Depreciation and Depletion11
hapter
Depreciation and Depletion
Intermediate Accounting 10th edition
Nikolai Bazley Jones
An electronic presentation
by Norman Sunderman
Angelo State University
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

2. Factors Involved in Depreciation
Asset cost
Service life
Residual value
Method of cost allocation

3. Factors Involved in Depreciation
Service Life
Service life is the measure of the number of units of service expected from the asset before its disposal.

4. Factors Involved in Depreciation
Service Life
The factors that limit the service life of an asset can be divided into two general categories.
Physical causes
Functional causes

5. Factors Involved in Depreciation
Residual Value
Residual, or salvage value, is the net amount that can be expected to be obtained when the asset is disposed.

6. Methods of Cost Allocation
Activity (or use) methods
Time-based methods a. Straight-line b. Accelerated (declining charge) (1) Sum-of-the-years’-digits (2) Declining balance

7. Methods of Cost Allocation
Time-Based Method: Straight Line
Depreciation Rate =
Cost - Residual Value
Service Life =
$120,000 - $20,000
5 Years
= $20,000 per year

8. Methods of Cost Allocation
Time-Based Method: Sum-of-the-Years’ Digits
Years of service remaining at beginning of year Years Remaining
1 5
Sum-of-the-Years’-Digits =
(n + 1) n = 30 = 15

9. Methods of Cost Allocation
Time-Based Method: Sum-of-the-Years’ Digits
Depreciation Book Value at
Year Base Fraction Depreciation Year-End
2006 $100,000 5/15 $ 33,333 $86,667
,000 4/15 26,667 60,000
,000 3/15 20,000 40,000
,000 2/15 13,333 26,667
,000 1/ ,667 20,000
$100,000
Residual Value

10. Methods of Cost Allocation
Time-Based Method: Declining-Balance
Double-Declining Balance
Book Value at Book Value at
Year Beginning of Year Rate Depreciation Year-End
2006 $120,000 40% $ 48,000 $72,000
,000 40% 28,800 43,200
,200 40% 17,280 25,920
, ,920 20,000
, ,000
$100,000
Plug
Residual Value

11. Methods of Cost Allocation
Time-Based Method: Declining-Balance
150%-Declining Balance
Book Value at Book Value at
Year Beginning of Year Rate Depreciation Year-End
2006 $120,000 30% $ 36,000 $84,000
,000 30% 25,200 58,800
,800 30% 17,640 41,160
,160 30% 12,348 28,812
, ,812 20,000
$100,000
Residual Value

12. Methods of Cost Allocation
Activity Method
Depreciation Rate =
Cost - Residual Value
Total Lifetime Activity Level =
$120,000 - $20,000
10,000 hours
= $10 per hour
Assume the asset is used for 2,100 hours.
Depreciation = $21,000 (2,100 hours x $10)

13. Recording Depreciation
The credit to depreciation is usually called Accumulated Depreciation or Allowance for Depreciation.

14. Conceptual Evaluation of Depreciation Methods$
Sum-of-the-Years-Digits
Depreciation Expense
Straight-Line
Double-Declining-Balance
During Year

15. Conceptual Evaluation of Depreciation Methods$
Sum-of-the-Years-Digits
Book Value
Straight-Line
Double-Declining-Balance
At End of Year

16. Conceptual Evaluation of Depreciation Methods
If a company expects that repairs and maintenance costs and the total economic benefits of the asset will remain similar each period,...

17. Conceptual Evaluation of Depreciation Methods
…a similar total cost each period can be achieved through straight-line depreciation and the similar repair and maintenance costs.

18. Conceptual Evaluation of Depreciation Methods
If the company expects that benefits of having the asset will decline each year for the life of the asset, ...

19. Conceptual Evaluation of Depreciation Methods
…and repairs and maintenance costs are constant each period, a declining total cost will be achieved by using accelerated depreciation.

20. Effect of Depreciation on Rate of Return
Book Value of Asset Rate of
Year Net Income at Beginning of Year Return
2006 $12,000 $120,000 10%
, ,000 12
,000 80,000 15
,000 60,000 20
,000 40,000 30

21. Disclosure of Depreciation
APB Opinion No. 12 requires the following:
Depreciation expense for the period.
Balance of major classes of depreciable assets, by nature or function, at the balance sheet date.
Accumulated depreciation, either by major classes of depreciable assets or in total, at the balance sheet date.
A general description of the method or methods used in computing depreciation with respect to major classes of depreciable assets.

22. Group Depreciation
A company purchased ten cars for $20,000 each, and the average expected life is 3 years with a residual value of $5,000 each.

23. To record the first year’s depreciation expense.
Group Depreciation
To record the purchase.
Cars 200,000
Cash 200,000
$200,000 – $50,000 3
To record the first year’s depreciation expense.
Depreciation Expense 50,000
Accumulated Depreciation 50,000
This same depreciation entry would be made at in the end of the second year.

