Intermediate Accounting - Chap011 potx

The equipment has an estimated service life of 5 years and estimated residual value of $5,000.What is the annual straight-line depreciation?. The equipment has an estimated service life

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Impairment

11

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Learning Objectives

Explain the concept of cost allocation as it

pertains to operational assets

Some of the cost is expensed each period.

The matching principle requires that part of the acquisition cost of operational assets be

expensed in periods when the future

revenues are earned.

The matching principle requires that part of the acquisition cost of operational assets be

expensed in periods when the future

revenues are earned.

Cost Allocation – An Overview

Some of the cost is expensed each period

Depreciation, depletion, and amortization are cost allocation processes used to help meet the matching principle requirements.

Depreciation, depletion, and amortization

are cost allocation processes used to help meet the matching principle requirements.

Type of Operational

Intangible Amortization Intangible Asset

Account Credited

Accumulated Depreciation

Property, Plant, &

Equipment Depreciation

Natural Resource Depletion Natural Resource

Asset

Caution!

Depreciation, depletion, and amortization are

processes of cost allocation, not valuation!

Cost allocation requires three pieces of

information for each asset:

The estimated expected

use from an asset

The estimated expected

use from an asset

Total amount of cost to be allocated.

Cost - Residual Value (at end of useful life)

Total amount of cost to be allocated.

Cost - Residual Value (at end of useful life)

The systematic approach used for allocation

The systematic approach used for allocation

Allocation Base

Allocation Base

Measuring Cost Allocation

Determine periodic depreciation using both time-based and activity-based methods.

Group and composite methods

Tax depreciation

Tax depreciation

Depreciation of Operational Assets

Net property, plant & equipment is the undepreciated cost (book value) of plant assets

The most widely

used and most

easily understood

method.

The most widely

used and most

$50,000 cash The equipment has an estimated service life of 5 years and estimated residual value of $5,000.

What is the annual straight-line

depreciation?

$50,000 cash The equipment has an estimated service life of 5 years and estimated residual value of $5,000.

What is the annual straight-line

depreciation?

Straight-Line

Accumulated Accumulated Undepreciated Depreciation Depreciation Depreciation Balance Year (debit) (credit) Balance (book value)

Note that at the end of the asset’s

useful life, BV = Residual Value

Note that at the end of the asset’s

useful life, BV = Residual Value

0 1000 2000 3000 4000 5000 6000 7000 8000 9000

Accelerated methods result in more

depreciation in the early years of an asset’s useful life and less depreciation

in later years of an asset’s useful life.

Accelerated methods result in more

depreciation in the early years of an asset’s useful life and less depreciation

in later years of an asset’s useful life.

Note that total depreciation over the asset’s useful life is the same as the Straight-

line Method.

Note that total depreciation over the asset’s useful life is the same as the Straight-

line Method.

SYD depreciation is computed as follows:

Sum-of-the-Years’ Digits (SYD)

$50,000 cash The equipment has a service life of 5 years and an estimated

residual value of $5,000.

Using SYD, compute depreciation

for the first two years.

$50,000 cash The equipment has a service life of 5 years and an estimated

residual value of $5,000.

Using SYD, compute depreciation

for the first two years.

Use this in your computation of SYD

Depreciation for Years 1 & 2.

Use this in your computation of SYD

Depreciation for Years 1 & 2.

Sum-of-the-Years’ Digits (SYD)

Accumulated Undepreciated Depreciation Depreciation Balance

Fraction (debit) Balance (book value)

50,000

$ 5/15 $ 15,000 $ 15,000 35,000 4/15 12,000 27,000 23,000 3/15 9,000 36,000 14,000 2/15 6,000 42,000 8,000 1/15 3,000 45,000 5,000

45,000

$

Accumulated Undepreciated Depreciation Depreciation Balance

Fraction (debit) Balance (book value)

50,000

$ 5/15 $ 15,000 $ 15,000 35,000 4/15 12,000 27,000 23,000 3/15 9,000 36,000 14,000 2/15 6,000 42,000 8,000 1/15 3,000 45,000 5,000

0 2000 4000 6000 8000 10000 12000 14000 16000

Note that the Book Value will get lower each time depreciation is computed!

Note that the Book Value will get lower each time depreciation is computed!

On January 1, we purchase equipment for $50,000

cash The equipment has a service life of 5 years

and an estimated residual value of $5,000.

