afm291-ch11 (1)

AFM 291chapter 11 1

Chapter Chapter 11 11

Depreciation, Impairment, and DispositionDepreciation, Impairment, and Disposition

AFM 291chapter 11 2

Depreciation – Concept

• Depreciation is a means of cost allocation• It is NOT a method of valuation• Depreciation involves:

– Allocating the cost of capital assets to expense (matching principle) in a systematic and rational manner to periods expected to benefit from use of assets

• The terms depreciation and amortization are used interchangeably

AFM 291chapter 11 3

Factors in the Depreciation Process

Questions to be answered:1. What asset components are depreciated separately?

2. What amount of the asset’s cost is to be depreciated?

3. What is the asset’s useful life (period of depreciation)?

4. What pattern and method of cost apportionment is best for this asset?

=> Which depreciation method best matches the way this asset is used/consumed?

AFM 291chapter 11 4

1. Components Depreciated Separately

• Each significant part of a PP&E asset should be identified and depreciated as a separate component

• Multiple components may be grouped for calculating depreciation if they have same useful lives and depreciation methods

• Parts of each PP&E asset that are not individually significant can be grouped and depreciated as a single component

• Application of components for the purpose of depreciation is required by both private entity GAAP and IFRS. However, IFRS is more detailed and strict.

AFM 291chapter 11 5

2. Depreciable Amount • Depreciable amount is initially calculated as:

Original cost of the assetless estimated residual value (or salvage value)

• IFRS does not permit the use of salvage value• Residual value is the net amount expected to be

received for the asset today if it were of the age and in the condition expected at the end of its useful life

• Salvage value is the asset’s estimated net realizable value at the end of the asset’s life

• Residual value should be reviewed regularly (at least annually under IFRS)

• Depreciation continues as long as residual value is lower than asset’s carrying amount

AFM 291chapter 11 6

3. Depreciation Period• Depreciation begins when the asset is available

for use• Depreciation ends when the asset is

derecognized or classified as held for sale.• An asset’s useful life and physical life are not the

same (expressed in time or units)• Useful life is sometimes referred to as the

economic life—the period of time over which the asset will produce revenue for the company

• Factors affecting useful life are:• economic factors (e.g. obsolescence)• physical factors (e.g. wear and tear)• legal life (e.g. expiration of contract)

AFM 291chapter 11 7

4. Choice of Depreciation Method• Depreciation method determines the systematic

allocation of the depreciable amount over the asset’s useful life

• Depreciation should reflect the pattern of benefits expected from the use of the asset (matching)

• Additional considerations for choosing a particular depreciation method include simplicity, cost, as well as perceived economic consequences

• Depreciation method affects: – The balance sheet– The income statement– The ratios (e.g. return on assets, etc)

AFM 291chapter 11 8

4. Amortization Methods: OverviewAmortizationAmortization

MethodsMethods

Financial AccountingFinancial AccountingDepreciation MethodsDepreciation Methods

TaxTaxDepreciationDepreciation

ActivityActivitymethodmethod

Straight-lineStraight-linemethodmethod

DecreasingDecreasingchargecharge

methodsmethods

1. Declining-balance1. Declining-balance2. Sum-of-the-years’-digits2. Sum-of-the-years’-digits (not widely used in Canada) (not widely used in Canada)

SpecialSpecialmethodsmethods

1. Group and Composite1. Group and Composite2. Hybrid methods2. Hybrid methods

IncreasingIncreasingChargeCharge

MethodsMethods

AFM 291chapter 11 9

4. Depreciation Methods: Example

Crane Ltd. buys a crane at the beginning of the current fiscal year. Information relating to the crane follows:

• Cost: $500,000• Estimated useful life: five years (or 30,000 hours)• Residual value end of five years of use: $50,000• Actual hours used during the current year: 4,000

hours and assume 4,700 in next year

Based on this information, calculate the amortization for the current year using: activity, straight-line, and decreasing charge methods

AFM 291chapter 11 10

Activity Method (unit = hour)

1. Depreciable base = $500,000 – $50,000 = $450,0001. Depreciable base = $500,000 – $50,000 = $450,000

2. Depreciation per hour = $450,000 / 30,000 = $15.002. Depreciation per hour = $450,000 / 30,000 = $15.00

3. Depreciation (current) = $15.00 X 4,000 hours = $60,0003. Depreciation (current) = $15.00 X 4,000 hours = $60,000 Depreciation (next) = $15.00 X 4,700 hours = $70,500Depreciation (next) = $15.00 X 4,700 hours = $70,500

4. 4. Depreciation ScheduleDepreciation Schedule: : BookBook Depreciation Accumulated Book value Depreciation Accumulated Book value

YearYear ValueValue ExpenseExpense DepreciationDepreciation End of yearEnd of year1 $500,000 $60,0001 $500,000 $60,000 $ 60,000 $ 60,000 $440,000 $440,0002 $440,000 $70,5002 $440,000 $70,500 $130,500 $130,500 $369,500 $369,500


Straight-Line Method

2. Annual Depreciation = $450,000 / 5 years = $90,0002. Annual Depreciation = $450,000 / 5 years = $90,000

1. Depreciable base = $500,000 – $50,000 = $450,0001. Depreciable base = $500,000 – $50,000 = $450,000

3. . Depreciation ScheduleDepreciation Schedule: : BookBook Depreciation Accumulated Book value Depreciation Accumulated Book value

YearYear ValueValue ExpenseExpense DepreciationDepreciation End of yearEnd of year1 $500,000 $90,0001 $500,000 $90,000 $ 90,000 $ 90,000 $410,000 $410,0002 $410,000 $90,0002 $410,000 $90,000 $180,000 $180,000 $320,000 $320,000


Decreasing Charge Method: Declining-Balance Method

1. Rate of Depreciation = 2 x (1/5) = 40%1. Rate of Depreciation = 2 x (1/5) = 40%

2. Depreciation (current) = $500,000 x 0.40 = $ 200,000 2. Depreciation (current) = $500,000 x 0.40 = $ 200,000 Depreciation (next) = ($500,000 - $200,000) x 0.40Depreciation (next) = ($500,000 - $200,000) x 0.40

= $120,000= $120,000

3. 3. Depreciation ScheduleDepreciation Schedule: : Book Depreciation Accumulated Book valueBook Depreciation Accumulated Book value

YearYear ValueValue ExpenseExpense DepreciationDepreciation End of yearEnd of year1 $500,000 $200,0001 $500,000 $200,000 $200,000 $200,000 $300,000 $300,00022 $300,000 $120,000$300,000 $120,000 $320,000 $320,000 $180,000 $180,00033 $180,000$180,000 $ 72,000 $ 72,000 $392,000 $392,000 $108,000 $108,00044 $108,000$108,000 $ 43,200 $ 43,200 $435,200 $435,200 $ 64,800 $ 64,80055 $ 64,800$ 64,800 $ 14,800 $ 14,800 $450,000 $450,000 $ 50,000 $ 50,000


Comparison of MethodsActivity Method• Best matches revenues

and expenses• Only appropriate where

usage not a function of time

• Difficult to estimate total number of units over life of asset

Straight-Line Method• Simple to use• Based on two broad

assumptions– Constant usage– Other costs same each

year

• Does not match always revenues and expenses

Decreasing Charge Method• Best match of some assets’ productivity to cost• Less variable total asset expense over asset life


Depletion: Terminology

• Depletion refers to the cost basis write off of natural resources

• Natural resources are characterized by:– complete removal or consumption of the

asset– replacement of the asset only by an act of

nature


Determining the Depletion Base: Factors

Types of CostsTypes of Costs• Acquisition cost

• Exploration costs

• Development costs (Tangible costs): not part of depletion base

• Development costs (Intangible costs)

What they AreWhat they Are• Price paid to search for and

find deposit of the natural resource

• Costs incurred to find the natural resource

• Costs of heavy equipment for extracting and shipping natural resources

• Drilling costs, tunnels, and shafts


Depletion of Resource Cost

• Depletion calculated using an activity approach

• Depletion charge initially debited to Inventory• Inventory credited when the resource is sold

– Follows matching principle– Becomes Cost of Goods Sold

• Where useful life is clearly linked to the resource, tangible assets are depreciated using units of production method


Depletion: ExampleMining Company has right to use land to mine gold:

Lease cost: $ 50,000

Exploration cost: $ 100,000

Development cost: $ 850,000

Total capitalized cost: $1,000,000

Estimated production (useful life*) = 100,000 ounces of gold

*Note: useful life is the # of units estimated to be in the resource deposit


Depletion of Resource CostDepletion Rate = Depletion Rate = Total Costs – Residual valueTotal Costs – Residual value

Total estimated unitsTotal estimated units

Depletion Rate = Depletion Rate = 1,000,000 – 01,000,000 – 0 = $10 per ounce = $10 per ounce 100,000100,000

Entry to record 25,000 ounces mined:Entry to record 25,000 ounces mined:

InventoryInventory $250,000$250,000

Accumulated depletionAccumulated depletion $250,000$250,000

On the balance sheet:On the balance sheet:

Gold mine (at cost)Gold mine (at cost) 1,000,0001,000,000

Less: Accumulated DepletionLess: Accumulated Depletion 250,000 250,000 750,000 750,000


Partial Year Depreciation

• When an asset is bought sometime during the year, a partial depreciation charge is required.

