Stice | Stice | Skousen
Intermediate Accounting,17E
Investments in Noncurrent
Operating Assets—
Utilization and Retirement
PowerPoint presented by: Douglas Cloud
Professor Emeritus of Accounting, Pepperdine University
© 2010 Cengage Learning
Depreciation
• The use of assets during the period should
be reported as an expense of that period.
• Accountants estimate this cost by using a
systematic method to allocate the recorded
costs, called:
 Depreciation for tangible property, such as
equipment.
 Depletion for minerals and natural
resources.
 Amortization for intangible assets, such as
patents and copyrights.
(continues)
11-2
Depreciation
• Depreciation is not a process through
which a company accumulates a cash
fund to replace its long-lived assets.
11-3
Factors Affecting the Periodic
Depreciation Charge
•
•
•
•
Asset cost
Residual or salvage value
Useful life
Pattern of use
11-4
Depreciation Vocabulary
• Asset cost is the purchase cost plus
any capitalized expenditures.
• Residual (salvage) value is the
estimated resale value of the asset
upon retirement.
• Useful life is the expected life of the
asset in years, hours of service, or
per unit of output.
11-5
Pattern of Use
Depreciable
Cost
(Asset)
Costs incurred are deferred
until future periods. They
are recorded as an asset
and the costs are assigned
to future periods.
Period 1
Period 2
Period 3
11-6
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.
11-7
Straight-Line Depreciation
Time-Factor Methods
Straight-line depreciation
relates depreciation to the passage
of time and recognizes equal
depreciation in each year of the life
of the asset.
11-8
Straight-Line Depreciation
Schuss Boom Ski Manufacturing
acquired a polyurethane plasticmolding machine at the beginning
of 2011 for $100,000. It has an
estimated life of five years and an
estimated residual value of $5,000.
(continues)
11-9
Straight-Line Depreciation
Depreciation =
Cost – Residual Value
Number of Years
Depreciation =
$100,000 – $5,000
5
Depreciation =
$19,000
11-10
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
SYD = 15
(continues)
11-11
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
 (Cost – Residual value)
Depreciation =
SYD
Depreciation =
5
 ($100,000 – $5,000)
15
Depreciation = $31,667
(continues)
11-12
Sum-of-the-Years’
Digits Method
For the second year, we reduce the
numerator by one.
t
 (Cost – Residual value)
Depreciation =
SYD
Depreciation =
4
 ($100,000 – $5,000)
15
Depreciation = $25,333
11-13
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.
• If double-declining balance
depreciation is used, then the
percentage is twice the straight-line
rate.
11-14
Declining-Balance Method
S/L 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%.
11-15
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.
11-16
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.
11-17
Service-Hours Depreciation
Let’s continue with the Schuss
Boom Ski Manufacturing machine.
It cost $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.
11-18
Service-Hours Depreciation
Depreciation =
Depreciation =
Cost – Residual value
Number of hours
$100,000 – $5,000
20,000 hours
Depreciation = $4.75 per hour
11-19
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. Assume a
company produced 3,200 units in
2011 and 5,400 units in 2012.
11-20
Productive-Output Depreciation
Cost – Residual value
Rate per unit =
Total number of units
$100,000 – $5,000
Rate per unit =
25,000 units
Rate per unit = $3.80 per unit
Annual depreciation for 2011 and 2012:
2011: 3,200 units  $3.80 = $12,160
2012: 5,400 units  $3.80 = $20,520
11-21
Group and Composite
Depreciation
• Group depreciation groups similar assets
into depreciation accounts.
• Calculate annual depreciation charge at the
straight-line rate times the group’s book
value.
• Recognize gains and losses only when all
assets in the group have been retired.
• Referred to as composite depreciation
when the assets in the group are related
but dissimilar.
11-22
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.
11-23
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 made.
Cash
Accumulated Depreciation
Equipment
3,500
2,500
6,000
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 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].
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
(continues)
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]
11-27
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.
11-28
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
2011, 80,000 tons of the estimated
1,000,000 tons are removed.
(continues)
11-29
Depletion of Natural Resources
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 2011 = $5.25  80,000 tons
= $420,000
(continues)
11-30
Depletion of Natural Resources
Record the initial purchase as follows:
Mineral Deposits
Cash
5,500,000
5,500,000
Record the depletion for 2011 as follows:
Depletion Expense
Accumulated Depletion
(or Mineral Deposits)
420,000
420,000
11-31
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.
At the beginning of the fifth year, it is
determined that the equipment will only
last four more years.
(continues)
11-32
Change in Estimated Life
Divide the book value
by the new estimated
remaining life
After four years, the
book value is $30,000
($50,000  $20,000) 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.
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
was 1,000,000 tons. In 2012,
100,000 tons of ore are withdrawn.
At the end of 2012, appraisers
indicate a remaining tonnage of
950,000.
