managerial accounting chapter 11
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Chapter 11-1
C H A P T E R C H A P T E R 1111
DEPRECIATION, IMPAIRMENTS, DEPRECIATION, IMPAIRMENTS, AND DEPLETIONAND DEPLETION
Chapter 11-2
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 Depreciation - Method of Cost AllocationAllocation
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Chapter 11-3
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
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?
Chapter 11-4
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Depreciable Base
Factors Involved in the Depreciation Process
Illustration 11-1Illustration 11-1
Chapter 11-5
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Estimation of Service Lifes
Factors Involved in the Depreciation Process
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).
Chapter 11-6
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
The profession requires the method employed be “systematic and rational.” Examples include:
Methods of Depreciation
(1) Activity method (units of use or production).
(2) Straight-line method.
(3) Sum-of-the-years’-digits.
(4) Declining-balance method.
(5) Group and composite methods.
(6) Hybrid or combination methods.
Accelerated Accelerated methodsmethods
Special methodsSpecial methods
Chapter 11-7
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Activity MethodIllustration 11-2Illustration 11-2
Illustration: If Stanley uses the crane for 4,000 hours the first year, the depreciation charge is:
Stanley Stanley Coal Mines Coal Mines
FactsFacts
Illustration 11-3Illustration 11-3
Chapter 11-8
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Straight-Line MethodIllustration 11-2Illustration 11-2
Illustration: Stanley computes depreciation as follows:
Stanley Stanley Coal Mines Coal Mines
FactsFacts
Illustration 11-4Illustration 11-4
Chapter 11-9
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Decreasing-Charge MethodsIllustration 11-2Illustration 11-2
Stanley Stanley Coal Mines Coal Mines
FactsFacts
Sum-of-the-Years’-Digits. Each fraction uses the sum
of the years as a denominator (5 + 4 + 3 + 2 + 1 =
15). The numerator is the number of years of
estimated life remaining as of the beginning of the
year.
Chapter 11-10
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Sum-of-the-Years’-DigitsIllustration 11-6Illustration 11-6
Chapter 11-11
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Decreasing-Charge MethodsIllustration 11-2Illustration 11-2
Stanley Stanley Coal Mines Coal Mines
FactsFacts
Declining-Balance Method.
Utilizes a depreciation rate (percentage) that is some
multiple of the straight-line method.
Does not deduct the salvage value in computing the
depreciation base.
Chapter 11-12
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Declining-Balance MethodIllustration 11-7Illustration 11-7
Chapter 11-13
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
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 $24,000 at the end of its service life. Its life is estimatedat 5 years and its working hours are estimated at 21,000 hours. Year-end is December 31.Instructions: Compute the depreciation expense under the
following methods.
(a) Straight-line depreciation. (c) Sum-of-the-years’-digits.
(b) Activity method (d) Double-declining
balance.
Chapter 11-14
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Current
Depreciable Annual Partial Year Accum.Year Base Years Expense Year Expense Deprec.
2010 126,000$ / 5 = 25,200$ x 5/12 = 10,500$ 10,500$
2011 126,000 / 5 = 25,200 25,200 35,700
2012 126,000 / 5 = 25,200 25,200 60,900
2013 126,000 / 5 = 25,200 25,200 86,100
2014 126,000 / 5 = 25,200 25,200 111,300
2015 126,000 / 5 = 25,200 x 7/12 = 14,700 126,000
126,000$
J ournal entry:
2010 Depreciation expense 10,500
Accumultated depreciation 10,500
Straight-line Method
Chapter 11-15
($126,000 / 21,000 hours = $6 per hour)(Given) Current
Hours Rate per Annual Partial Year Accum.Year Used Hours Expense Year Expense Deprec.
2010 800 x $6 = 4,800$ 4,800$ 4,800$
2011 x =
2012 x =
2013 x =
2014 x =
800 4,800$
J ournal entry:
2010 Depreciation expense 4,800
Accumultated depreciation 4,800
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
LO 3LO 3
Activity Method(Assume 800 hours used in 2010)(Assume 800 hours used in 2010)
Chapter 11-16
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Sum-of-the-Years’-Digits Method Current
Depreciable Annual Partial Year Accum.Year Base Years Expense Year Expense Deprec.
2010 126,000$ x 5/15 = 42,000 x 5/12 17,500$ 17,500$
2011 126,000 x 4.58/15 = 38,500 38,500 56,000
2012 126,000 x 3.58/15 = 30,100 30,100 86,100
2013 126,000 x 2.58/15 = 21,700 21,700 107,800
2014 126,000 x 1.58/15 = 13,300 13,300 121,100
2015 126,000 x .58/15 = 4,900 4,900 126,000
126,000$
J ournal entry:
2010 Depreciation expense 17,500
Accumultated depreciation 17,500 LO 3LO 3
5/12 = .416667
7/12 = .583333
Chapter 11-17
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Double-Declining Balance MethodCurrent
Depreciable Rate Annual Partial YearYear Base per Year Expense Year Expense
2010 150,000$ x 40% = 60,000$ x 5/12 = 25,000$
2011 125,000 x 40% = 50,000 50,000
2012 75,000 x 40% = 30,000 30,000
2013 45,000 x 40% = 18,000 18,000
2014 27,000 x 40% = 10,800 Plug 3,000
126,000$
J ournal entry:
2010 Depreciation expense 25,000
Accumultated depreciation 25,000
LO 3LO 3
Chapter 11-18
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
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).
