Chapter
11-1
CHAPTER
11
DEPRECIATION, IMPAIRMENTS,
AND DEPLETION
Intermediate Accounting
13th Edition
Kieso, Weygandt, and Warfield
Chapter
11-2
Learning Objectives
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.
5.
Explain the accounting issues related to asset impairment.
6.
Explain the accounting procedures for depletion of natural
resources.
7.
Explain how to report and analyze property, plant, equipment,
and natural resources.
Chapter
11-3
Depreciation, Impairments, and Depletion
Depreciation
Impairments
Factors involved
Recognizing
impairments
Establishing a
base
Measuring
Impairments
Write-off of
resource cost
Restoration of
loss
Estimating
reserves
Assets to be
disposed of
Liquidating
dividends
Methods of
depreciation
Special methods
Special issues
Depletion
Continuing
controversy
Chapter
11-4
Presentation and
Analysis
Presentation
Analysis
Depreciation - Method of Cost Allocation
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.
Allocating costs of long-term assets:
Fixed assets = Depreciation expense
Intangibles = Amortization expense
Natural resources = Depletion expense
Chapter
11-5
LO 1 Explain the concept of depreciation.
Depreciation - Method of Cost Allocation
Factors Involved in the Depreciation Process
Three basic questions:
(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
11-6
LO 2 Identify the factors involved in the depreciation process.
Depreciation - Method of Cost Allocation
Factors Involved in the Depreciation Process
Depreciable Base
Illustration 11-1
Chapter
11-7
LO 2 Identify the factors involved in the depreciation process.
Depreciation - Method of Cost Allocation
Factors Involved in the Depreciation Process
Estimation of Service Lifes
 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
11-8
LO 2 Identify the factors involved in the depreciation process.
Depreciation - Method of Cost Allocation
Methods of Depreciation
The profession requires the method employed be
“systematic and rational.” Examples include:
(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.
Chapter
11-9
Accelerated methods
Special methods
LO 3 Compare activity, straight-line, and decreasingcharge methods of depreciation.
Depreciation - Method of Cost Allocation
Activity Method
Illustration 11-2
Stanley Coal
Mines Facts
Illustration: If Stanley uses the crane for 4,000 hours
the first year, the depreciation charge is:
Illustration 11-3
Chapter
11-10
LO 3 Compare activity, straight-line, and decreasingcharge methods of depreciation.
Depreciation - Method of Cost Allocation
Straight-Line Method
Illustration 11-2
Stanley Coal
Mines Facts
Illustration: Stanley computes depreciation as follows:
Illustration 11-4
Chapter
11-11
LO 3 Compare activity, straight-line, and decreasingcharge methods of depreciation.
Depreciation - Method of Cost Allocation
Decreasing-Charge Methods
Illustration 11-2
Stanley Coal
Mines Facts
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
11-12
LO 3 Compare activity, straight-line, and decreasingcharge methods of depreciation.
Depreciation - Method of Cost Allocation
Sum-of-the-Years’-Digits
Illustration 11-6
Chapter
11-13
LO 3 Compare activity, straight-line, and decreasingcharge methods of depreciation.
Depreciation - Method of Cost Allocation
Decreasing-Charge Methods
Illustration 11-2
Stanley Coal
Mines Facts
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
11-14
LO 3 Compare activity, straight-line, and decreasingcharge methods of depreciation.
Depreciation - Method of Cost Allocation
Declining-Balance Method
Illustration 11-7
Chapter
11-15
LO 3 Compare activity, straight-line, and decreasingcharge methods of depreciation.
Depreciation - Method of Cost Allocation
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 estimated
at 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
11-16
LO 3 Compare activity, straight-line, and decreasingcharge methods of depreciation.
Depreciation - Method of Cost Allocation
Straight-line Method
Current
Year
Expense
Accum.
Deprec.
