1 investments in noncurrent operating assets-- utilization and retirement

1

Investments in Investments in Noncurrent Noncurrent Operating Operating Assets--Assets--

Utilization and Utilization and RetirementRetirement

2

Use straight-line, accelerated, use-factor, and group depreciation methods to compute annual depreciation expense.

Discuss the issues impacting proper amortization of intangible assets.

Apply the productive-output method to the depletion of natural resources.

Learning Objectives

3

Incorporate changes in estimates into the computation of depreciation for current and future periods.

Identify whether an asset is impaired and measure the amount of the impairment loss, using U.S. GAAP and international accounting standards.

Account for the sale of depreciable assets in exchange for cash and in exchange for other depreciable assets.

Learning Objectives

4

Learning Objectives

EXPANDED MATERIAL Compute depreciation for partial periods, using

both straight-line and accelerated methods. Understand the depreciation methods underlying

the MACRS income tax depreciation system.

5

ACQUIRE long-term

operating assets

Time Line of Business Issues

CHANGE estimates

related to an asset’s life

ESTIMATE and RECOGNIZE an

asset’s use (depreciation,

amortization, and depletion)

6

Time Line of Business Issues

MONITOR asset value for

possible declines

DISPOSE of a

depreciable asset

7Factors Affecting the Periodic Depreciation Charge

• Asset cost

• Residual or salvage value

• Useful life

• Pattern of use

• Asset cost

• Residual or salvage value

• Useful life

• Pattern of use

8Depreciation--Financial Statement Impacts

Depreciation

Balance Sheet

C. Assets XXP P & E XXXXAcc. Dep. (XX)Total XXXXLiab. XXXOE XXXTotal XXXX

IncomeStatement

Revenue XXXXCOGS XXXGr. Profit XXXDep. Exp. (XX)Net Inc. XXX

Statement ofCash Flows

From Oper. Net Inc. XXX Dep. Exp. XXNet Cash XXX


Depreciation

Balance Sheet


IncomeStatement





Indirect Method

Depreciation

Balance Sheet


IncomeStatement




11

Depreciation Vocabulary

• Book Value: Historical cost of the asset less accumulated depreciation.

• Depreciation: Periodic charge for cost allocation of long-term assets.

• Accumulated Depreciation: Total depreciation recorded since acquisition.

• Asset Cost: Purchase cost plus any capitalized expenditures.

• Residual Value: Estimated resale value of the asset upon retirement.

• Useful Life: Estimated life of asset in years, hours of service, or per unit of output.

12

Depreciation Illustration

Costs incurred are deferred Costs incurred are deferred until future periods. They until future periods. They

are recorded as an asset and are recorded as an asset and the costs are assigned to the costs are assigned to

future periods.future periods.

Costs incurred are deferred Costs incurred are deferred until future periods. They until future periods. They

are recorded as an asset and are recorded as an asset and the costs are assigned to the costs are assigned to

future periods.future periods.

Cost(Asset)

Cost(Asset)

Depreciable

Period 2Period 2Period 2Period 2 Period 3Period 3Period 3Period 3Period 1Period 1Period 1Period 1

13

Cost(Asset)

Cost(Asset)

Period 2Period 2Period 2Period 2 Period 3Period 3Period 3Period 3

A depreciation method is A depreciation method is selected to assign these selected to assign these costs to future periods.costs to future periods.


Depreciable


Period 1Period 1Period 1Period 1Period 1Period 1

14

Period 2Period 2Period 2Period 2 Period 3Period 3Period 3Period 3


Period 1Period 1

Cost(Asset)

Cost(Asset)Cost A depreciation method is A depreciation method is

selected to assign these selected to assign these costs to future periods.costs to future periods.


Period 2Period 2

DepreciableDepreciable

15

The allocation of a deferred cost, in The allocation of a deferred cost, in this case depreciation expense, has this case depreciation expense, has

no direct effect on cash. The no direct effect on cash. The allocation is based on the allocation is based on the

depreciable cost, useful life, and depreciable cost, useful life, and depreciation method.depreciation method.

The allocation of a deferred cost, in The allocation of a deferred cost, in this case depreciation expense, has this case depreciation expense, has

no direct effect on cash. The no direct effect on cash. The allocation is based on the allocation is based on the

depreciable cost, useful life, and depreciable cost, useful life, and depreciation method.depreciation method.


