CHAPTER 11
DEPRECIATION, DEPLETION,
AND IMPARIMENTS
Sommers – ACCT 3311
Special Depreciation Methods
Choice of method depends on 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).
Example 4: Group Depreciation
Highsmith Rental Company purchased an apartment
building early in 2011. There are 20 apartments in the
building and each is furnished with major kitchen
appliances. The company has decided to use the group
depreciation method for the appliances. The following data
are available:
Appliance
Cost
ResVal
ServLife
Stoves
$15,000
$3,000
6
Refrigerators
10,000
1,000
5
Dishwashers
8,000
500
4
Calculate the group depreciation rate and group life.
Example 4: Continued
Asset
Stoves
Refrigerators
Dishwashers
Totals
Cost
$15,000
10,000
8,000
$33,000
Residual
Value
$3,000
1,000
500
$4,500
Group depreciation rate
Group life
Depreciable
Base
$12,000
9,000
7,500
$28,500
Estimated
Life(yrs.)
6
5
4
Depreciation
per Year
(straight line)
Discussion Questions
Q11–10 What are the major factors considered in determining
what depreciation method to use?
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. Significant decrease in the fair value of an asset.
b. Significant 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.
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.
Impairments
Finite-life Assets to be Held and Used
Step 1 – Recoverability
• An asset is impaired when the undiscounted sum of its estimated
future cash flows is less than its book value
Step 2 – Measurement
• Impairment loss is book value less fair value (Market value, price of
similar assets, or PV of future net cash inflows)
• Impairment loss is reported as part of income from continuing
operations
$0
Fair Value
$125
Case 1: $50 book value.
No loss recognized
Undiscounted future
cash flows
$250
Case 3: $275 book value.
Loss = $275 - $125
Case 2: $150 book value. No loss recognized
Example 5: Asset Impairment
Chadwick Enterprises, Inc., operates several restaurants
throughout the Midwest. Three of its restaurants located in the
center of a large urban area have experienced declining profits
due to declining population. The company’s management has
decided to test the operational assets of the restaurants for
possible impairment. The relevant information for these assets
is presented below.
Book value
$6.5 million
Estimated undiscounted sum of future cash flows 4.0 million
Fair value
3.5 million
Determine the amount of the impairment loss, if any.
Example 5: Continued
Step 1:
Step 2:
Example 5b: Asset Impairment
Chadwick Enterprises, Inc., operates several restaurants
throughout the Midwest. Three of its restaurants located in the
center of a large urban area have experienced declining profits
due to declining population. The company’s management has
decided to test the operational assets of the restaurants for
possible impairment. The relevant information for these assets
is presented below.
Book value
$6.5 million
Estimated undiscounted sum of future cash flows 6.8 million
Fair value
5.0 million
Determine the amount of the impairment loss, if any.
Example 5b: Continued
Step 1:
Example 6: Asset Impairment
General Optic Corporation operates a manufacturing plant in Arizona.
Due to a significant decline in demand for the product manufactured at
the Arizona site, an impairment test is deemed appropriate.
Management has acquired the following information for the assets at
the plant:
Cost
$32,500,000
Accumulated depreciation
14,200,000
General’s estimate of the total cash flows to
be generated by selling the products manufactured at its Arizona plant, not discounted
to present value
15,000,000
The fair value of the Arizona plant is estimated to be $11,000,000.
1. Determine the amount of impairment loss, if any.
2. If a loss is indicated, where would it appear in General Optic’s
multiple-step income statement?
Example 6: Continued
Assets Held for Sale
• Assets held for sale include assets that management
has committed to sell immediately in their present
condition and for which sale is probable.
Impairment
loss
=
Book
value
Fair value less
– cost to sell
Depletion and Amortization
Depletion of Natural Resources
• As natural resources are “used up”, or depleted, the cost
of the natural resources must be allocated to the units
extracted.
• The approach is based on the units-of-production
method.
Establishing a Depletion Base
Computation of the depletion base involves four factors:
(1) Acquisition cost.
(2) Exploration costs.
(3) Development costs.
(4) Restoration costs.
Example 7: Depletion
At the beginning of 2011, Terra Lumber Company purchased a timber
tract from Boise Cantor for $3,200,000. After the timber is cleared, the
land will have a residual value of $600,000. Roads to enable logging
operations were constructed and completed on March 30, 2011. The
cost of the roads, which have no residual value and no alternative use
after the tract is cleared, was $240,000. During 2011, Terra logged
500,000 of the estimated five million board feet of timber. Calculate the
2011 depletion of the timber tract and depreciation of the logging roads
assuming the units-of-production method is used for both assets.
Continuing Controversy
Oil and Gas Industry has two acceptable accounting
alternatives
• Successful efforts method – Exploration costs resulting
in unsuccessful wells (dry holes) are expensed.
• Full-cost method – Exploration costs resulting in
unsuccessful wells may be capitalized.
Political pressure prevented the FASB from requiring all
companies to use the successful efforts method.
MACRS vs. GAAP
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.
(Basically DDB with a half-year convention)
IFRS vs. GAAP
RELEVANT FACTS - Similarities
The
definition of property, plant, and equipment is essentially the
same under GAAP and IFRS.
Under
both GAAP and IFRS, changes in depreciation method and
changes in useful life are treated in the current and future periods.
Prior periods are not affected. GAAP recently conformed to IFRS in
this area.
The
accounting for plant asset disposals is the same under GAAP
and IFRS.
The
accounting for the initial costs to acquire natural resources is
similar under GAAP and IFRS.
Under
both GAAP and IFRS, interest costs incurred during
construction must be capitalized. Recently, IFRS converged to GAAP.
IFRS vs. GAAP
RELEVANT FACTS - Similarities
The
accounting for exchanges of nonmonetary assets has
recently converged between IFRS and GAAP. GAAP now requires
that gains on exchanges of nonmonetary assets be recognized if
the exchange has commercial substance. This is the same
framework used in IFRS.
GAAP
also views depreciation as allocation of cost over an
asset’s life. GAAP permits the same depreciation methods
(straight-line, diminishing-balance, units-of-production) as IFRS.
IFRS vs. GAAP
RELEVANT FACTS - Differences
IFRS
requires component depreciation. Under GAAP, component
depreciation is permitted but is rarely used.
Under
IFRS, companies can use either the historical cost model
or the revaluation model. GAAP does not permit revaluations of
property, plant, and equipment or mineral resources.
In
testing for impairments of long-lived assets, GAAP uses a twostep model to test for impairments. As long as future undiscounted
cash flows exceed the carrying amount of the asset, no impairment
is recorded. The IFRS impairment test is stricter. However, unlike
GAAP, reversals of impairment losses are permitted.
Example 8: GAAP vs. IFRS Depreciation
On June 30, 2011, Rosetta Granite purchased a machine
for $120,000. The estimated useful life of the machine is
eight years and no residual value is anticipated. An
important component of the machine is a specialized highspeed drill that will need to be replaced in four years. The
$20,000 cost of the drill is included in the $120,000 cost of
the machine. Rosetta uses the straight-line depreciation
method for all machinery.
Calculate depreciation for 2011 and 2012 applying the
typical U.S. GAAP treatment.
Repeat applying IFRS.
Example 8: Continued
• U.S. GAAP
• IFRS: