1. Operational Assets: Depreciation, Impairment, and Depletion of Operational Assets

2. DEPRECIATION CONCEPTS
Depreciation - expiration or consumption of the
economic service potential of plant assets.
AN ECONOMIC FACT
Depreciation accounting - the systematic and
rational allocation of the cost of tangible capital
assets, less salvage, over the estimated useful
life of the asset
AN ACCOUNTING PROCEDURE
Depreciation accounting is a cost allocation process
and is not related to the “market value” of the asset

3. DEPRECIATION CONCEPTS
Related Areas
Depletion accounting - periodic allocation of
the cost of natural resources against revenue
earned.
Amortization accounting - periodic allocation
of intangible assets against revenue earned.

4. DEPRECIATION CONCEPTS
Factors Impacting Computed Depreciation
Expense
Asset cost.
Estimated residual value.
Estimated useful life.
Method of depreciation.

5. DEPRECIATION METHODS (1) Straight-line.
(2) Based on inputs and outputs (Activity).
Service hours (SH) method.
Productive output (PO) or units-of-production.
(3) Accelerated methods.
Sum-of-the-years’-digits (SYD).
Declining-balance (normally 200% - DDB).
(4) Tax depreciation.
(5) Depreciation systems.
Group and composite.
Retirement and replacement.

6. STRAIGHT-LINE (SL) = Annual SL Acquisition cost – Residual value
Depreciation
Acquisition cost – Residual value
Estimated useful life in years = SL

7. ACTIVITY METHODS Inputs and Outputs
Depreciation based upon measures of input or output like. . .
Service hours
Productive output (units-of-production)
No depreciation is taken if the asset is idle.

8. Acquisition cost – Residual value Estimated service life in hours
Service Hours (SH)
Depreciation
Per SH =
Acquisition cost – Residual value
Estimated service life in hours
Depreciation
Per Period
Depreciation Number of hours
Per SH running time × =

9. PRODUCTIVE OUTPUT (PO)
Depreciation rate
per unit of output =
Acquisition Cost – Residual Value
Estimated Productive Output in Units
Depreciation
Expense
Depreciation Number of units
rate per unit produced × =

10. ACCELERATED DEPRECIATION
Sum-of-the-Years’-Digits
Declining Balance Methods

11. SUM-OF-YEARS’-DIGITS
No. of years remaining
in useful life
Depreciation
Fraction =
SYD
Depreciation per
period
Depreciation
Fraction = x
(Cost - SV)

12. DOUBLE-DECLINING-BALANCE (DDB)
DDB rate = 2 x Straight-line rate
(SL Rate = 1/Useful Life
Depr. base = Book value (Cost - Accum. depr.)
at beginning of the year
Depr. per period = Depr. rate x Depr. base

13. TAX DEPRECIATION
For income tax reporting the IRS permits the use of “modified accelerated cost recovery system” (MACRS).
MACRS ignores residual value.
Depreciation is based upon percentages related
to the “class life” of the asset.

14. DEPRECIATION POLICY If a company expected asset obsolescence,
accelerated methods are appropriate.
Many companies use SL for financial reporting and accelerated depreciation for tax reporting.
SL depreciation is the most popular method (about 94% of companies surveyed use SL).

15. DEPRECIATION POLICY
Depreciation expense is a tax shield because it is a noncash expense that is deductible for income tax purposes.
By lowering our income taxes, depreciation improves our cash flows.

16. FRACTIONAL-YEAR DEPRECIATION
So far we have assumed that the depreciable asset
was purchased at the beginning of the year.
If the asset is purchased sometime during the year,
we have to adjust annual depreciation.

17. DEPRECIATION DISCLOSURES
Depreciation expense.
Balances of major classes of depreciable assets.
Accumulated depreciation by asset or in total.
General description of depreciation methods used.

18. PLANT ASSET IMPAIRMENT
Impairment is the loss of a significant portion of the utility of an asset through casualty, obsolescence or lack of demand for the company’s asset.
When plant assets suffer a permanent impairment in value, a loss should be recorded.

19. IMPAIRMENT OF LONG-LIVED ASSETS
Background
SFAS No. 121
SFAS No. 144
Reporting requirements
Disclosure requirements

20. IMPAIRMENT OF LONG-LIVED ASSETS Assets to be Held and Used
Reviewed when circumstances indicate the carrying value may not be recoverable
Recognition of impairment loss
Required if sum of expected future net cash flows is less than carrying value of the asset
Evaluated on a “component basis”
Measurement of impairment loss
The amount by which the carrying value of the asset exceeds the fair value of the asset

21. IMPAIRMENT OF LONG-LIVED ASSETS Assets to be Held and Used - Continued
Presentation of impairment losses
Shown as a component of income from
continuing operations before taxes
Restoration of impairment losses
Reduced carrying value is basis for future
accounting and restoration is prohibited

22. IMPAIRMENT OF LONG-LIVED ASSETS Disclosure Requirements
Description of impaired assets
Circumstances leading to impairment
Amount of impairment loss
How fair value was determined
Segment in which the impaired asset group is reported – SFAS 131

23. I guess this boat is about fully depreciated!

24. NATURAL RESOURCES Sometimes referred to as wasting assets.
Supplied by nature and extracted from natural environment.
Gold, oil, timber, coal, and other minerals.
Presented on the balance sheet as noncurrent assets.

25. NATURAL RESOURCES SFAS No. 19 identifies total costs as including
acquisition costs
exploration costs
development costs
production costs
support equipment and facilities cost.
Total cost is allocated over periods benefited by means of depletion.

26. NATURAL RESOURCES Depletion
Depletion is calculated using the
units-of-production method.
Unit depletion rate is calculated as follows:
Estimated Recoverable Units
Capitalized Cost of Residual
Natural Resource Value –
The numerator, cost – residual value, is called the depletion base.

27. Total depletion cost for a period is:
NATURAL RESOURCES
Total depletion cost for a period is:
UNIT DEPLETION
RATE
NUMBER OF UNITS
EXTRACTED IN PERIOD ×
The unit depletion rate . . .
is inventoried with each extracted unit.
is expensed as a part of cost of goods sold for each unit sold.
remains in inventory with each unsold unit.

28. NATURAL RESOURCES Restoration Costs
In some cases, the extractor is required to restore the land to its original state subsequent to the resources being extracted.
The estimated cost of restoration increases the depletion base.

29. RESTORATION COSTS
Assume mine property has a capitalized cost of $4,000,000,
estimated recoverable ore of 2,000,000 tons, with 300,000
tons produced in Year 1. If the company must restore the
land to its original state after mining at an estimated cost of
$1 million, present the entry for production.
Unit depletion rate = ($4,000,000 + $1,000,000) / 2,000,000 tons
= $2.50 per ton
Entry: Inventory of ore ,000*
Accum depletion - Mine property ,000**
Estim. Liability for mine restoration ,000***
*300,000 tons x $2.50
**300,000 tons x $2,00
***300,000 tons x $.50

30. NATURAL RESOURCES Change in Estimate
The unit depletion rate is based on estimated recoverable units.
Those estimates may change over time.
The revised unit depletion rate is computed for the remaining costs.
Prior depletion costs are not revised.

31. NATURAL RESOURCES Income Tax Reporting
The cost-based depletion method is for financial reporting purposes.
The Internal Revenue Code allows the use of statutory depletion (also called percentage depletion) for tax purposes.
Use of different methods for tax and financial reporting purposes leads to different incomes.

32. EXPLORATION COSTS Oil and Gas Industry
The costs of exploration for the oil and gas industry are very large.
An accounting question arises as to how much of the exploration costs can be capitalized.
Two basic methods are allowed when accounting for those costs:
Successful-efforts method
Full-cost method

33. EXPLORATION COSTS Successful-Efforts Method
Only the exploration costs associated with successful wells are capitalized in the cost of the natural resource.
The costs associated with unsuccessful wells are expensed as incurred.

34. EXPLORATION COSTS Full-Cost Method
All exploration costs are capitalized as part of the cost of the natural resource.
This method tends to be used by smaller firms primarily in the exploration business.