• The procedure is:1. determine depreciation for a full year, and

2. allocate the amount between the two periods affected


Depreciation and Partial Periods

Units of Production/Use Method• No special calculations required• Calculate the usage rate and apply to actual

for the period• Same rate used in subsequent yearsStraight-Line Method• Calculate the depreciation for the portion of

the year• Generally use the nearest full monthDeclining-Balance Method• More complex calculations involved


Partial Year Depreciation: Example

• Asset purchased on July 1, 2011. Information relating to the asset is:• Cost: $10,000• Estimated service life: five years• Residual value end of five years: None

• Determine depreciation expense under the double-

declining balance method Determine full year depreciation as follows:Determine full year depreciation as follows:

First full year = $10,000 x 40% = $4,000First full year = $10,000 x 40% = $4,000

Second full year = $6,000 x 40% = $2,400Second full year = $6,000 x 40% = $2,400

Third full year = $3,600 x 40% = $1,440Third full year = $3,600 x 40% = $1,440


Partial Year Depreciation: Example

Double-declining: date of purchase, July 1, 2011Double-declining: date of purchase, July 1, 2011

Pro-rate first full year’sPro-rate first full year’sdepreciation of $4,000depreciation of $4,000

between 2011 and 2012between 2011 and 2012

$2,000$2,000 $2,000$2,000

Pro-rate second full year’s Pro-rate second full year’s depreciation of $2,400depreciation of $2,400

between 2012 and 2013between 2012 and 2013

$1,200$1,200 $1,200$1,200

20112011 20122012 20132013


Revision of Depreciation Estimates

• Determination of depreciation involves initial estimates (life, residual value)

• These estimates need to be reviewed regularly (under IFRS, at least at the end of every fiscal year end)

• When these estimates are revised, depreciation is recalculated

• These revised depreciation expenses apply prospectively to the remaining life of asset (i.e., it is accounted for in the period of change and in future periods)

• The changes do not affect prior periods


Revision of Depreciation Estimates: Example

• Depreciable asset purchased for $90,000 – Estimated life was 20 years– Estimated residual value was $10,000– Pattern of benefits received: equal amounts per

period• In Year 9, estimates were revised as follows:

– Estimated life: Total of 30 years– Estimated residual value: $2,000

• Determine depreciation for 9th year based on the straight-line method of depreciation


Revision of Depreciation Estimates: Example

• Carrying Value and Accumulated Depreciation to date of revision of estimates:• ($90,000 – $10,000) / 20 years = $4,500 per year• $4,000 x 8 years = $32,000 Accumulated Depreciation• Carrying Value: $90,000 – $32,000 = $58,000

• Amount to be depreciated (9th to 30th year = 22 years remaining)• ($58,000 – $2,000) / 22 years = $2,545 each year• (current carrying value – revised residual) / remaining years


Impairment: Overview• Impairment occurs when the carrying amount of

the long-lived asset (such as PP&E) is greater than its future economic benefit to the company

• There are many external and internal indicators that provide evidence of possible impairment

• Management needs to regularly evaluate assets for these indicators of impairment– IFRS requires this at the end of each reporting period

• If there is an indicator of possible impairment, then the asset must be tested for impairment

• Two main approaches to measuring impairment losses are:– Cost recovery impairment model– Rational entity impairment model


Cost Recovery Impairment Model• Under this model, an asset is impaired only if

carrying amount cannot be recovered from using and eventually disposing of the asset (recoverability test)– i.e. impaired if carrying amount > undiscounted future net

cash flows• Impairment loss is then measured as asset’s

– carrying amount – less fair value

• Fair value of the asset is best measured by quoted market prices in active markets– It is by its nature a present value or discounted measure

