StIce | StIce |Skousen
Investments in Noncurrent
Operating Assets –
Utilization and Retirement
Chapter 11
Intermediate Accounting
16E
Prepared by: Sarita Sheth | Santa Monica College
COPYRIGHT © 2007
Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are
trademarks used herein under license.
Learning Objectives
1. Use straight-line, accelerated, use factor,
and group depreciation methods to
compute annual deprecation expense.
2. Apply the productive-output method to
the depletion of natural resources.
3. Incorporate changes in estimates and
methods into the computation of
depreciation for current and future
periods.
4. Identify whether an asset is impaired and
measure the amount of the impairment
loss using both U.S. GAAP and
international accounting standards.
Learning Objectives
5. Discuss the issues impacting proper
recognition of amortization or impairment
for intangible assets.
6. Account for the sale of depreciable assets
in exchange for cash and in exchange for
other depreciable assets.
7. Compute depreciation for partial periods,
using both straight-line and accelerated
methods.
8. Understand the depreciation methods
underlying the MACRS income tax
depreciation system.
Depreciation
• The use of assets during the period
should be reported as an expense of
that period.
• Accounts estimates this cost by using
a systematic method to allocate the
recorded costs.
• Depreciation is not a process through
which a company accumulates a cash
fund to replace its long-lived assets.
Factors Affecting the Periodic
Depreciation Charge
• Asset cost
• Residual or
salvage value
• Useful life
• Pattern of use
Depreciation Vocabulary
• Book Value: Historical cost of the
asset less accumulated
depreciation.
• 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.
Pattern of Use
Depreciable
Cost
(Asset)
Costs incurred are deferred
until
future periods.
They
A depreciation
method
is
areselected
recorded
an asset
and
toas
assign
these
the
costs
are assigned
to
costs
to future
periods.
future periods.
Period 1
Period 2
Period 3
Pattern of Use
Depreciable
Cost
(Asset)
A depreciation method is
selected to assign these
costs to future periods.
Period 1
Period 2
Period 3
Pattern of Use
Depreciable
Cost
Cost
(Asset)
Period 1
Period 2
Period 3
Pattern of Use
Depreciable
Cost
Cost
(Asset)
Period 1
Period 2
Period 3
Pattern of Use
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.
Methods of Depreciation
Time-Factor Methods
• Straight-line: This method
recognizes equal periodic
depreciation charges over the
asset’s life.
12
10
8
6
Machine
4
2
0
2004
2005
2006
2007
2008
Methods of Depreciation
Time-Factor Methods
• 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.
Methods of Depreciation
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.
Methods of Depreciation
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.
Depletion of Natural Resources
Natural
resources
(wasting assets)
are consumed as
the physical units
representing
these resources
are removed and
sold.
Depletion of Natural Resources
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 2005,
80,000 tons of the estimated
1,000,000 tons are removed.
Depletion
Depletion
=
charge per ton
$5,500,000 – $250,000
1,000,000 tons
Depletion
= $5.25
charge per ton
$450,000 –
$200,000
Depletion for 2005 = $5.25 x 80,000 tons
Depletion for 2005 = $420,000
Depletion
The initial purchase:
Mineral Deposits
Cash
5,500,000
5,500,000
Depletion for 2005:
Depletion Expense
420,000
Accumulated Depletion
(or Mineral Deposits)
420,000
Impairment
• Before the end of an asset’s useful life,
events occur that impair its value.
• This requires an immediate writedown of the asset.
1. When should an asset be reviewed for
possible impairment?
If An
management
impairmentobtains
review information
should be
suggesting
the market
of the
conducted that
whenever
there value
has been
a
asset has
declined,
impairment
material
change
in theanway
an asset is
should
be conducted.
usedreview
or in the
business
environment.
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.
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.
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.
International Accounting for
Asset Impairment
• IFRS 36 requires that a company recognize
an impairment loss whenever the
recoverable value of an asset is less than its
book value.
• Recoverable value- The higher of the selling
price of the asset or the discounted cash
flows associated with the asset’s use.
• IFRS 36 allows for the reversal of an
impairment loss if events in subsequent
years suggest the asset is no longer
impaired.
Impairment of Intangibles Not
Subject to Amortization
SFAS No. 142 describe the following examples
of intangibles with indefinite lives:
• Broadcast license
• Trademark
A trademark right is
Broadcast
often
granted forlicense
a limited
have
a renewal
period
time,
but can be
of renewed
ten years.
Because
almost
renewal is
routinely.
Asvirtually
long as
automatic,issuch
the trademark
useful,
considered
it license
has an are
indefinite
life.
to have an indefinite
life.
Impairment of Goodwill
Procedures in Testing Goodwill
1. Compute the fair value of each
reporting unit to which goodwill
has been assigned.
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.
Impairment of Goodwill
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, a new fair
value of goodwill is computed.
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.
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.
Asset Retirement by Exchange
(Dissimilar Asset)
1. Remove old asset from books: debit
Accumulated Depreciation; credit the
asset.
2. Record new asset at fair market
value: debit asset
3. Record any cash received or paid:
debit or credit Cash as appropriate.
4. Record any gain or loss: debit loss
account or credit gain account.
Asset Retirement by Exchange
(Similar Asset)
• 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.
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.