$ 10,500
$ 10,500
Year
Depreciable
Base
2010
$ 126,000
/
5
=
$ 25,200
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
14,700
126,000
Annual
Expense
Years
Partial
Year
x
x
5/12
7/12
=
=
$ 126,000
Journal entry:
2010
Depreciation expense
10,500
Accumultated depreciation
Chapter
11-17
10,500
LO 3 Compare activity, straight-line, and decreasingcharge methods of depreciation.
Depreciation - Method of Cost Allocation
Activity Method
(Assume 800 hours used in 2010)
($126,000 / 21,000 hours = $6 per hour)
Year
(Given)
Hours
Used
800
2010
Annual
Expense
Rate per
Hours
x
$6
=
2011
x
=
2012
x
=
2013
x
=
2014
x
=
$
Partial
Year
4,800
800
Current
Year
Expense
$
4,800
$
4,800
Accum.
Deprec.
$ 4,800
Journal entry:
2010
Depreciation expense
Accumultated depreciation
Chapter
11-18
4,800
4,800
LO 3
Depreciation - Method of Cost Allocation
Sum-of-the-Years’-Digits Method
5/12 = .416667
7/12 = .583333
Current
Year
Depreciable
Base
2010
$ 126,000
x
2011
126,000
2012
Annual
Expense
Years
5/15
Year
Expense
Accum.
Deprec.
5/12
$ 17,500
$ 17,500
=
42,000
x
4.58/15 =
38,500
38,500
56,000
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
=
x
Partial
Year
$ 126,000
Journal entry:
2010
Chapter
11-19
Depreciation expense
Accumultated depreciation
17,500
17,500
LO 3
Depreciation - Method of Cost Allocation
Double-Declining Balance Method
Year
Depreciable
Base
Rate
per Year
Annual
Expense
Partial
Year
Current
Year
Expense
2010
$ 150,000 x
40%
=
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
$ 60,000 x
5/12
Plug
= $ 25,000
3,000
$ 126,000
Journal entry:
2010
Depreciation expense
Accumultated depreciation
Chapter
11-20
25,000
25,000
LO 3
Depreciation - Method of Cost Allocation
Special Depreciation Methods
The choice of method depends on the nature of the
assets involved:
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
11-21
LO 4 Explain special depreciation methods.
Depreciation - Method of Cost Allocation
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
11-22
LO 4 Explain special depreciation methods.
Depreciation - Method of Cost Allocation
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
Chapter
11-23
LO 4 Explain special depreciation methods.
Change in Estimate Example
Arcadia HS, purchased equipment for $510,000 which
was estimated to have a useful life of 10 years with a
salvage value of $10,000 at the end of that time.
Depreciation has been recorded for 7 years on a
straight-line basis. In 2010 (year 8), it is determined
that the total estimated life should be 15 years with a
salvage value of $5,000 at the end of that time.
Questions:
 What is the journal entry to correct
the prior years’ depreciation?
 Calculate the depreciation expense
for 2010.
Chapter
11-24
No Entry
Required
LO 4 Explain special depreciation methods.
Change in Estimate Example
Equipment cost
Salvage value
Depreciable base
Useful life (original)
Annual depreciation
After 7 years
$510,000
First, establish
- 10,000
NBV at date of
change in estimate.
500,000
10 years
$ 50,000 x 7 years = $350,000
Balance Sheet (Dec. 31, 2009)
Fixed Assets:
Chapter
11-25
Equipment
Accumulated depreciation
$510,000
350,000
Net book value (NBV)
$160,000
LO 4 Explain special depreciation methods.
Change in Estimate Example
Net book value
Salvage value (new)
Depreciable base
Useful life remaining
Annual depreciation
$160,000
5,000
155,000
8 years
$ 19,375
After 7 years
Depreciation
Expense calculation
for 2010.
Journal entry for 2010
Depreciation expense
19,375
Accumulated depreciation
Chapter
11-26
19,375
LO 4 Explain special depreciation methods.
Impairments
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.
Chapter
11-27
A projection or forecast that demonstrates continuing losses
associated with an asset.
