1. ACTG 3110 Chapter 11 – Depreciation, Impairments, and Depletion

2. Depreciation, Depletion, and Amortization Definition - asset cost allocation to expense over period benefited Satisfies matching principle Does not represent valuation adjustments Does not represent cash flows

3. Depreciation Adjusting entry –Depreciation ExpenseXX – Accumulated DepreciationXX Balance sheet presentation –Asset cost100,000 – Less accumulated depreciation (20,000) –=Book or carrying value 80,000

4. Depreciation Allocation Base –Cost - salvage value Estimated useful life (how long asset used) Salvage (Residual) value - worth at end of life

5. Depreciation Methods Activity-based –Units-of-production method (Cost - salvage)/total output x units produced Time-based –Straight line (Cost - salvage)/useful life –Sum-of-the-years-digits –Declining balance method Book value x Depr. Rate = Depreciation expense

6. Comparison of Methods Straight line –Equal expense each period –Generally lowest depreciation in early years generating the highest net income Units of Production –Expense varies based on output –Allows depreciation to be a variable expense –Most reflective of use allocation

7. Comparison of Methods Sum-of-the-years’-digits –Accelerated method –Probably outdated Declining balance –Generally highest amounts of depreciation in early years resulting in lowest net income –Constant depreciation rate is applied –Tax tables based on declining balance –Most conservative

8. Fractional Year Depreciation Partial years –1-15 go back to 1st day of month –16-31 go to 1st day of next month –Multiply annual amounts by months held Half-year convention –All assets get 1/2 year depreciation in first and last years

9. Revisions of Estimates Change in estimates, i.e. –Change in depreciation method –Change in salvage value –Change in useful life All reported prospectively, no revision to earlier years

10. Impairment of Assets For assets that lose a SIGNIFICANT portion of their value: –You must write down the assets to fair market value is loss is expected to be permanent –Compare undiscounted future cash flows to book value of asset –If book value is more, write down to FMV must occur. Fair market value can be determined as the present value of the future cash flows from the asset

11. Impairment of Assets Impairment loss will be the difference in book value and fair market value of asset Loss reported in income from continuing operations Footnote disclosure necessary Reduced carrying value becomes the new cost to depreciate

12. Impairment of Assets 3 Categories: 1.Tangible operational assets and finite life intangibles 2.Infinite lived intangibles 3.Goodwill Category 1 tested only when changes or events occur. Categories 2 and 3 tested at least annually

13. Depletion of Natural Resources Establishment of depletion base –Acquisition cost –Exploration costs Successful efforts method Full-cost approach –Development costs –Restoration costs Depletion – write-off off the resource cost –Units-of-production method often used –Percentage of depletion method used for tax purposes Change in estimates revises current year and future year calculations only, not past years Estimating recoverable reserves is difficult

14. Presentation of PP&E Disclosures for PPE –Basis of valuation –Liens –Depreciation expense –Balances of major classes of assets –Accumulated depreciation –Description of depreciation methods used

15. Presentation of PP&E Disclosures for Natural Resources –Basis of valuation –Liens –Accounting methods used –Manner of disposing of costs relating to oil and gas activities –Reserve quantities –Capitalized costs –Acquisition, exploration and development activities

16. Tax Depreciation MACRS Assets put into classifications Tables have predetermined rates with half- year convention incorporated Simply multiply cost by table percentage Salvage value is ignored No book value computations