Chapter 11-19
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Special Depreciation Issues
(1) How should companies compute depreciation for partial periods?
Companies normally compute depreciation on the basis of the nearest full month.
(2) Does depreciation provide for the replacement of assets?
Funds for the replacement of the assets come from the revenues
(3) How should companies handle revisions in depreciation rates?
Chapter 11-20
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
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Depreciation - Method of Cost Depreciation - Method of Cost AllocationAllocation
Chapter 11-21
Arcadia HS, purchased equipment for $510,000 Arcadia HS, purchased equipment for $510,000 which was estimated to have a useful life of 10 years which was estimated to have a useful life of 10 years with a salvage value of $10,000 at the end of that with a salvage value of $10,000 at the end of that time. Depreciation has been recorded for 7 years on time. Depreciation has been recorded for 7 years on a straight-line basis. In 2010 (year 8), it is a straight-line basis. In 2010 (year 8), it is determined that the total estimated life should be 15 determined that the total estimated life should be 15 years with a salvage value of $5,000 at the end of years with a salvage value of $5,000 at the end of that time.that time.
Questions:Questions: What is the journal entry to correct What is the journal entry to correct
the prior years’ depreciation?the prior years’ depreciation? Calculate the depreciation expense Calculate the depreciation expense
for 2010.for 2010.
No Entry No Entry RequiredRequired
Change in Estimate ExampleChange in Estimate ExampleChange in Estimate ExampleChange in Estimate Example
Chapter 11-22
EquipmenEquipmentt
$510,000$510,000
Fixed Assets:Fixed Assets:
Accumulated depreciationAccumulated depreciation 350,000350,000
Net book value (NBV)Net book value (NBV) $160,000$160,000
Balance SheetBalance Sheet (Dec. 31, (Dec. 31, 2009)2009)
Change in Estimate ExampleChange in Estimate ExampleChange in Estimate ExampleChange in Estimate ExampleAfter 7 yearsAfter 7 years
Equipment cost Equipment cost $510,000$510,000
Salvage valueSalvage value - 10,000 - 10,000
Depreciable baseDepreciable base 500,000500,000
Useful life (original)Useful life (original) 10 years 10 years
Annual depreciationAnnual depreciation $ 50,000 $ 50,000 x 7 years = x 7 years = $350,000$350,000
First, establish First, establish NBV at date of NBV at date of
change in change in estimate.estimate.
First, establish First, establish NBV at date of NBV at date of
change in change in estimate.estimate.
Chapter 11-23
Change in Estimate ExampleChange in Estimate ExampleChange in Estimate ExampleChange in Estimate ExampleAfter 7 yearsAfter 7 years
Net book value Net book value $160,000$160,000
Salvage value (new) Salvage value (new) 5,0005,000
Depreciable baseDepreciable base 155,000155,000
Useful life remainingUseful life remaining 8 years 8 years
Annual depreciationAnnual depreciation $ 19,375$ 19,375
Depreciation Depreciation Expense Expense
calculation for calculation for 2010.2010.
Depreciation Depreciation Expense Expense
calculation for calculation for 2010.2010.
Depreciation expense 19,375
Accumulated depreciation 19,375
Journal entry for 2010
Chapter 11-24
ImpairmentsImpairmentsImpairmentsImpairments
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:
a. Decrease in the market value of an asset.
b. Change in the manner in which an asset is used.
c. Adverse change in legal factors or in the business climate.
d. An accumulation of costs in excess of the amount originally expected to acquire or construct an asset.
e. A projection or forecast that demonstrates continuing losses associated with an asset.
Chapter 11-25
ImpairmentsImpairmentsImpairmentsImpairments
Measuring Impairments
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.
Chapter 11-26
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 $5,100,000. Prepare the journal entry (if any) necessary to record this increase in fair value.
Cost 9,000,000$ Accumulated depreciation to date 1,000,000 Expected future net cash flows 7,000,000 Fair value 4,400,000
ImpairmentsImpairmentsImpairmentsImpairments
Chapter 11-27
Loss on impairment 3,600,000
Accumulated depreciation 3,600,000
ImpairmentsImpairmentsImpairmentsImpairments
Cost $9,000,000
Accumulated depreciation 1,000,000
Carrying amount 8,000,000
Fair value 4,400,000
Loss on impairment $3,600,000
(a).(a).