24. Group Depreciation Three cars were sold after 2 years for $8,000 each.
Cash 24,000
Accumulated Depreciation 36,000
Cars 60,000
.25 ($200,000 – $60,000)
To record the third year’s depreciation expense.
Depreciation Expense 35,000
Accumulated Depreciation 35,000

25. Five cars were sold after 3 years for $6,000 each.
Group Depreciation
Five cars were sold after 3 years for $6,000 each.
Cash 30,000
Accumulated Depreciation 70,000
Cars 100,000
To reduce the $11,000 book value to the salvage value.
To record the fourth year’s depreciation expense.
Depreciation Expense 1,000
Accumulated Depreciation 1,000

26. Two cars were sold after 3 years for $4,800 each.
Group Depreciation
Two cars were sold after 3 years for $4,800 each.
The final two cars were sold for $4,800 each.
Cash 9,600
Accumulated Depreciation 30,000
Loss on Disposal 400
Cars 40,000
Book value = $10,000
Cash received = 9,600
Loss $

27. Composite Depreciation
Annual
Asset Cost Residual Value Life Depreciation
A $25,000 $5, yrs. $2,000
B 13,000 1, ,000
C 12, ,000
$50,000 $6,000 $7,000
Depreciation Rate = = 14%
7,000
$50,000

28. Depreciation for Partial Periods
A company purchases a $6,000 asset with a 3-year life and no residual value on August 18. The firm uses the double-declining-balance method.

29. Depreciation for Partial Periods
Annual
Year Depreciation
1 $6, x 2/3 x 4/12 = $1,333
2 ($6,000-$1,333) x 2/3 = $3,111
3 ($4,667-$3,111) x 2/ = 1,037
4 Remaining balance = $ 518
Declining-Balance-Method

30. Impairment of Noncurrent Assets
The FASB issued FASB Statement No. 144 which requires a company to review its property, plant, and equipment for impairment.

31. Impairment of Noncurrent Assets
Impairment occurs whenever events or changes in circumstances indicate that the book value of a noncurrent asset may not be recoverable.

32. Impairment of a Noncurrent Asset
Impairment Test
If the total undiscounted cash flows are less than the book value of the asset, an impairment loss is recognized.
Measurement of the Loss
The loss is measured as the difference between the book value of the asset and the present value of future cash flows.

33. Impairment of a Noncurrent Asset
On January 1, 2004, the Hall Company purchased a factory for $1 million (20-year life) and machinery for $3 million (10-year life).
Late in 2007, the company believes that its asset(s) may be impaired and the remaining useful life is 5 years. The company estimates that the asset will produce cash inflows of $700,000 and incur cash outflow of $300,000 each year for the next 5 years.

34. Impairment of a Noncurrent Asset
Impairment Test
December 31, 2007
Factory cost $1,000,000
Less: Accumulated depreciation
(4 x $50,000) (200,000)
Book value $ 800,000
Machinery cost $3,000,000
(4 x $300,000) (1,200,000)
Book value 1,800,000
Total Book Value $2,600,000

35. Impairment of a Noncurrent Asset
Impairment Test
Undiscounted expected
net cash flows
= 5 x ($700,000 - $300,000)
Cash Inflows
Cash Outflows
Years
= 5 x $400,000
= $2,000,000
Because $2,000,000 is less than $2,600,000 (the book value), an impairment loss must be recognized.

36. Impairment of a Noncurrent Asset
Measurement of the Loss
Undiscounted annual cash flows
Present value of the expected
cash flows (fair value)
= $400,000 x
= $1,309,718 (rounded)
n= 5, i = 0.16 from Table 4 in Appendix
Book value $2,600,000
Fair value (1,309,718)
Impairment loss $1,290,282

37. Impairment of a Noncurrent Asset
FASB Statement No. 121 does not specify how to record the write-down. It does indicate that the reduced book value is to be accounted for as the new cost.

38. Impairment of a Noncurrent Asset
Loss from Impairment 1,290,282
Accumulated Depreciation:
Factory 200,000
Machinery 1,200,000
Factory (new cost) 327,429
Machinery (new cost) 982,289
Factory (old cost) 1,000,000
Machinery (old cost) 3,000,000
$1,309,718 x [$1,000,000 ÷ ($3,000,000 + $1,000,000)]
$1,309,718 x [$3,000,000 ÷ ($3,000,000 + $1,000,000)]

39. Conceptual Evaluation of Asset Impairment
Although FASB Statement No. 121 has been replaced by FASB Statement No. 144, the principles it established have only changed slightly.
Although the Statement narrows GAAP, it still allows for significant management flexibility.

40. Depreciation for Tax Purposes
For an asset purchased in 1987 and later, the Modified Accelerated Cost Recovery System (MACRS) is required for tax purposes. A company’s computation of depreciation for income tax and financial reporting differ in three major respects:
A mandated tax life, which is usually shorter than the economic life.
The acceleration of the cost recovery (except for buildings).
The elimination of residual value.

41. Determine depreciation for 2006-2011.
MACRS Principles
On January 1, 2006, Melville Company purchased an asset for $200,000. The estimated economic life and MACRS life are 8 years and 5 years, respectively. The estimated residual value is $20,000.
Examine Exhibit l1-3 to determine the annual depreciation rate for 2006.
20%
Determine depreciation for

42. Changes and Corrections of Depreciation
A change in an estimate of the residual value or the service life of a currently owned asset is accounted for prospectively.
A change in the depreciation method for currently owned assets is accounted for prospectively.
Correction of an error in depreciation is treated as prior period adjustment (restatement).

43. Depletion
Depletion of natural resources is calculated using the units of activity method
Any environmental costs at the end of the project are added to the cost in determining depletion per unit

44. Depletion Cost - Residual Value Units Unit Depletion Rate =
Reggio Company purchases land for $3,000,000 from which it expects to extract 1,000,000 tons of coal, the estimated residual value is $200,000, and it mines 80,000 tons of coal in the first year.
Unit Depletion Rate =
$3,000,000 - $200,000
1,000,000 tons

45. Depletion Cost - Residual Value Units Unit Depletion Rate =
$3,000,000 - $200,000
1,000,000 tons
Unit Depletion Rate = $2.80 per ton
Depletion for Year = $2.80 x 80,000 = $224,000

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