Intermediate accounting 13th kieso warfield chapter 11

Chapter 11-5 Allocating costs of long-term assets: Fixed assets = Depreciation expense Intangibles = Amortization expense Natural resources = Depletion expense Depreciation is the accoun

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Chapter 11-1

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Chapter

11-3

1. Explain the concept of depreciation

2. Identify the factors involved in the depreciation process

3. Compare activity, straight-line, and decreasing-charge methods

of depreciation

4. Explain special depreciation methods

5. Explain the accounting issues related to asset impairment

6. Explain the accounting procedures for depletion of natural

resources

7. Explain how to report and analyze property, plant, equipment,

and natural resources

Learning Objectives

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Assets to be disposed of

Presentation Analysis

Establishing a base

Write-off of resource cost Estimating reserves Liquidating dividends Continuing controversy

Depreciation, Impairments, and Depletion

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Chapter

11-5

Allocating costs of long-term assets:

Fixed assets = Depreciation expense Intangibles = Amortization expense Natural resources = Depletion expense

Depreciation is the accounting process of allocating

the cost of tangible assets to expense in a systematic and rational manner to those periods expected to

benefit from the use of the asset.

Depreciation - Method of Cost Allocation

LO 1 Explain the concept of depreciation.

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Chapter

11-6

LO 2 Identify the factors involved in the depreciation process.

Three basic questions :

Factors Involved in the Depreciation Process

(1) What depreciable base is to be used?

(2) What is the asset’s useful life?

(3) What method of cost allocation is best?

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Chapter

11-7

Depreciable Base

Illustration 11-1

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Chapter

11-8

Estimation of Service Lifes

 Service life of an asset often differs from its

physical life.

 Companies retire assets for two reasons:

 physical factors (such as casualty or

expiration of physical life) and

 economic factors (obsolescence).

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Chapter

11-9

LO 3 Compare activity, straight-line, and

decreasing-charge methods of depreciation.

The profession requires the method employed be

“systematic and rational.” Examples include:

Accelerated methods

Special methods

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Chapter

11-10

Activity Method

Illustration: If Stanley uses the crane for 4,000 hours

the first year, the depreciation charge is:

Stanley Coal

Mines Facts

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Chapter

11-11

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Chapter

11-12

numerator is the number of years of estimated life

remaining as of the beginning of the year.

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Chapter

11-13

Sum-of-the-Years’-Digits

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Chapter

11-14

multiple of the straight-line method

depreciation base

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Chapter

11-15

Declining-Balance Method

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Chapter

11-16

E11-5 (Depreciation Computations—Four Methods): KC

Corporation purchased a new machine for its assembly process on

August 1, 2010 The cost of this machine was $150,000 The

company estimated that the machine would have a salvage value of

$24,000 at the end of its service life Its life is estimated

at 5 years and its working hours are estimated at 21,000 hours

Year-end is December 31

Instructions: Compute the depreciation expense under the

following methods

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Chapter

11-17

Straight-line Method

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Chapter

11-18

LO 3

Activity Method (Assume 800 hours used in 2010)

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Chapter

11-19

Sum-of-the-Years’-Digits Method

LO 3

5/12 = 416667 7/12 = 583333

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Chapter

11-20

Double-Declining Balance Method

LO 3

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Chapter

11-21

LO 4 Explain special depreciation methods.

The choice of method depends on the nature of the

assets involved:

Special Depreciation Methods

Group method used when the assets are similar in nature and have approximately the same useful lives.

Composite approach used when the assets are dissimilar and have different lives.

Companies are also free to develop tailor-made depreciation methods, provided the method results in the allocation of an asset’s cost in a systematic and rational manner (Hybrid or Combination Methods)

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Chapter

11-22

Special Depreciation Issues

(1) How should companies compute depreciation for

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Chapter

11-23

Changes in Depreciation Rate

Accounted for in the period of change and future periods (Change in Estimate)

Not handled retrospectively Not considered errors or extraordinary items

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Chapter

11-24

Arcadia HS, purchased equipment for $510,000 which

was estimated to have a useful life of 10 years with a

salvage value of $10,000 at the end of that time

Depreciation has been recorded for 7 years on a

straight-line basis In 2010 (year 8), it is determined

that the total estimated life should be 15 years with a

salvage value of $5,000 at the end of that time.

Questions:

 What is the journal entry to correct

the prior years’ depreciation?

 Calculate the depreciation expense

for 2010.

No Entry Required

Change in Estimate Example

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Balance Sheet (Dec 31, 2009)

Change in Estimate Example After 7 years

First, establish NBV at date of change in estimate.

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Chapter

11-26

Change in Estimate Example After 7 years

Net book value

for 2010.

Depreciation Expense calculation

for 2010.

Accumulated depreciation 19,375

Journal entry for 2010

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Chapter

11-27

Impairments

LO 5 Explain the accounting issues related to asset impairment.

When the carrying amount of an asset is not

recoverable, a company records a write-off referred

to as an impairment

Events leading to an impairment:

c Adverse change in legal factors or in the business climate

expected to acquire or construct an asset

associated with an asset

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1 Review events for possible impairment.

2 If the review indicates impairment, apply the

recoverability test If the sum of the expected future net cash flows from the long-lived asset is less than the carrying amount of the asset, an impairment has

occurred.

3 Assuming an impairment, the impairment loss is the

amount by which the carrying amount of the asset exceeds the fair value of the asset The fair value is the market value or the present value of expected future net cash flows.

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Chapter

11-30

E11-16 (Impairment): Presented below is information related to

equipment owned by Pujols Company at December 31, 2010 Assume that Pujols will continue to use this asset in the future As of

December 31, 2010, the equipment has a remaining useful life of 4 years

Instructions:

(a) Prepare the journal entry (if any) to record the impairment of the

asset at December 31, 2010.

(b) Prepare the journal entry to record depreciation expense for 2011.

(c) The fair value of the equipment at December 31, 2011, is $5,100,000

Prepare the journal entry (if any) necessary to record this increase in fair value.

Impairments

LO 5 Explain the accounting issues related to asset impairment.

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Chapter

11-31

Accumulated depreciation 3,600,000

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Chapter

11-32

Accumulated depreciation 1,100,000

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Chapter

11-33

Natural resources , often called wasting assets,

include petroleum, minerals, and timber.

They have two main features:

Depletion

LO 6 Explain the accounting procedures for depletion of natural resources.

1 complete removal (consumption) of the asset, and

2 replacement of the asset only by an act of nature.

Depletion is the process of allocating the cost of

natural resources.

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Computation of the depletion base involves four factors:

(1) Acquisition cost of the deposit,

(2) Exploration costs,

(3) Development costs, and

(4) Restoration costs.

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Normally, companies compute depletion on a

units-of-production method (an activity approach) Thus,

depletion is a function of the number of units extracted during the period.

Calculation:

Total cost – Salvage value Total estimated units available = Depletion cost per unit Units extracted x Cost per unit = Depletion

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Chapter

11-36

E11-19 (Depletion Computations—Timber): Hernandez Timber

Company owns 9,000 acres of timberland purchased in 1999 at a

cost of $1,400 per acre At the time of purchase the land without the timber was valued at $400 per acre In 2000, Hernandez built fire lanes and roads, with a life of 30 years, at a cost of $87,000 Every year Hernandez sprays to prevent disease at a cost of

$3,000 per year and spends $7,000 to maintain the fire lanes and roads During 2001, Hernandez selectively logged and sold 700,000 board feet of timber, of the estimated 3,000,000 board feet In

2002, Hernandez planted new seedlings to replace the trees cut at

Determine the depreciation expense and the cost of timber sold

related to depletion for 2001

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 Same as accounting for changes in estimates.

 Revise the depletion rate on a prospective basis.

 Divides the remaining cost by the new estimate of the

recoverable reserves.

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Chapter

11-40

Liquidating Dividends - Dividends greater than the

amount of accumulated net income.

Depletion

Illustration: Callahan Mining had a retained earnings

balance of $1,650,000 and paid-in capital in excess of par

of $5,435,493 Callahan’s board declared a dividend of $3

a share on the 1,000,000 shares outstanding It records

the $3,000,000 cash dividend as follows.

Retained Earnings 1,650,000 Paid-in Capital in Excess of Par 1,350,000

Cash 3,000,000

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Chapter

11-41

Continuing Controversy

Oil and Gas Industry:

Full cost concept Successful efforts concept

Depletion

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Chapter

11-42

Presentation of Property, Plant, Equipment,

and Natural Resources

Presentation and Analysis

Basis of valuation (cost)Pledges, liens, and other commitmentsDepreciation expense for the period

Balances of major classes of depreciable assets.Accumulated depreciation

A description of the depreciation methods used

Depreciating assets, use Accumulated Depreciation.

Depleting assets may include use of Accumulated Depletion

account, or the direct reduction of asset.

Disclosures

LO 7 Explain how to report and analyze property,

plant, equipment, and natural resources.

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Chapter

11-43

The assets turnover is a measure of a firm’s ability to

generate sales from a particular investment in assets

Solution on notes page

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Chapter

11-44

The profit margin on sales is a measure of the ability to

generate operating income from a particular level of sales.

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Chapter

11-45

Rate of Return on Assets measures a firm’s success in using

assets to generate earnings.

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Chapter

11-46

The analyst obtains further insight into the behavior of ROA

by

by disaggregating disaggregating it into components of profit margin on

sales and asset turnover as follows:

Profit Margin on

Sales

Asset Turnover

x

x Average Total Assets

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Chapter

11-47

$64.2 ($811.8 + 665.3) / 2

x

($811.8 + 665.3) / 2

The analyst obtains further insight into the behavior of ROA

by

by disaggregating disaggregating it into components of profit margin on

sales and asset turnover as follows:

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Chapter

11-48

construction must be capitalized.

self-constructed assets

converged between iGAAP and U.S GAAP

accelerated, units-of-production) as U.S GAAP.

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Chapter

11-49

asset revaluations (which are not permitted in U.S GAAP)

Consequently, companies that use the revaluation framework must follow revaluation depreciation procedures

However, iGAAP does not use the first-stage recoverability test used under U.S GAAP—comparing the undiscounted cash flows to the carrying amount Thus, the iGAAP test is more strict than U.S GAAP.

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