• Impairment losses cannot be reversed• Applied by private entity and U.S. GAAP


Rational Entity Impairment Model• Impairment loss is measured by comparing the

asset’s carrying amount and recoverable amount• Recoverable amount is measured as higher of

1. Value in use, and(present value of future net cash flows)

2. Fair value less cost to sell

• If carrying amount < recoverable amount, then there is no impairment loss

• If carrying amount > recoverable amount, then impairment loss is difference between two values

• Impairment losses may be reversed• Applied under IFRS


Impairment: Accounting

1. Loss equals carrying 1. Loss equals carrying value less fair value less fair valuevalue

2. Depreciate new cost basis2. Depreciate new cost basis3. Restoration of impairment 3. Restoration of impairment loss is permitted under loss is permitted under

IAS36 IAS36 (not permitted under (not permitted under ASPE cost recovery model)ASPE cost recovery model)

1. Loss equals carrying value 1. Loss equals carrying value less fair value less less fair value less

cost of disposal cost of disposal 2. No depreciation is taken2. No depreciation is taken3. Restoration of impairment3. Restoration of impairment loss loss isis permitted (under permitted (under

IFRS5 and ASPE)IFRS5 and ASPE)

Impairment has occurredImpairment has occurred

Assets held for use or Assets held for use or to be disposed of to be disposed of other than by saleother than by sale

Assets are heldAssets are heldfor salefor sale


Asset Groups and Cash -Generating Units (CGU)

• Many assets do not generate cash flows independently, so impairment analysis cannot be done at the level of the individual asset

• These assets are identified with an asset group or cash-generating unit (CGU)– i.e. “smallest identifiable group of assets that generates cash inflows

that are largely independent of the cash flows from other assets or groups of assets” (IAS 36.6)

• Both cost recovery and the rational entity impairment models are then applied to the groups of assets, instead of the individual asset

• Any impairment losses are then allocated to individual assets on a pro-rata basis

• No individual asset should be reduced below its fair value (under cost recovery model) or recoverable amount (under rational entity model) – if these amounts are known


Held for Sale• Long-lived asset is classified as held for sale if

the company intends on disposing the asset by sale and meets strict criteria (described in Ch. 4)

• Held for sale assets are – Reported separately on the balance sheet– Not depreciated– Measured at the lower of

• Carrying amount, and • Fair value less costs to sell

• Subsequent increases in net realizable value may be recognized as gains, but only to the extent they offset previously recognized losses


Dispositions of PP&E• Plant assets may be:

– retired voluntarily, or– disposed of by sale, exchange, involuntary

conversion

• Depreciation is recorded up to the date of disposal before determining gain or loss

• Gains or losses from disposal are normally shown with “Other” revenues and expenses in the income statement

• See textbook for examples of journal entries


Donations of Assets• Donation by company is recorded as an

expense at the donated asset’s FV. • Example: A company donated land (cost =

$30k) + building (cost = $95k, acc dep = $45k) to the city. FV of land and building = $110k

Entry to record donation:Entry to record donation:

Donation ExpenseDonation Expense 110,000110,000

Accum. Depreciation (Building)Accum. Depreciation (Building) 45,000 45,000

BuildingBuilding 95,00095,000

LandLand 30,00030,000

Gain on Disposal of land and buildingGain on Disposal of land and building 30,00030,000


Long-Lived Assets to be Disposed of

By SaleBy Sale Other than by SaleOther than by Sale

Classify AsClassify As Held for saleHeld for sale Held and usedHeld and used

Balance Balance Sheet Sheet

ClassificationClassification

Separate Separate classificationclassificationof long-termof long-termassetsassets

Property, Plant,Property, Plant,& Equipment& Equipment

MeasurementMeasurementAt lower of carryingAt lower of carryingamount and NRV under amount and NRV under IFRS5IFRS5ASPE: Same treatment,ASPE: Same treatment,Section 3475Section 3475

At cost or fair value underAt cost or fair value underIAS16 revaluation modelIAS16 revaluation modelASPE: ASPE: At cost under S3061, At cost under S3061, test for impairment under test for impairment under S3063S3063


Presentation and Disclosure• There are many significant disclosures

required for property, plant, and equipment • Types of disclosures include the following:

– cost and the accumulated depreciation– depreciation method and rate or period– assumptions surrounding fair-value-related

measurements– carry amounts of assets held for sale– outstanding contingencies

• Specific standards under IFRS generally have more extensive disclosure requirements compared to ASPE / private entity GAAP

afm291-ch11 (1)

Documents