(continues)
11-35
Change in Estimated
Units of Production
Cost assignable to recoverable tons
as of the beginning of 2012:
Original costs applicable to
depletable resources
Deduct: Depletion charge for 2011
Balance of cost subject to depletion
(continues)
$5,250,000
420,000
$4,830,000
11-36
Change in Estimated
Units of Production
Estimated recoverable tons as of the
beginning of 2012:
Number of tons withdrawn in 2011
Estimated recoverable tons as of
the end of 2012
Total recoverable tons as of the
beginning of 2012
100,000
950,000
1,050,000
Depletion charge per ton for 2012:
$4,830,000/1,050,000 = $4.60
Depletion charge for 2012:
100,000  $4.60 = $460,000
(continues)
11-37
Change in Estimated
Units of Production
Cost assignable to recoverable tons as
of the beginning of 2012:
Original costs applicable to depletable
resources
Add: Additional costs incurred in 2012
$5,250,000
525,000
$5,775,000
420,000
$5,355,000
Deduct: Depletion charge for 2011
Balance of cost subject to depletion
Estimated recoverable tons as of the
beginning of 2012
1,050,000
Depletion charge per ton for 2012:
$5,355,000/1,050,000 = $5.10
Depletion for 2012: 100,000 × $5.10 = $510,000
11-38
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)
11-39
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.
(continues)
11-40
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.
(continues)
11-41
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.
11-42
Accounting for Asset
Impairment
• Guangzhou Company purchased a
building five years ago for $600,000. It has
an expected life of 20 years (zero residual
value) and has a book value of $450,000
(using straight-line depreciation).
• Guangzhou estimates that the building has
a remaining useful life of 15 years. Net
cash inflow from the building is expected
to be $25,000 per year, and the fair value
of the building is $230,000.
(continues)
11-43
Accounting for Asset
Impairment
• The $450,000 book value is compared to
the $375,000 ($25,000  15 years)
undiscounted future cash flows. An
impairment loss should be recognized. The
loss is $220,000 ($450,000 – $230,000).
The impairment loss would be recorded as
follows:
Accumulated Depreciation—Building 150,000
Loss on Impairment of Building
220,000
Building ($600,000  $230,000)
370,000
11-44
International Accounting for
Asset Impairment: IAS 16
Using the Guangzhou Company
example, assume that after five years
the fair market value is $540,000.
Guangzhou elects to employ IAS 16. A
journal entry is needed to recognize the
asset revaluation.
Accumulated Depreciation—Building
Revaluation Equity Reserve
Building ($600,000  $540,000)
150,000
90,000
60,000
11-45
Recording the Disposal of
Revalued Asset
Immediately after revaluing the building
to $540,000, Guangzhou Company sells
it for $540,000 in cash. The disposal
would be recorded as follows:
Cash
Building
Revaluation Equity Reserve
Retained Earnings
540,000
540,000
90,000
Note that because Guangzhou
chose to revalue the asset, the
“gain” is never reported as a gain.
90,000
11-46
Amortization and Impairment
of Intangible Assets
• 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.
11-47
Amortization and Impairment
of Intangible Assets
Ethereal Company purchased a customer
list for $30,000 on January 1, 2011. It is
expected to have economic value for four
years. The expected residual value is zero.
On December 31, 2011, the following
journal entry is made to recognize
amortization expense:
Amortization Expense
Accumulated Amortization—
Customer List
(continues)
7,500
7,500
11-48
Amortization and Impairment
of Intangible Assets
On December 31, 2012, before the amortization
entry is made, a test for impairment is made. The
future cash flow of the list is expected to be
$15,000—which is less than the book value of
$22,500 ($30,000 – $7,500). The amount of the
impairment loss is $10,500 ($22,500 – $12,000).
Impairment Loss
Accumulated Amortization—
Customer List
Customer List
10,500
7,500
18,000
11-49
Impairment of Intangibles Not
Subject to Amortization
SFAS No. 142 describes the following examples
of intangibles with indefinite lives:
• Broadcast licenses often have a renewal
period of ten 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. As long as the
trademark is useful, it has an indefinite
life.
11-50
Impairment of Intangibles Not
Subject to Amortization
• Impalable Company has a broadcast
license that has no foreseeable end to its
useful life. The license cost $60,000,
and it was estimated that the license
generated cash flows of $7,000 per year.
• Recent events have convinced
management that the cash flow will be
reduced. The weighted probability
shows that the estimated fair value is
$52,000.
(continues)
11-51
Impairment of Intangibles Not
Subject to Amortization
Because the estimated fair value is
less than the book value ($52,000 <
$60,000), the intangible asset is
impaired. The loss is recognized with
the following journal entry:
Impairment Loss ($60,000  $52,000)
Broadcast License
8,000
8,000
11-52
Procedures in Testing
Goodwill for Impairment
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.
(continues)
11-53
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.
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.
11-54
Asset Retirement by Sale
On July 1, 2011, Landon Supply Co. sells for
$43,600 machinery that is recorded on the
books at a cost of $83,600 with accumulated
depreciation as of January 1, 2011, of
$50,600. Assume a 10 percent straight-line
rate.