What is depreciation for the first two years using double-declining-balance?

On January 1, we purchase equipment for $50,000

cash The equipment has a service life of 5 years

and an estimated residual value of $5,000.

What is depreciation for the first two years using double-declining-balance?

Double-Declining-Balance (DDB)

Accumulated Undepreciated Depreciation Depreciation Balance

Year (debit) Balance (book value)

0 2000 4000 6000 8000 10000 12000 14000 16000 18000 20000

Activity-Based Depreciation

 Depreciation can also be

based on measures of input

 Depreciation can also be

based on measures of input

On January 1, we purchased equipment for

$50,000 cash The equipment is expected

to produce 100,000 units during its life and has an estimated residual value of $5,000.

If 22,000 units were produced this year,

what is the amount of depreciation?

On January 1, we purchased equipment for

$50,000 cash The equipment is expected

to produce 100,000 units during its life and has an estimated residual value of $5,000.

If 22,000 units were produced this year,

what is the amount of depreciation?

Units-of-Production

Recent Survey of Large Public Companies (Sample of 684)

580

22 7

41 30 4

Straight Line Declining Balance Sum-of-the-years' digits Other Accelerated

Units of Production Other

Use of Various Depreciation Methods

 Balances of major classes of depreciable

assets.

 Accumulated depreciation by asset or in

total.

 General description of

depreciation methods used.

 Balances of major classes of depreciable

 Assets are grouped by common

characteristics.

 An average depreciation rate is used.

 Annual depreciation is the average rate ×

the total group acquisition cost.

 Accumulated depreciation records are not maintained for individual assets.

 Assets are grouped by common

characteristics.

 An average depreciation rate is used.

 Annual depreciation is the average rate ×

the total group acquisition cost.

 Accumulated depreciation records are not

maintained for individual assets.

Group and Composite Methods

 If assets in the group are sold, or

new assets added, the composite

rate remains the same.

 When an asset in the group is sold or

retired, debit accumulated

depreciation for the difference

between the asset’s cost and the

proceeds

 If assets in the group are sold, or

new assets added, the composite

rate remains the same.

 When an asset in the group is sold or

retired, debit accumulated

depreciation for the difference

between the asset’s cost and the

proceeds

Learning Objectives

Calculate the periodic depletion of a natural

resource

The approach is based on the units- of-production method.

The approach is based on the units- of-production method.

As natural resources

are “used up”, or

depleted, the cost of

the natural resources

must be allocated to

the units extracted.

As natural resources

are “used up”, or

depleted, the cost of

the natural resources

must be allocated to

the units extracted.

Depletion of Natural Resources

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 unit depletion rate?

What is ABC’s unit depletion rate?

For the year ABC mined 13,000 tons and sold 9,000 tons What is the total depletion and the depletion expense?

For the year ABC mined 13,000 tons and sold 9,000 tons What is the total depletion and the depletion expense?

Expense = 9,000 x $25 = $225,000

Depletion = 13,000 x $25 = $325,000

Expense = 9,000 x $25 = $225,000

Learning Objectives

Calculate the periodic amortization of an

intangible asset

The amortization process uses the straight-line method, but assumes

or

Amortization of Intangible Assets

The amortization entry is:

Note that the amortization process does

not use a contra-asset account.

Torch, Inc has developed a new device Patent

registration costs consisted of $2,000 in attorney

fees and $1,000 in federal registration fees The

device has a useful life of 5 years The legal life is

20 years.

At the end of year 1, what is Torch’s amortization

expense?

Torch, Inc has developed a new device Patent

registration costs consisted of $2,000 in attorney

fees and $1,000 in federal registration fees The

device has a useful life of 5 years The legal life is

20 years.

At the end of year 1, what is Torch’s amortization

expense?

Record the amortization entry.

Amortization of Intangible Assets

Note that the patent will have a book value of

$2,400 after this amortization entry is posted.

Intangible Assets Not Subject

to Amortization

Not amortized.

Subject to assessment

for impairment value and may be written down.

Subject to assessment

for impairment value and may be written down.

Goodwill

I bought an asset on May

19 this year Do I get a full year’s depreciation?

May 19

Partial-Period Depreciation

Half-Year Convention Take ½ of a year of depreciation in the

year of acquisition, and the other ½ in

the year of disposal.