12/31/10
Chapter 11-28
Depreciation expense 1,100,000
Accumulated depreciation 1,100,000
ImpairmentsImpairmentsImpairmentsImpairments
Net carrying amount $4,400,000
Useful life 4 years
Depreciation per year $1,100,000
(b).(b).
(c).(c). Restoration of any impairment loss is not permitted.
12/31/11
Chapter 11-29
Natural resources, often called wasting assets, include petroleum, minerals, and timber.
They have two main features:
DepletionDepletionDepletionDepletion
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.
Chapter 11-30
Establishing a Depletion Base
DepletionDepletionDepletionDepletion
Computation of the depletion base involves four factors:
(1) Acquisition cost of the deposit,
(2) Exploration costs,
(3) Development costs, and
(4) Restoration costs.
Chapter 11-31
Write-off of Resource Cost
DepletionDepletionDepletionDepletion
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 valueTotal cost – Salvage value
Total estimated units availableTotal estimated units available= Depletion cost per = Depletion cost per unitunit
Units extracted x Cost per unitUnits extracted x Cost per unit = Depletion= Depletion
Chapter 11-32
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 a cost of $100,000.
DepletionDepletionDepletionDepletion
Instructions:
Determine the depreciation expense and the cost of timber sold related to depletion for 2001.
Chapter 11-33
E11-19 (Depletion Computations—Timber)
DepletionDepletionDepletionDepletion
Depreciation Expense:
Fire lanes and roads 87,000$ Useful lif e 30 Depreciation expense per year 2,900$
Chapter 11-34
E11-19 (Depletion Computations—Timber)
DepletionDepletionDepletionDepletion
Depletion:
Cost of timberland per acre 1,400$ Cost of land per acre (400) Cost of timber only per acre 1,000$ Total acres 9,000 Value of timber 9,000,000$ Estimated total board feet 3,000,000 Cost per board foot 3.00$ Board feet of timber sold 700,000 Cost of timber sold related to depletion 2,100,000$
Chapter 11-35
Estimating Recoverable Reserves
DepletionDepletionDepletionDepletion
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.
Chapter 11-36
Liquidating Dividends - Dividends greater than the amount of accumulated net income.
DepletionDepletionDepletionDepletion
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
Chapter 11-37
Continuing Controversy
Oil and Gas Industry:
Full cost concept
Successful efforts concept
DepletionDepletionDepletionDepletion
Chapter 11-38
Presentation of Property, Plant, Equipment, and Natural Resources
Presentation and AnalysisPresentation and AnalysisPresentation and AnalysisPresentation and Analysis
Basis of valuation (cost)
Pledges, liens, and other commitments
Depreciation 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.
DisclosuresDisclosures
Chapter 11-39
The The assets turnover is a measure of a firm’s ability to is a measure of a firm’s ability to generate sales from a particular investment in assets. generate sales from a particular investment in assets.
Presentation and AnalysisPresentation and AnalysisPresentation and AnalysisPresentation and Analysis
Illustration 11-Illustration 11-2020
Chapter 11-40
Presentation and AnalysisPresentation and AnalysisPresentation and AnalysisPresentation and Analysis
The The profit margin on sales is a measure of the ability to on sales is a measure of the ability to generate operating income from a particular level of sales.generate operating income from a particular level of sales.
Illustration 11-Illustration 11-2121
Chapter 11-41
Presentation and AnalysisPresentation and AnalysisPresentation and AnalysisPresentation and Analysis
Rate of Return on Assets measures a firm’s success measures a firm’s success in using assets to generate earnings.in using assets to generate earnings.
Illustration 11-Illustration 11-2222
Chapter 11-42
The analyst obtains further insight into the behavior of The analyst obtains further insight into the behavior of ROA by ROA by disaggregatingdisaggregating it into components of profit it into components of profit margin on sales and asset turnover as follows:margin on sales and asset turnover as follows:
Net Income
Average Total Assets
Rate of Return on Assets
=
Net Income
Net Sales
Profit Margin on Sales
=
Net Sales
Asset Turnover
x
x Average Total Assets
Presentation and AnalysisPresentation and AnalysisPresentation and AnalysisPresentation and Analysis
Chapter 11-43
$64.2
($811.8 + 665.3) / 2
Rate of Return on Assets
=
$64.2
$420.1
Profit Margin on Sales
=
$420.1
Asset Turnover
x
x
Presentation and AnalysisPresentation and AnalysisPresentation and AnalysisPresentation and Analysis
8.7% 15.28% =
x
.569
($811.8 + 665.3) / 2
The analyst obtains further insight into the behavior of The analyst obtains further insight into the behavior of ROA by ROA by disaggregatingdisaggregating it into components of profit it into components of profit margin on sales and asset turnover as follows:margin on sales and asset turnover as follows: