18th
Edition
Chapter 11
Investments in
Noncurrent Operating
Assets—Utilization
and Retirement
Intermediate
Accounting
James D. Stice
Earl K. Stice
PowerPoint presented by Douglas Cloud
Professor Emeritus of Accounting, Pepperdine University
© 2012 Cengage Learning
11-1
What is depreciation?
•
Depreciation is not a process through which
a company accumulates a cash fund to
replace its long-lived fixed assets.
•
Depreciation is not a way to compute the
current value of long-lived assets.
•
Depreciation is the systematic allocation of
the cost of an asset over the different
periods benefited by the use of the asset.
11-2
Factors Affecting the Periodic
Depreciation Charge
Four factors are taken into consideration in
determining the appropriate amount of annual
depreciation expense.
• Asset cost
• Residual or salvage value
• Useful life
• Pattern of use
11-3
Depreciation Vocabulary
•
•
•
Asset cost is the purchase cost plus any
capitalized expenditures.
Residual (salvage) value of property is an
estimate of the amount for which the asset
can be sold when it is retired.
Useful life is the expected life of the asset
in years, hours of service, or per unit of
output.
(continued)
11-4
Useful Life
The physical factors that limit the service life
of an asset are—
1) wear and tear,
2) deterioration and decay, and
3) damage or destruction.
The primary functional factor limiting the
useful life of assets is obsolescence.
11-5
Depreciation Formula Symbols
The examples that follow assume the acquisition
of a polyurethane plastic-molding machine at
the beginning of 2013 by Schuss Boom Ski
Manufacturing, Inc., at a cost of $100,000 with
an estimated residual value of $5,000.
C = Asset cost
R = Estimated residual value
n = Estimated life in years, hours of service, or
units of output
r = Depreciation rate per period, per hour of
service, or per unit of output
D = Periodic depreciation charge
11-6
Time-Factor Methods
Straight-Line
•
•
•
Of the time-factor methods, straight-line
depreciation is by far the most popular.
Straight-line depreciation relates to the
passage of time and recognizes equal
depreciation in each year of the life of the
asset.
This method assumes the asset is equally
useful during each time period.
(continued)
11-7
Straight-Line Depreciation
Using data for the machine acquired by
Schuss Boom Ski Manufacturing and
assuming a 5-year life, annual depreciation is
computed as follows:
C–R
D=
N
=
$100,000 – $5,000
5 years
= $19,000 per year
(continued)
11-8
Sum-of-the-Years’
Digits Method
The sum-of-the-years’-digits depreciation
method yields decreasing depreciation in
each successive year. To determine the
denominator, use the following formula
(assuming 5 years):
[n (n + 1)]
SYD =
2
[5 (5 + 1)]
SYD =
2
Or, simple add
+2+3+4+5
1
SYD = 15
(continued)
11-9
Sum-of-the-Years’
Digits Method
Now that we know the denominator, we can
determine the depreciation for the year using
the following formula, where “t” equals years
remaining at the beginning of the period.
t
 (C – R)
D=
SYD
5
 ($100,000 – $5,000)
D=
15
D = $31,667
(continued)
11-10
Sum-of-the-Years’
Digits Method
For the second year, we reduce the numerator
by one.
t
 (C – R)
D=
SYD
4
 ($100,000 – $5,000)
D=
15
D = $25,333
(continued)
11-11
Declining-Balance Method
•
The declining-balance depreciation
method provides decreasing charges by
applying a constant percentage rate to a
declining asset book value. First, the
constant percentage must be calculated.
•
The most popular rate is two times the
straight-line rate, and this method is called
double-declining balance depreciation.
11-12
Declining-Balance Method
•
•
Or you can use the following formula to get
the straight-line rate: 1/n
Thus, the molding machine would have a
straight-line rate of 20% (1/5). This number
is doubled to arrive at the double-declining
percentage of 40%.
11-13
Factors Suggesting the Use of an
Accelerated Method
1) The anticipation of a significant
contribution in early periods with the
extent of the contribution to be realized
in later periods being less definite.
2) The possibility that inadequacy or
obsolescence may result in premature
retirement of the asset.
11-14
Use-Factor Methods
Use-factor depreciation methods
view asset exhaustion as related
primarily to asset use or output and
provide periodic charges varying with
the degree of such services.
(continued)
11-15
Service-Hours Depreciation
• The first use-factor method we will
examine is service-hours
depreciation.
• This method is based on the theory that
the purchase of an asset represents the
purchase of a number of hours of direct
service.