LO 5 Explain the accounting issues related to asset impairment.
Impairments
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
11-28
LO 5 Explain the accounting issues related to asset impairment.
Impairments
Illustration 11-16
Accounting for
Impairments
Chapter
11-29
LO 5 Explain the accounting issues related to asset impairment.
Impairments
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:
Cost
Accumulated depreciation to date
Expected future net cash flows
Fair value
$
9,000,000
1,000,000
7,000,000
4,400,000
(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.
Chapter
11-30
LO 5 Explain the accounting issues related to asset impairment.
Impairments
(a).
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
12/31/10
Loss on impairment
Accumulated depreciation
Chapter
11-31
3,600,000
3,600,000
LO 5 Explain the accounting issues related to asset impairment.
Impairments
(b).
Net carrying amount
$4,400,000
Useful life
Depreciation per year
4 years
$1,100,000
12/31/11
Depreciation expense
Accumulated depreciation
1,100,000
1,100,000
(c). Restoration of any impairment loss is not permitted.
Chapter
11-32
LO 5 Explain the accounting issues related to asset impairment.
Depletion
Natural resources, often called wasting assets,
include petroleum, minerals, and timber.
They have two main features:
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
11-33
LO 6 Explain the accounting procedures for depletion of natural resources.
Depletion
Establishing a Depletion Base
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
11-34
LO 6 Explain the accounting procedures for depletion of natural resources.
Depletion
Write-off of Resource Cost
Normally, companies compute depletion on a units-ofproduction method (an activity approach). Thus,
depletion is a function of the number of units extracted
during the period.
Calculation:
Total cost – Salvage value
Total estimated units available
Units extracted x Cost per unit
Chapter
11-35
= Depletion cost per unit
= Depletion
LO 6 Explain the accounting procedures for depletion of natural resources.
Depletion
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.
Instructions:
Determine the depreciation expense and the cost of timber sold
related to depletion for 2001.
Chapter
11-36
LO 6 Explain the accounting procedures for depletion of natural resources.
Depletion
E11-19 (Depletion Computations—Timber)
Depreciation Expense:
Fire lanes and roads
Useful life
Depreciation expense per year
Chapter
11-37
$ 87,000
30
$ 2,900
LO 6 Explain the accounting procedures for depletion of natural resources.
Depletion
E11-19 (Depletion Computations—Timber)
Depletion:
Cost of timberland per acre
Cost of land per acre
Cost of timber only per acre
Total acres
Value of timber
Estimated total board feet
Cost per board foot
Board feet of timber sold
Cost of timber sold related to depletion
Chapter
11-38
$
$
$
$
$
1,400
(400)
1,000
9,000
9,000,000
3,000,000
3.00
700,000
2,100,000
LO 6 Explain the accounting procedures for depletion of natural resources.
Depletion
Estimating Recoverable Reserves
 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
11-39
LO 6 Explain the accounting procedures for depletion of natural resources.
Depletion
Liquidating Dividends -
Dividends greater than the
amount of accumulated net income.
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
Chapter
11-40
3,000,000
LO 6 Explain the accounting procedures for depletion of natural resources.
Depletion
Continuing Controversy
Oil and Gas Industry:
Full cost concept
Successful efforts concept
Chapter
11-41
LO 6 Explain the accounting procedures for depletion of natural resources.
Presentation and Analysis
Presentation of Property, Plant, Equipment,
and Natural Resources
Depreciating assets, use Accumulated Depreciation.
Depleting assets may include use of Accumulated Depletion
account, or the direct reduction of asset.
Disclosures
Chapter
11-42
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.
LO 7 Explain how to report and analyze property,
plant, equipment, and natural resources.
Presentation and Analysis
The assets turnover is a measure of a firm’s ability to
generate sales from a particular investment in assets.
Illustration 11-20
Chapter
11-43
Solution on
notes page
LO 7 Explain how to report and analyze property,
plant, equipment, and natural resources.
