chapter 11: depreciation, impairments and depletion intermediate accounting, 11th ed. kieso,...
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Chapter 11: Depreciation, Chapter 11: Depreciation, Impairments and Impairments and
DepletionDepletion
Intermediate Accounting, 11th ed.Kieso, Weygandt, and Warfield
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.
After studying this chapter, you should be able to:
Chapter 11: Depreciation, Chapter 11: Depreciation, Impairments and Impairments and
DepletionDepletion
5. Explain the accounting issues related to asset impairment.
6. Explain the accounting procedures for depletion of natural resources.
7. Explain how property, plant, equipment, and natural resources are reported and analyzed.
Chapter 11: Depreciation, Chapter 11: Depreciation, Impairments and Impairments and
DepletionDepletion
• Depreciation is a means of cost allocation.
• It is not a method of valuation.• Depreciation involves:
allocating the cost of tangible assets to expense in a systematic and rational manner to periods expected to benefit from use of its depreciable assets.
Depreciation: ConceptDepreciation: Concept
Questions to be answered:
1. What is the depreciable base of the asset?
2. What is the asset’s useful life?3. What method of depreciation is best
for the asset in question?
Factors in the Factors in the Depreciation ProcessDepreciation Process
• Depreciable base is the dollar amount subject to depreciation.
• It is determined as:
Original cost of the asset lessEstimated salvage or disposal value
Depreciable BaseDepreciable Base
• An asset’s service life and physical life are not the same.
• Assets’ service life are affected by: physical factors, and economic factors • Economic factors include: Inadequacy (asset can not meet
current demand) Supercession (by a better asset) Obsolescence (other factors)
Estimated Service LivesEstimated Service Lives
DepreciationMethods
Financial AccountingDepreciation Methods
TaxDepreciation
Specialmethods
1. Declining Balance2. Sum-of-the-years’ digits
Straight-line
Activity DecreasingCharge
1. Composite method2. Hybrid methods
Depreciation Methods: Depreciation Methods: OverviewOverview
• Is a function of time rather than usage• Results in an equal amount of
depreciation expense for a given period
• Depreciation Expense is computed as:Cost – Salvage Value
Estimated Life
Depreciation Methods: Depreciation Methods: Straight-LineStraight-Line
• Is a function of usage rather than time.• Estimated life is in terms of total
input/output of asset.• Depreciation expense is computed as:
Cost – Salvage Value x Input/Output this period
Total Estimated Input/Output
Depreciation Methods: Depreciation Methods: ActivityActivity
These methods result in higher depreciation expense in the earlier years and lower charges in the later years.
Two decreasing charge methods are:1. Declining balance2. Sum-of-the-years’-digits
Depreciation Methods: Depreciation Methods: Decreasing Charge Decreasing Charge
(Accelerated)(Accelerated)
1. Salvage value is not deducted when computing depreciable base.
2. Utilizes a depreciation rate (%) that is some multiple of the SL rate.
3. The depreciation rate is multiplied by the asset’s book value at the beginning of the period to get the depreciation expense for the period.
4. Since the book value decreases over time this results in a decreasing amount of depreciation expense over time.
5. An asset’s book value can never be less than its estimated salvage value.
Depreciation Methods: Depreciation Methods: Declining BalanceDeclining Balance
• A fraction is multiplied by the depreciable base to arrive at the depreciation expense per period.
• The fraction is:1. Numerator: number of years remaining in the
asset’s life as of the beginning of the period.2. Denominator: sum of the years in the life3. For example, a 5 year life property would have
depreciation expense for the first year as:4. (Cost – Salvage value) X 5 (years remaining)
15 (computed as 5+4+3+2+1)
Depreciation Methods: Depreciation Methods: Sum-of-the-Years’ DigitsSum-of-the-Years’ Digits
• The group method is applied to a collection of assets similar in nature.
• The composite method is applied to a collection of assets dissimilar in nature.
• The composite depreciation rate is determined as follows:
total of annual depreciation for all assets
total cost of all assets
Group and Composite Group and Composite Depreciation MethodsDepreciation Methods
• When an asset is bought sometime during the year, a partial depreciation charge is required.
• The procedure is:determine depreciation for a full
year, and allocate the amount between the two periods affected
Partial Year DepreciationPartial Year Depreciation
• Determination of depreciation involves initial estimates (e.g., life, salvage value)
• When these estimates are revised, depreciation must be re-computed:
Remaining B.V. – Est. Salvage ValueRemaining Est. Life
• These revised depreciation expenses apply prospectively to the remaining life of asset.
• These changes do not affect prior periods.
Revision of Depreciation Revision of Depreciation EstimatesEstimates
An impairment of a depreciable asset occurs when:
• the carrying amount of the asset is not recoverable, and therefore a write-off is needed.The recoverability test determines if an impairment has occurred.
ImpairmentsImpairments
Impairment?
Sum of expected future net cash flows
from use and disposal of asset is less thanthe carrying amount
Sum of expected future net cash flows
from use and disposal of asset is
equal to or more than the carrying amount
Impairment has occurred No impairment
Impairments: The Impairments: The Recoverability TestRecoverability Test
Impairment has occurred Loss =Carrying amount
lessFair value of asset
Does an active marketexist for the asset?
Determine impairment loss
Yes
No
Loss =Carrying amount
lesspresent value of
expected net cashflowsUse company’s market
rate of interest
Impairments: Measuring Impairments: Measuring LossLoss
Impairment has occurred
1. Loss = Carrying value less Fair value2. Depreciate new cost basis3. Restoration of impairment loss is NOT permitted
1. Loss = Carrying value less Fair Value less cost of disposal 2. No depreciation is taken3. Restoration of impairment loss is permitted
Assets are held
for useAssets are held
for sale
Impairment: AccountingImpairment: Accounting
Graphic of Accounting for Graphic of Accounting for ImpairmentsImpairments
Depletion refers to the cost basis write-off of natural resources (e.g., coal, oil, timber)
Depletion expense per unit is calculated:
Cost – Estimated Salvage ValueTotal Estimated Units Available
This per unit cost is the multiplied by the units extracted during a period to derive the depletion for the period.
Depletion: TerminologyDepletion: Terminology
• Difficulty of estimating recoverable reserves
• Problems of discovery value• Accounting for liquidating
dividends
Depletion: Special Depletion: Special ProblemsProblems
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