Intermediate Accounting, 11th ed.
Kieso, Weygandt, and Warfield
Chapter 11: Depreciation,
Impairments and Depletion
Prepared by
Jep Robertson and Renae Clark
New Mexico State University
Chapter 11: Depreciation,
Impairments and Depletion
After studying this chapter, you should
be able to:
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.
Chapter 11: Depreciation,
Impairments and Depletion
5. Explain the accounting issues related to
asset impairment.
6. Explain the accounting procedures for
depletion of natural resources.
7. Explain how property, plant, equipment,
and natural resources are reported and
analyzed.
Depreciation: Concept
• Depreciation is a means of cost
allocation.
• It is not a method of valuation.
• Depreciation involves:
allocating the cost of tangible assets to
expense in a systematic and rational manner
to periods expected to benefit from use of
its depreciable assets.
Factors in the Depreciation
Process
Questions to be answered:
1. What is the depreciable base of the asset?
2. What is the asset’s useful life?
3. What method of depreciation is best for
the asset in question?
Depreciable Base
• Depreciable base is the dollar amount
subject to depreciation.
• It is determined as:
Original cost of the asset less
Estimated salvage or disposal value
Estimated Service Lives
• An asset’s service life and physical life are
not the same.
• Assets’ service life are affected by:
physical factors, and economic factors
• Economic factors include:
Inadequacy (asset can not meet current
demand)
Supercession (by a better asset)
Obsolescence (other factors)
Depreciation Methods: Overview
Depreciation
Methods
Financial Accounting
Depreciation Methods
Activity
Straightline
Tax
Depreciation
Decreasing
Charge
1. Declining Balance
2. Sum-of-the-years’ digits
Special
methods
1. Composite method
2. Hybrid methods
Depreciation Methods: StraightStraightLine
• Is a function of time rather than usage
• Results in an equal amount of
depreciation expense for a given
period
• Depreciation Expense is computed as:
Cost – Salvage Value
Estimated Life
Depreciation Methods: Activity
• Is a function of usage rather than time.
• Estimated life is in terms of total input/output
of asset.
• Depreciation expense is computed as:
Cost – Salvage Value x Input/Output this period
Total Estimated Input/Output
Depreciation Methods: Decreasing
Charge (Accelerated)
These methods result in higher
depreciation expense in the earlier years
and lower charges in the later years.
Two decreasing charge methods are:
1. Declining balance
2. Sum-of-the-years’-digits
Depreciation Methods: Declining
Balance
1.
2.
3.
4.
5.
Salvage value is not deducted when computing
depreciable base.
Utilizes a depreciation rate (%) that is some
multiple of the SL rate.
The depreciation rate is multiplied by the asset’s
book value at the beginning of the period to get
the depreciation expense for the period.
Since the book value decreases over time this
results in a decreasing amount of depreciation
expense over time.
An asset’s book value can never be less than its
estimated salvage value.
Depreciation Methods: SumSum-of
of-the--Years’ Digits
the
•
•
A fraction is multiplied by the depreciable base to
arrive at the depreciation expense per period.
The fraction is:
Numerator: number of years remaining in the
asset’s life as of the beginning of the period.
2. Denominator: sum of the years in the life
3. For example, a 5 year life property would have
depreciation expense for the first year as:
4. (Cost – Salvage value) X 5 (years remaining)
15 (computed as
5+4+3+2+1)
1.
Group and Composite
Depreciation Methods
• The group method is applied to a collection
of assets similar in nature.
• The composite method is applied to a
collection of assets dissimilar in nature.
• The composite depreciation rate is
determined as follows:
total of annual depreciation for all assets
total cost of all assets
Partial Year Depreciation
• When an asset is bought sometime
during the year, a partial depreciation
charge is required.
• The procedure is:
determine depreciation for a full year,
and allocate the amount between the
two periods affected
Revision of Depreciation
Estimates
• Determination of depreciation involves
initial estimates (e.g., life, salvage value)
• When these estimates are revised,
depreciation must be re-computed:
Remaining B.V. – Est. Salvage Value
Remaining Est. Life
• These revised depreciation expenses apply
prospectively to the remaining life of asset.
• These changes do not affect prior periods.
Impairments
An impairment of a depreciable asset
occurs when:
• the carrying amount of the asset is
not recoverable, and therefore a
write-off is needed.
The recoverability test determines if
an impairment has occurred.
Impairments: The Recoverability
Test
Impairment?
Sum of expected
future net cash flows
from use and disposal
of asset is less than
the carrying amount
Impairment has occurred
Sum of expected
future net cash flows
from use and disposal
of asset is
equal to or more than
the carrying amount
No impairment
Impairments: Measuring Loss
Impairment has occurred
Determine
impairment loss
Yes
Does an active market
exist for the asset?
No
Use company’s market
rate of interest
Loss =
Carrying amount
less
Fair value of asset
Loss =
Carrying amount
less
present value of
expected net cash
flows
Impairment: Accounting
Impairment has occurred
Assets are held
Assets are held
for use
for sale
1. Loss = Carrying value
less Fair value
2. Depreciate new cost basis
3. Restoration of impairment
loss is NOT permitted
1. Loss = Carrying value
less Fair Value less
cost of disposal
2. No depreciation is taken
3. Restoration of impairment
loss is permitted
Graphic of Accounting for
Impairments
Depletion: Terminology
Depletion refers to the cost basis
write-off of natural resources (e.g.,
coal, oil, timber)
Depletion expense per unit is calculated:
Cost – Estimated Salvage Value
Total Estimated Units Available
This per unit cost is the multiplied by the
units extracted during a period to derive the
depletion for the period.
Depletion: Special Problems
• Difficulty of estimating recoverable
reserves
• Problems of discovery value
• Accounting for liquidating dividends
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