Half-Year Convention

Take ½ of a year of depreciation in the

year of acquisition, and the other ½ in

the year of disposal.

Pro-rating the depreciation based on the

date of acquisition is time-consuming

and costly A commonly used alternative

is the

required when a change is made in the service life or residual value of an operational asset.

Changes in Estimates

Depreciation Expense is based on

ESTIMATED service life

ESTIMATED service life residual value ESTIMATED

ESTIMATED residual value

If the estimates change, the book value less

any residual value at the date of change is

depreciated over the remaining useful life.

If the estimates change, the book value less

any residual value at the date of change is

depreciated over the remaining useful life.

On January 1, equipment was

purchased that cost $30,000,

has a useful life of 10 years and

no salvage value At the

beginning of the fourth year, it

was decided that there were

only 5 years remaining, instead

of 7 years

Calculate depreciation expense

for the fourth year using the

straight-line method.

On January 1, equipment was

purchased that cost $30,000,

has a useful life of 10 years and

no salvage value At the

beginning of the fourth year, it

was decided that there were

only 5 years remaining, instead

of 7 years

Calculate depreciation expense

for the fourth year using the

straight-line method.

Asset cost $ 30,000

Accumulated depreciation

Accumulated depreciation

($3,000 per year × 3 years) 9,000

Remaining book value 21,000

Divide by remaining life ÷ 5

Revised annual depreciation $ 4,200

Changes in Estimates

What happens if we change depreciation methods?

required when a change in depreciation

method is made

Change in Depreciation Method

We account for these changes

prospectively, , exactly as we would any

other change in estimate.

We account for these changes

prospectively, , exactly as we would any

other change in estimate.

A change in depreciation, amortization, or

depletion method is considered a change in

accounting estimate that is achieved by a

change in accounting principle.

A change in depreciation, amortization, or

depletion method is considered a change in

accounting estimate that is achieved by a

change in accounting principle.

On January 1, 2004, Matrix, Inc., a calendar year-end company purchased equipment for $400,000 Matrix expected a residual value $40,000, and a service life

of 5 years Matrix uses the double-declining-balance method to depreciate this type of asset During 2006, the company switched from double-declining balance

to straight-line depreciation Let’s determine the amount of depreciation to be recorded at the end of

2006.

On January 1, 2004, Matrix, Inc., a calendar year-end company purchased equipment for $400,000 Matrix expected a residual value $40,000, and a service life

of 5 years Matrix uses the double-declining-balance method to depreciate this type of asset During 2006, the company switched from double-declining balance

to straight-line depreciation Let’s determine the

amount of depreciation to be recorded at the end of

2006.

Change in Depreciation Method

Depreciation - 2004 $ 160,000 ($400,000 × 40%) Depreciation - 2005 96,000 [($400,000 - $160,000) × 40%]

Total Depreciation $ 256,000

2006 Depreciation

when an error in accounting for an operational

asset is discovered

statements.

Reporting the correction as a prior period adjustment to Beginning R/E.

impairment of the value of operational assets

and describe the required accounting

procedures

Impairment of Value

Occasionally, asset value must

be written down due to

permanent loss of benefits of

the asset through

 Casualty.

 Obsolescence.

 Lack of demand for the asset’s

services.

Occasionally, asset value must

be written down due to

permanent loss of benefits of

the asset through

 Casualty.

 Obsolescence.

 Lack of demand for the asset’s

services.

Accounting treatment differs.

indefinite useful lives

Intangible

with indefinite useful lives

Goodwill

indefinite useful lives

Intangible

with indefinite useful lives

Goodwill

Test for impairment of value

when it is suspected that

book value may not be

recoverable

Test for impairment of value at least annually

Test for impairment

of value when considered for sale

Recoverable cost < Book value

Recoverable cost < Book value

An asset is impaired if

Expected future total undiscounted net cash inflows generated by use of

Reported as

part of income from

continuing

operations.

Reported as

part of income from

continuing

operations.

Impairment

loss = value Book – value Fair

Market value, price of

similar assets, or PV of future net cash inflows.

Fair value < recoverable

value due to the time value of money.

Market value, price of

similar assets, or PV of future net cash inflows.

Fair value < recoverable

value due to the time value of money.

Impairment of Value –

Tangible and Finite-Life Intangibles

Measurement – Step 2