Presentation and Analysis
The profit margin on sales is a measure of the ability to
generate operating income from a particular level of sales.
Illustration 11-21
Chapter
11-44
Solution on
notes page
LO 7 Explain how to report and analyze property,
plant, equipment, and natural resources.
Presentation and Analysis
Rate of Return on Assets measures a firm’s success in using
assets to generate earnings.
Illustration 11-22
Chapter
11-45
Solution on
notes page
LO 7 Explain how to report and analyze property,
plant, equipment, and natural resources.
Presentation and Analysis
The analyst obtains further insight into the behavior of ROA
by disaggregating it into components of profit margin on
sales and asset turnover as follows:
Rate of Return
on Assets
Net Income
Average Total Assets
Chapter
11-46
=
=
Profit Margin on
Sales
Net Income
Net Sales
x
x
Asset
Turnover
Net Sales
Average Total Assets
LO 7 Explain how to report and analyze property,
plant, equipment, and natural resources.
Presentation and Analysis
The analyst obtains further insight into the behavior of ROA
by disaggregating it into components of profit margin on
sales and asset turnover as follows:
Rate of Return
on Assets
$64.2
=
=
($811.8 + 665.3) / 2
8.7%
Chapter
11-47
Profit Margin on
Sales
$64.2
x
x
15.28%
$420.1
($811.8 + 665.3) / 2
$420.1
=
Asset
Turnover
x
.569
LO 7 Explain how to report and analyze property,
plant, equipment, and natural resources.

Under both iGAAP and U.S. GAAP, interest costs incurred during
construction must be capitalized.

iGAAP, like U.S. GAAP, capitalizes all direct costs in selfconstructed assets.

The accounting for exchanges of nonmonetary assets has recently
converged between iGAAP and U.S. GAAP.

iGAAP permits the same depreciation methods (straight-line,
accelerated, units-of-production) as U.S. GAAP.
Chapter
11-48

As discussed in the Chapter 4 Convergence Corner, iGAAP permits
asset revaluations (which are not permitted in U.S. GAAP).
Consequently, companies that use the revaluation framework must
follow revaluation depreciation procedures.

iGAAP also uses a fair value test to measure the impairment loss.
However, iGAAP does not use the first-stage recoverability test
used under U.S. GAAP—comparing the undiscounted cash flows to
the carrying amount. Thus, the iGAAP test is more strict than U.S.
GAAP.
Chapter
11-49
Modified Accelerated Cost Recovery System
MACRS differs from GAAP in three respects:
1. a mandated tax life, which is generally shorter than
the economic life;
2. cost recovery on an accelerated basis; and
3. an assigned salvage value of zero.
Chapter
11-50
LO 8 Describe income tax methods of depreciation.
Modified Accelerated Cost Recovery System
Tax Lives (Recovery Periods)
Chapter
11-51
Illustration 11A-1
LO 8 Describe income tax methods of depreciation.
Modified Accelerated Cost Recovery System
Tax Depreciation Methods
Illustration 11A-2
Chapter
11-52
LO 8 Describe income tax methods of depreciation.
Modified Accelerated Cost Recovery System
Illustration: Computer and peripheral equipment
purchased by Denise Rode Company on January 1, 2009.
Chapter
11-53
LO 8 Describe income tax methods of depreciation.
Modified Accelerated Cost Recovery System
Illustration:
Chapter
11-54
Illustration 11A-3
LO 8 Describe income tax methods of depreciation.
Modified Accelerated Cost Recovery System
Illustration: Using the rates
from the MACRS
depreciation rate schedule
for a 5-year class of
property, Rode computes
depreciation as follows
Illustration 11A-4
Illustration 11A-5
Chapter
11-55
LO 8 Describe income tax methods of depreciation.
Modified Accelerated Cost Recovery System
Additional Issues
Optional straight-line method
Tax versus book depreciation
Chapter
11-56
LO 8 Describe income tax methods of depreciation.
Copyright
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Chapter
11-57