(continued)
11-16
Service-Hours Depreciation
The Schuss Boom Ski Manufacturing
machine costs $100,000 and had a
residual value of $5,000. It is estimated
that the machine will perform for an
estimated service life of 20,000 hours.
Now we can determine the rate to be
applied to each service hour.
(continued)
11-17
Service-Hours Depreciation
D=
C–R
n
=
$100,000 – $5,000
20,000 hours
D = $4.75 per hour
Equals the projected
residual value
11-18
Productive-Output Depreciation
•
Productive-output depreciation is based
on the theory that an asset is acquired for
the service it can provide in the form of
production output.
•
The Schuss Boom asset is estimated to
have a productive life of 25,000 units.
•
Assume the company produced 3,200
units in 2013 and 5,400 units in 2014.
(continued)
11-19
Productive-Output Depreciation
r =
C–R
n
$100,000 – $5,000
=
25,000 units
r = $3.80 per unit
Annual depreciation for 2013 and 2014:
2013: 3,200 units  $3.80 = $12,160
2014: 5,400 units  $3.80 = $20,520
11-20
Group and Composite Depreciation
•
•
•
Group depreciation groups similar assets
into depreciation accounts (e.g., all of a
company’s delivery vans).
Composite depreciation refers to placing
assets in the group that are related but
dissimilar (e.g., all of a company’s desks,
chairs, and computers).
The group depreciation procedure treats a
collection of assets as a single group.
(continued)
11-21
Group and Composite Depreciation
The rate of 12.5%, applied to the cost of
existing assets, $20,000, results in annual
depreciation of $2,500.
(continued)
11-22
Group and Composite Depreciation
Because the accumulated depreciation
account applies to the entire group of assets,
no book value can be calculated for any
specific asset. If asset B were sold for $3,500
after two years, the following entry would be as
follows:
Cash
Accumulated Depreciation
Equipment
3,500
2,500
6,000
No gain or loss is recognized.
11-23
Depreciation and IAS 16
The component approach is required under
IASB standards. The following requirement is
contained in IAS 16:
“Each part of an item of property, plant
and equipment with a cost that is
significant in relation to the total cost
of the item shall be depreciated
separately.”
11-24
Depreciation and Accretion of an
Asset Retirement Obligation
•
Bryan Beach Company purchases and
erects an oil platform at a total cost of
$750,000. Bryan Beach is legally
obligated to dismantle and remove the
platform after 10 years.
•
It is estimated that this will cost $100,000.
Assuming an 8% interest rate, the present
value of the obligation is $46,319 [46.319
(n = 10; i = 8%)  $100,000].
(continued)
11-25
Depreciation and Accretion of an
Asset Retirement Obligation
The journal entries to record the purchase
of the oil platform and the recognition of
the asset retirement obligation are as
follows:
Oil Platform
Cash
750,000
750,000
Oil Platform
46,319
Asset Retirement Obligation
46,319
(continued)
11-26
Depreciation and Accretion of an
Asset Retirement Obligation
The cost of the oil platform asset, including
the estimated retirement obligation, is
depreciated just like any other long-term
asset.
Depreciation Expense
Accumulated Depreciation—
Oil Platform
79,632*
79,632
*Assuming straight-line depreciation [($750,000 +
$46,319)/10]
(continued)
11-27
Depreciation and Accretion of an
Asset Retirement Obligation
Each year an entry must be made to
recognize the increase in the present value
of the asset retirement obligation.
Accretion Expense
Asset Retirement Obligation
3,706*
3,706
* ($46,319 x 0.08) = $3,706
11-28
Depletion of Natural Resources
• Natural resources (also called wasting
•
assets) are consumed as the physical units
representing these resources are removed
and sold.
The computation of depletion expense is an
adaption of the productive-output method of
depreciation.
• Perhaps the most difficult problem is
estimating the amount of resources available
for economical removal from the land.
(continued)
11-29
Depletion of Natural Resources
•
Land containing mineral deposits is
purchased at a cost of $5,500,000. It is
expected to have a residual value of
$250,000.
•
The natural resource supply is estimated at
1,000,000 tons. The unit-depletion charge
and the total depletion charge for the first
year, assuming the withdrawal of 80,000
tons, are calculated on Slide 11-51.
(continued)
11-30
Depletion of Natural Resources
Depletion
=
charge per ton
$5,500,000 – $250,000
1,000,000 tons
Depletion
= $5.25
charge per ton
Depletion for 2013 = $5.25  80,000 tons
= $420,000
(continued)
11-31
Depletion of Natural Resources
Record the initial purchase as follows:
Mineral Deposits
Cash
5,500,000
5,500,000
Record the depletion for 2013 as follows:
Depletion Expense
Accumulated Depletion
(or Mineral Deposits)
420,000
420,000
If only 60,000 tons are sold, $105,000 is
reported as part of ending inventory.
