1
Investments in
Noncurrent
Operating
Assets-Utilization and
Retirement
Learning Objectives
 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.
2
Learning Objectives
 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.
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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.
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Time Line of Business Issues
ACQUIRE
long-term
operating assets
ESTIMATE and
RECOGNIZE an
asset’s use
(depreciation,
amortization, and
depletion)
CHANGE
estimates
related to an
asset’s life
5
Time Line of Business Issues
MONITOR
asset value for
possible
declines
DISPOSE
of a
depreciable
asset
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Factors Affecting the Periodic
Depreciation Charge
• Asset cost
• Residual or
salvage value
• Useful life
• Pattern of use
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Depreciation--Financial
Statement Impacts
Depreciation
Balance Sheet
C. Assets
PP&E
Acc. Dep.
Total
Liab.
OE
Total
XX
XXXX
(XX)
XXXX
XXX
XXX
XXXX
Income
Statement
Revenue XXXX
COGS
XXX
Gr. Profit
XXX
Dep. Exp.
(XX)
Net Inc.
XXX
Statement of
Cash Flows
From Oper.
Net Inc.
XXX
Dep. Exp. XX
Net Cash
XXX
8
Depreciation--Financial
Statement Impacts
Depreciation
Balance Sheet
C. Assets
PP&E
Acc. Dep.
Total
Liab.
OE
Total
XX
XXXX
(XX)
XXXX
XXX
XXX
XXXX
Income
Statement
Revenue XXXX
COGS
XXX
Gr. Profit
XXX
Dep. Exp.
(XX)
Net Inc.
XXX
Statement of
Cash Flows
From Oper.
Net Inc.
XXX
Dep. Exp. XX
Net Cash
XXX
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Depreciation--Financial
Statement Impacts
Depreciation
Balance Sheet
C. Assets
PP&E
Acc. Dep.
Total
Liab.
OE
Total
XX
XXXX
(XX)
XXXX
XXX
XXX
XXXX
Income
Statement
Revenue XXXX
COGS
XXX
Gr. Profit
XXX
Dep. Exp.
(XX)
Net Inc.
XXX
Statement of
Cash Flows
From Oper.
Net Inc.
XXX
Dep. Exp. XX
Net Cash
XXX
Indirect Method
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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.
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Depreciation Illustration
Depreciable
Cost
(Asset)
Costs incurred are deferred
until future periods. They
are recorded as an asset and
the costs are assigned to
future periods.
Period 1
Period 2
Period 3
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Depreciation Illustration
Depreciable
Cost
(Asset)
Period 1
A depreciation method is
selected to assign these
costs to future periods.
Period 2
Period 3
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Depreciation Illustration
Depreciable
Cost
(Asset)
Period 1
A depreciation method is
selected to assign these
costs to future periods.
Period 2
Period 3
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Depreciation Illustration
Depreciable
Cost
(Asset)
(Asset)
The allocation of a deferred cost, in
this case depreciation expense, has
no direct effect on cash. The
allocation is based on the
depreciable cost, useful life, and
depreciation method.
Period 1
Period 2
Period 3
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Depreciation Methods
Time-Factor Methods
• Straight-line: This method recognizes
equal periodic depreciation charges over
the asset’s life.
• 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.
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Depreciation Methods
Use-Factor Methods
• 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.
• 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.
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Depreciation Methods
Group and Composite
Methods
This approach treats an entire group of assets as
if the group were one asset.
• Group: Used when the assets in the group
are similar.
• Composite: Used when the assets in the
group are related, but dissimilar.
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Depreciation Methods
Schuss Boom Ski Manufacturing
acquired a polyurethane plasticmolding 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.
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Time-Factor Methods
Straight-Line Method
Cost - Residual Value
Depreciation =
Number of Years
$100,000 - $5,000
Depreciation =
5
Depreciation = $19,000
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Time-Factor Methods
Straight-Line Method
$35,000
Depreciation Expense
$28,000
$21,000
$14,000
$7,000
$0
2002
2003
2004
2005
2006
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Time-Factor Methods
Sum-of-the-Years’-Digits Method
[n
(n
+
1)]
SYD =
2
SYD = [5 (5 + 1)]
2
SYD = 15
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Time-Factor Methods
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Sum-of-the-Years’-Digits Method
t x
Depreciation = SYD (Cost - Residual Value)
5 x
Depreciation
(2002)
= in15n at $95,000
t = years
remaining
the beginning of the period
Depreciation (2002) = $31,667
Time-Factor Methods
Sum-of-the-Years’-Digits Method
$35,000
Depreciation Expense
$28,000
$21,000
$14,000
$7,000
$0
2002
2003
2004
2005
2006
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Time-Factor Methods
Declining-Balance Method
Depreciation = F x (Cost - Accum. Depr.)
F = declining
Depreciation
(2002) =balance
.40 x factor
$100,000
(e.g., 150% or 200%)
Depreciation (2002) = $40,000
Note:
• Do not depreciate below salvage value.
• Optional: Switch to straight-line when it
yields higher depreciation.
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Time-Factor Methods
Declining-Balance Method
$42,000
$35,000
Depreciation Expense
$28,000
$21,000
$14,000
$7,000
$0
2002
2003
2004
2005
2006
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Use Factor Methods
Service Hours Method
Cost
Residual
Value
Depreciation =
Number of Hours
Depreciation = $100,000 - $5,000
20,000 hours
Depreciation = $4.75 per hour
Total Estimated
Depreciation (2002)
$4.75
x 3,000
Service =
Life
of Asset
Depreciation (2002) = $14,250
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Use Factor Methods
Productive-Output Method
Cost - Residual Value
r (per unit) =
Total Number of Units
$100,000 - $5,000
r (per unit) =
25,000 units
r (per unit) = $3.80 per unit
Depreciation (2002) = $3.80 x 3,500
Depreciation (2002) = $13,300
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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.
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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.
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Depletion
Depletion = $5,500,000 - $250,000
1,000,000 tons
charge per ton
Depletion = $5.25
charge per ton
$450,000 $200,000
Depletion for 2002 = $5.25 x 80,000 tons
Depletion for 2002 = $420,000
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.
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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.
Also, if management obtains
information suggesting that the market
value of the asset has declined.
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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.
The sum of the undiscounted future
cash flows will always be greater than
the fair value of the asset.
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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 fair value can be approximated
using the present value of estimated
future cash flows from the asset.
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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.
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Asset 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.
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Asset 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.
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Asset Retirement-Unusual Considerations
Are assets
similar in nature?
Record transaction
according to general
procedure.
NO
Let’s takeYESa closer
look at this last NO
section.
Are the parties
in the same line
of business?
Record transaction
according to general
procedure.
YES
Does the
transaction
create a gain?
Zero
Defer
all
gains
Record transaction
according to general
procedure.
NO
YES
25% or more
What percentage
of the transaction’s
FMV is in cash?
Record
transaction
using general
procedure.
Less than 25%
Less than 25%
Party paying cash
defers all gains.
Party receiving cash
defers a portion
of all gains
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Asset Retirement-Unusual Considerations
Zero
Defer
all
gains.
Yes
25% or more
What percentage
of the transaction’s
FMV is in cash?
Record
transaction
using general
procedure.
Less than 25%
Party paying cash
defers all gains.
Party receiving cash
defers a portion
of all gains
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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.
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The End