Period 1Period 1 Period 2Period 2

Cost(Asset)

Cost(Asset)Cost

DepreciableDepreciable

(Asset)

Period 3Period 3Period 3Period 3Period 3Period 3Period 3Period 3Period 3

16

Depreciation Methods

• Straight-line: This method recognizes equal periodic depreciation charges over the asset’s life.

Time-Factor MethodsTime-Factor MethodsTime-Factor MethodsTime-Factor Methods

• Accelerated methods: – Sum-of-the-years’-digits--This method yields decreasing depreciation

in each successive year.– Declining-balance--This method provides decreasing charges by

applying a constant percentage rate to a declining asset book value.

17


• Service hours: This depreciation method is based on the theory that purchase of an asset represents the purchase of a number of hours of direct service.

Use-Factor MethodsUse-Factor MethodsUse-Factor MethodsUse-Factor Methods

• Productive output: This method is based on the theory that an asset is acquired for the service it can provide in the form of production output.

18


Group and Composite Group and Composite MethodsMethods

Group and Composite Group and Composite MethodsMethods

• Group: Used when the assets in the group are similar.• Composite: Used when the assets in the group are

related, but dissimilar.

This approach treats an entire group of assets as if the group were one asset.

19

Depreciation MethodsSchuss Boom Ski Manufacturing acquired a polyurethane plastic-

molding machine at the beginning of 2002 for $100,000.

It has an estimated life of five years, 20,000 hours, or 25,000 units. The estimated residual value is $5,000. In 2002, the

equipment was used 3,000 hours to produce 3,500 units.

Schuss Boom Ski Manufacturing acquired a polyurethane plastic-

molding machine at the beginning of 2002 for $100,000.

It has an estimated life of five years, 20,000 hours, or 25,000 units. The estimated residual value is $5,000. In 2002, the

equipment was used 3,000 hours to produce 3,500 units.

20

Time-Factor Methods

Straight-Line Method

Depreciation =Cost - Residual Value

Number of Years

Depreciation =$100,000 - $5,000

5

Depreciation = $19,000

21

$35,000

$28,000

$21,000

$14,000

$7,000

$0

Depreciation Expense

Straight-Line Method

Time-Factor Methods

2002 2003 2004 2005 2006

22

SYD = [n (n + 1)]2

Time-Factor Methods

SYD = [5 (5 + 1)]2

SYD = 15

Sum-of-the-Years’-Digits Method

23


tDepreciation = SYD x (Cost - Residual Value)

t = years remaining in n atthe beginning of the period

t = years remaining in n atthe beginning of the period

Depreciation (2002) = 5 15 x $95,000

Depreciation (2002) = $31,667

Time-Factor Methods

24

$35,000

$28,000

$21,000

$14,000

$7,000

$0



Time-Factor Methods

2002 2003 2004 2005 2006

25

F = declining balance factor(e.g., 150% or 200%)

F = declining balance factor(e.g., 150% or 200%)

Declining-Balance Method

Note:• Do not depreciate below salvage value.• Optional: Switch to straight-line when it

yields higher depreciation.

Note:• Do not depreciate below salvage value.• Optional: Switch to straight-line when it

yields higher depreciation.

Depreciation = F x (Cost - Accum. Depr.)

Depreciation (2002) = .40 x $100,000


Time-Factor Methods

26

$42,000

$35,000

$28,000

$21,000

$14,000

$7,000

$0


Declining-Balance Method

Time-Factor Methods

2002 2003 2004 2005 2006

27

Service Hours Method

Depreciation = Cost - Residual ValueNumber of Hours

Use Factor Methods

Depreciation = $100,000 - $5,00020,000 hours

Total Estimated Service Life of Asset

Depreciation = $4.75 per hour


Depreciation (2002) = $4.75 x 3,000

28

Productive-Output Method

r (per unit) = Cost - Residual ValueTotal Number of Units

Use Factor Methods

r (per unit) = $100,000 - $5,000 25,000 units

r (per unit) = $3.80 per unit

Depreciation (2002) = $3.80 x 3,500


29

Group Depreciation

Group similar assets into depreciation accounts.

Calculate annual depreciation charge at the straight-line rate times the group’s book value.

Recognize gains and losses only when all assets in the group have been retired.

Referred to as composite depreciation when the assets in the group are related but dissimilar.

30

Depletion

Land containing mineral deposits is purchased at a cost

of $5,500,000. The cost to restore the land to its original

state after removal of the resources is estimated to be

$200,000 (then it can be sold for $450,000). In 2002, 80,000 tons of the estimated 2,000,000

tons are removed.

Land containing mineral deposits is purchased at a cost

of $5,500,000. The cost to restore the land to its original

state after removal of the resources is estimated to be

$200,000 (then it can be sold for $450,000). In 2002, 80,000 tons of the estimated 2,000,000

tons are removed.

31

Depletion

Depletion charge per ton

$5,500,000 - $250,0001,000,000 tons

=

Depletion charge per ton

= $5.25

Depletion for 2002 = $5.25 x 80,000 tons

Depletion for 2002 = $420,000

$450,000 - $200,000

32

Impairment

Before the end of an asset’s useful life, events occur that impair its

value. This requires an immediate write-down of the asset.

Before the end of an asset’s useful life, events occur that impair its

value. This requires an immediate write-down of the asset.

33

Impairment

1. When should an asset be reviewed for possible impairment?

An impairment review should be conducted whenever there has been a material change in the way an asset is used or in the business environment.

An impairment review should be conducted whenever there has been a material change in the way an asset is used or in the business environment.

Also, if management obtains information suggesting that the market

value of the asset has declined.

34

Impairment

2. When is an asset impaired?

An asset is impaired when the undiscounted sum of estimated future

cash flows from an asset is less than the book value of the asset.

An asset is impaired when the undiscounted sum of estimated future

cash flows from an asset is less than the book value of the asset.

The sum of the undiscounted future cash flows will always be greater than

the fair value of the asset.

35

Impairment

3. How should an impairment loss be measured?

The impairment loss is the difference between the book value of the asset and

the asset’s fair value.

The impairment loss is the difference between the book value of the asset and

the asset’s fair value.

The fair value can be approximated using the present value of estimated

future cash flows from the asset.

36

Impairment

4. What information should be disclosed about an impairment?

Disclosure should include a description of the impaired asset, reasons for the

impairment, a description of the measurement assumptions, and the

business segment or segments affected.

Disclosure should include a description of the impaired asset, reasons for the

impairment, a description of the measurement assumptions, and the

business segment or segments affected.

37Asset Retirement--General Procedure

• Remove old asset from books: debit Accumulated Depreciation; credit the asset.

• Record new asset at fair market value: debit asset

• Record any cash received or paid: debit or credit Cash as appropriate.

• Record any gain or loss: debit loss account or credit gain account.

38Asset Retirement--Determining Gain or Loss

• Gain or Loss =

(FMV New Asset + Cash Received) less

(Book Value Old Asset + Cash Paid)

• If answer is greater than zero, record a gain.

• If answer is less than zero, record a loss.

39Asset Retirement--Unusual Considerations

Are assetssimilar in nature?

Record transactionaccording to generalprocedure.






YES

YES

YES

NO

NO

NO

Are the partiesin the same line

of business?

Does thetransaction

create a gain?

Zero

Defer all

gains

25% or more

Recordtransaction

using generalprocedure.

Recordtransaction

using generalprocedure.

What percentageof the transaction’s

FMV is in cash?

Less than 25%

Party paying cashdefers all gains.

Party receiving cashdefers a portion

of all gains

Let’s take a closer look at this

last section.

Let’s take a closer look at this

last section.

Less than 25%

40

What percentageof the transaction’s

FMV is in cash?

25% or moreRecord

transactionusing general

procedure.

Defer all

gains.

Defer all

gains.

Zero

Less than 25%

Party paying cashdefers all gains.

Party receiving cashdefers a portion

of all gains

Asset Retirement--Unusual Considerations

Yes

41

Partial Periods

Nearest whole month. Nearest whole year. Half-year convention. No depreciation in year of acquisition; full

year depreciation in year of retirement. Full year depreciation in year of acquisition;

no depreciation in year of retirement.

Nearest month makes the most intuitive sense.

Nearest month makes the most intuitive sense.

42

The EndThe End

1 investments in noncurrent operating assets-- utilization and retirement

Documents

total depreciation

accumulated depreciation

computation of depreciation

cost asset cost asset

depreciable asset slide

group depreciation methods

net cashxxx slide

annual depreciation