11-32
Change in Estimated Life
•
A company purchased $50,000 of equipment
and estimated a 10-year life. Using the
straight-line method with no residual value, the
annual depreciation would be $5,000.
• After four years, accumulated depreciation
would amount to $20,000, and the remaining
book value would be $30,000.
•
Early in the fifth year, a reevaluation of the life
indicates only four more years of service can
be expected from the asset.
(continued)
11-33
Change in Estimated Units
of Production
A change in accounting for natural
resources occurs when the estimate of
the recoverable units changes as a result
of further discoveries, improved
extraction processes, or changes in sales
prices that indicate changes in the
number of units that can be extracted
profitably.
(continued)
11-34
Change in Estimated Units
of Production
•
Land is purchased at a cost of $5,500,000
with estimated net residual value of
$250,000. The original estimate of natural
resources in the land was 1,000,000 tons.
•
In the second year of operations, 100,000
tons of ore are withdrawn. At the end of
that year appraisers indicate a remaining
tonnage of 950,000.
(continued)
11-35
Change in Estimated Units
of Production
Cost assignable to recoverable tons
as of the beginning of second year:
Original costs applicable to
depletable resources
$5,250,000
Deduct: Depletion charge for first
year
420,000
Balance of cost subject to depletion $4,830,000
(continued)
11-36
Change in Estimated Units
of Production
Estimated recoverable tons as of the
beginning of second year:
Number of tons withdrawn in 2nd year
Estimated recoverable tons as of
the end of the second year
Total recoverable tons as of the
beginning of the second year
100,000
950,000
1,050,000
Depletion charge per ton for second year:
$4,830,000/1,050,000 = $4.60
Depletion charge for second year:
100,000  $4.60 = $460,000
(continued)
11-37
Change in Estimated Units
of Production
Cost assignable to recoverable tons as
of the beginning of second year:
Original costs applicable to depletable
resources
Add: Additional costs incurred in 2nd year
$5,250,000
525,000
$5,775,000
420,000
$5,355,000
Deduct: Depletion charge for first year
Balance of cost subject to depletion
Estimated recoverable tons as of the
beginning of second year
1,050,000
Depletion charge per ton for second year:
$5,355,000/1,050,000 = $5.10
Depletion for second year: 100,000 × $5.10 = $510,000
11-38
Change in
Depreciation Method
•
Another change in estimate occurs when
the actual pattern of consumption of an
asset doesn’t match the pattern of
consumption implicit in the depreciation
method.
•
Example: An asset is purchased for
$120,000 with a 12-year expected useful
life and zero salvage value. After two years
of straight line depreciation, the asset has a
remaining book value of $10,000.
(continued)
11-39
Change in
Depreciation Method
•
The company decides the double-decliningbalance method would yield a better
estimate of periodic depreciation.
•
The straight-line depreciation rate is 10%
(1/n = 1/10 = 10%). Double that rate is
20%.
•
Year 3 depreciation is $100,000 x 0.20, or
$20,000.
11-40
Accounting for Asset Impairment
FASB Statement No. 144 addresses four
questions:
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.
(continued)
11-41
Accounting for Asset 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.
(continued)
11-42
Accounting for Asset 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.
(continued)
11-43
Accounting for Asset 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.
(continued)
11-44
International Accounting for Asset
Impairment: IAS 36
•
•
•
IAS 36 requires that a company recognize an
impairment loss whenever the “recoverable
amount” of an asset is less than its book value.
Recoverable amount is the higher of the
selling price of the asset or the discounted
future cash flows associated with the asset’s
use.
IAS 36 allows for the reversal of an impairment
loss if events in subsequent years suggest the
asset is no longer impaired.
11-45
Amortization and Impairment of Intangible
Assets Subject to Amortization
•
•
Intangible assets are to be amortized by the
straight-line method unless there is strong
justification for using another method.
Because companies must disclose both the
original cost and the accumulated
amortization for an amortizable intangible,
the credit should be to a separate
accumulated amortization account.
(continued)
11-46
Impairment of Intangibles Not
Subject to Amortization
The FASB describes the following examples of
intangibles with indefinite lives:
• Broadcast licenses often have a renewal
period of 10 years. Because renewal is
virtually automatic, such licenses are
considered to have an indefinite life.
• A trademark right is granted for a limited
time, but can be renewed almost routinely.
If economic factors suggest that the
trademark will continue to have value in the
foreseeable future, then its useful life is
indefinite.
(continued)
11-47
Procedures in Testing
Goodwill for Impairment
•
The procedure in testing goodwill for
impairment is a four step test.
•
Buyer Company acquired Target Company
on January 1, 2013. As part of the
acquisition, $1,000 in goodwill was
recognized; this goodwill was assigned to
Buyer’s Manufacturing unit. For 2013,
earnings for the Manufacturing unit were
$350.
(continued)
11-48
Procedures in Testing
Goodwill for Impairment
•
Separately traded companies with
operations similar to the manufacturing
reporting unit have market values
approximately equal to six times earning.
(continued)
11-49
Procedures in Testing
Goodwill for Impairment
As of December 31, 2013, book and fair
values of assets and liabilities of the
Manufacturing reporting units are as follow:
Book Values
Identifiable assets
Goodwill
Liabilities
$3,500
1,000
2,000
Fair Values
$4,000
?
2,000
(continued)
11-50
Procedures in Testing
Goodwill for Impairment
1. Compute the fair value of each reporting
unit to which goodwill has been assigned.
 Using the earnings multiple, the
fair value of the Manufacturing
reporting unit is estimated to be
$2,100 ($350 x 6).
(continued)
11-51
Procedures in Testing
Goodwill for Impairment
2. If the fair value of the reporting unit
exceeds the net book value of the assets
and liabilities of the reporting unit, the
goodwill is assumed to not be impaired
and no impairment is recognized.
 The net book value of the assets and
liabilities of the Manufacturing reporting
unit is $2,500 [($3,500 +$1,000) – $2,000].
Since $2,100 (step 1) is less than $2,500,
further computations are needed.
(continued)
11-52
Procedures in Testing
Goodwill for Impairment
3. If the fair value of the reporting unit is less
than the net book value of the assets and
liabilities of the reporting unit, then a new
fair value of goodwill is computed.
Goodwill value is always a residual value.
 Implied fair value of goodwill is calculated as
follows:
Estimated fair value of Manufacturing
Fair value of identifiable assets – fair
value of liabilities ($4,000 – $2,000)
Implied fair value of goodwill
(continued)
$2,100
2,000
$ 100
11-53
Procedures in Testing
Goodwill for Impairment
4. If the implied amount of goodwill computed in
(3) is less than the amount initially recorded, a
goodwill impairment loss is recognized for the
difference.
 The implied fair value of goodwill is less than
the recorded amount of goodwill
($100 < $1,000). The journal entry necessary
to recognize goodwill impairment loss is as
follows:
Goodwill Impairment Loss
Goodwill
900
900
11-54
Asset Retirement by Sale
On July 1, 2013, Landon Supply Co. sells
machinery for $43,600 that is recorded on the
books at a cost of $83,600 with accumulated
depreciation as of January 1, 2013, of $50,600.
Assume a 10 percent straight-line rate.
Depreciation Expense—Machinery
4,180
Accumulated Depreciation—
Machinery
4,180
To record depreciation for six$83,600 x .10 x
months in 2013.
6/12
(continued)
11-55
Asset Retirement by Sale
The entry to record the sale is as follows:
Cash
Accumulated Depreciation—Machinery
Machinery
Gain on Sale of Machinery
To record sale of machinery at
a gain.
43,600
54,780
83,600
14,780
[$43,600 – ($83,600 – $54,780)]
11-56
Asset Classified as Held for Sale
Special accounting is required if the following
conditions are satisfied:
• Management commits to a plan to sell a
long-term operating asset.
• The asset is available for immediate sale.
• An active effort to locate a buyer is
underway.
• It is probable that the sale will be
completed within one year.
(continued)
11-57
Asset Classified as Held for Sale
If the criteria are satisfied, two uncommon
accounting actions are required. During the
interval between being classified as held for
sale and actually being sold:
1. No depreciation is to be recognized, and
2. The asset is to be reported at the lower of
its book value or its fair value (less the
estimated cost to sell).
(continued)
11-58
Asset Classified as Held for Sale
•
On July 1, 2013, Haas Company has a
building that cost $100,000 and
accumulated depreciation of $35,000.
Haas commits to plans to sell the building
by March 1, 2013.
•
On July 1, 2013, the building has an
estimated fair value of $40,000 and it is
estimated that the selling costs will be
$3,000.
(continued)
11-59
Asset Classified as Held for Sale
The following entry would be made on July 1:
Building—Held for Sale
37,000
Loss on Held-for-Sale Classification 28,000
Accumulated Depreciation—Building 35,000
Building
100,000
If the net realizable value had been greater
than the book value of $65,000
($100,000  $35,000), no journal entry would
have been made.
