1. Depreciation, Impairments, and Depletion
Chapter 11
Depreciation, Impairments, and Depletion
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2. 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
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3. 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.
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4. 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
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5. 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
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6. 4. Depreciation Methods
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7. 4. Depreciation Methods
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8. 4. Depreciation Methods Straight Line most commonly used method
easy to use
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9. 4. Depreciation Methods
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10. 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)
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11. 4. Depreciation Methods
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12. 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%
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13. 4. Depreciation Methods
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14. 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
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15. 4. Depreciation Methods BRIEF EXERCISE 11-6 Asset Depreciation Expense
$202, $16, $21,800
Composite rate = $21,800/$202,000 = %
Composite life = ($202,000 – 16,000) / $21,800 = years
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16. 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 ,000
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17. 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
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18. 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
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19. 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
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20. 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
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21. 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, / 4 = 1,000
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22. 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
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23. 6. Depletion
Example
ABC Mining acquired a tract of land containing ore deposits. Total costs of acquisition and development were $1,100, 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?
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24. 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?
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25. 7. Impairments
An impairment occurs when expected future net cash flows (undiscounted) of an asset are less than the asset’s carrying amount
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26. 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
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27. 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
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28. 7. Impairments
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