(continued)
11-60
Asset Classified as Held for Sale
On December 31, 2013, the estimated selling
price was $58,000 (with $3,000 estimated
selling costs), the following journal entry would
be necessary:
Building—Held for Sale
Gain on Recovery Value—Held for
Sale
18,000
18,000
($58,000 – $3,000) – $37,000
11-61
Asset Retirement by Exchange for
Other Nonmonetary Assets
• When an operating asset is acquired in
exchange for another nonmonetary asset, the
new asset acquired is generally recorded at
its fair market value or the fair value of the
nonmonetary asset given in exchange,
whichever is more clearly determinable.
•
However, if the exchange has no real
commercial substance, the asset received is
sometimes recorded at the BOOK value of
the asset given.
11-62
Nonmonetary Exchange without
Commercial Substance
Example 1—No Cash Involved
Republic Manufacturing Company owns a molding
machine that it decided to exchange for a machine
owned by Logan Square Company. The following cost
and market data relate to the two machines:
(continued)
11-63
Nonmonetary Exchange without
Commercial Substance
The entry on Republic’s books to record the
exchange will be:
Machinery (new)
Accumulated Depreciation—Machinery (old)
Machinery
14,000
32,000
46,000
The entry on Logan’s books to record the
exchange will be:
Machinery (new)
Accumulated Depreciation—Machinery (old)
Loss on Exchange of Machinery
Machinery (old)
16,000
37,700
300
54,000
11-64
Nonmonetary Exchange without
Commercial Substance
Example 2—Small Amount of Cash Involved
Assume the same facts as Example 1, except that
it is agreed that Republic’s machine has a market
value of $16,000 and Logan’s machine is worth
$17,000. Republic pays Logan $1,000 cash.
17,000
(continued)
11-65
Nonmonetary Exchange without
Commercial Substance
The entry on Republic’s books to record the
exchange will be:
Machinery (new)
Accumulated Depreciation—Machinery (old)
Machinery (old)
Cash
15,000
32,000
46,000
1,000
The book value of Logan’s machine is less
than the fair value, indicating a $700 gain
($17,000 – $16,300). A portion of the gain
should be recognized as having been
earned.
(continued)
11-66
Nonmonetary Exchange without
Commercial Substance
The amount to be recognized is computed
using the following formula:
Recognized
=
gain
Cash received
Cash received + Fair value of
acquired asset
Total
x indicated
gain
For Logan:
Recognized
=
gain
$1,000
x $700 = $41
$1,000 + $16,000
(continued)
11-67
Nonmonetary Exchange without
Commercial Substance
The entry on Logan’s books to record the
exchange is as follows:
Cash
Machinery (new)
Accumulated Depreciation—Machinery (old)
Machinery (old)
Gain on Exchange of Machinery
1,000
15,341
37,700
54,000
41
11-68
Nonmonetary Exchange without
Commercial Substance
Example 3—Large Amount of Cash Involved
Assume the same facts as in Example 2, except
that it is agreed that Republic’s machine has a
fair value of $12,750 and Logan’s machine has
a fair value of $17,000. Republic pays Logan
$4,250 cash.
(continued)
11-69
Nonmonetary Exchange without
Commercial Substance
The entry on Republic’s books to record the
exchange will be:
Machinery (new)
Accumulated Depreciation—Machinery (old)
Loss on Exchange of Machinery
Machinery (old)
Cash
17,000
32,000
1,250
46,000
4,250
The entry on Logan’s books:
Cash
Machinery (new)
Accumulated Depreciation—Machinery (old)
Machinery (old)
Gain on Exchange of Machinery
4,250
12,750
37,700
54,000
700
11-70
Depreciation for Partial Periods
Makes the
1. Nearest whole month
most intuitive
2. Nearest whole year
sense
3. Half-year convention
4. No depreciation in year of acquisition;
full year depreciation in year of
retirement.
5. Full year depreciation in year of
acquisition; no depreciation in year of
retirement.
(continued)
11-71
Depreciation for Partial Periods
Sum-of-the-Years’-Digits Method
11-72
Depreciation for Partial Periods
Declining-Balance Method
11-73
Income Tax Depreciation
•
•
•
The term cost recovery was used in the
tax regulations to emphasize that ACRS is
not a standard depreciation method
because the system is not based strictly on
asset life or pattern of use.
Salvage values are ignored.
Depreciate over three to five years.
(continued)
11-74
Income Tax Depreciation
The MACRS method for personal
property also incorporates a halfyear convention, meaning that onehalf of a year’s depreciation is
recognized on all assets purchased
or sold during the year.
11-75
Chapter 11
₵
The End
$
11-76
11-77