Depreciation Expense—Machinery
Accumulated Depreciation—
Machinery
4,180
4,180
($83,600  0.10  6/12)
(continues)
11-55
Asset Retirement by Sale
On July 1, 2011, Landon Supply Co. sells for $43,600
machinery that is recorded on the books at a cost of
$83,600 with accumulated depreciation as of January
1, 2011, of $50,600. Assume a 10 percent straightline rate. An entry for $4,180 would be made for
depreciation from January to June ($83,600  0.10 
1/2), then the retirement is recorded.
Cash
Accumulated Depreciation—Machinery
Machinery
Gain on Sale of Machinery
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.
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).
11-58
Asset Classified as Held for Sale
On July 1, 2011, 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, 2011. On July 1,
2011, the building has an estimated
fair value of $40,000 and it is
estimated that the selling costs will be
$3,000.
(continues)
11-59
Asset Classified as Held for Sale
The following entry would be made
on July 1:
Building—Held for Sale
Loss on Held-for-Sale Classification
Accumulated Depreciation—Building
Building
37,000
28,000
35,000
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.
11-60
Asset Classified as Held for Sale
On December 31, 2011, 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.
11-62
Asset Retirement by Exchange
for Other Nonmonetary Assets
A machine that cost $83,600 and has
accumulated depreciation of $54,780
is exchanged for delivery equipment
that has a fair market value of
$43,600.
Delivery Equipment
Accumulated Depreciation—Machinery
Machinery
Gain on Exchange of Machinery
43,600
54,780
83,600
14,780
11-63
Asset Retirement by Exchange
for Other Nonmonetary Assets
Assume the delivery equipment’s fair
market value is not determinable, but
the machinery has a market value of
$25,000.
Delivery Equipment
Accumulated Depreciation—Machinery
Loss on Exchange of Machinery
Machinery
25,000
54,780
3,820
83,600
11-64
Asset Retirement by Exchange
for Other Nonmonetary Assets
Assume the delivery equipment’s fair
market value is not determinable, but
the machinery has a market value of
$25,000. In addition to the delivery
equipment, cash of $3,000 was received.
Cash
Delivery Equipment
Accumulated Depreciation—Machinery
Loss on Exchange of Machinery
Machinery
3,000
22,000
54,780
3,820
Fair market value
of machine
83,600
11-65
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:
(continues)
11-66
Nonmonetary Exchange without
Commercial Substance
Example 1—No Cash Involved
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
11-67
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
(continues)
11-68
Nonmonetary Exchange without
Commercial Substance
Example 2—Small Amount of Cash Involved
The entry on Republic’s books to record the
exchange will be:
Machinery (new)
Accumulated Depreciation—Machinery (old)
Machinery
Cash
15,000
32,000
46,000
1,000
The entry on Logan’s books to record the exchange
will be:
Cash
Machinery (new)
Accumulated Depreciation—Machinery (old)
Machinery (old)
1,000
15,300
37,700
54,000
11-69
Nonmonetary Exchange without
Commercial Substance
Example 3—Large Amount of Cash Involved
Assume the same facts as in Example 1,
except that it is agreed that Republic’s
machine has a market value of $12,750
and Logan’s machine is worth $17,000.
Republic pays Logan $4,250 cash.
12,750
(continues)
17,000
11-70
Nonmonetary Exchange without
Commercial Substance
Example 3—Large Amount of Cash Involved
The entry on Republic’s books to record the
exchange will be:
Machinery (new)
Accumulated Depreciation—Machinery (old)
Loss on Exchange of Machinery
Machinery
Cash
(continues)
17,000
32,000
1,250
46,000
4,250
11-71
Nonmonetary Exchange without
Commercial Substance
Example 3—Large Amount of Cash Involved
The entry on Logan’s books to record the exchange:
Cash
Machinery (new)
Accumulated Depreciation—Machinery (old)
Machinery (old
Gain on Exchange of Machinery
4,250
12,750
37,700
54,000
700
How much cash constitutes an amount large enough
to require the approach used in Example 3? The
FASB failed to establish a “bright line” test, so the
old 25% rule will continue to serve as a guideline.
11-72
Depreciation for Partial Periods
1.
2.
3.
4.
Makes the
Nearest whole month.
most intuitive
Nearest whole year.
sense
Half-year convention.
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.
11-73
Depreciation for Partial Periods
From this point, each year’s
depreciation will be $6,333 less than
the previous year’s depreciation.
11-74
Depreciation for Partial Periods
Sum-of-the-Years’-Digits Method
11-75
Depreciation for Partial Periods
Declining-Balance Method
11-76
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.
11-77
Income Tax Depreciation
The MACRS method for personal
property also incorporates a halfyear convention, meaning that
one-half of a year’s depreciation
is recognized on all assets
purchased or sold during the
year.
11-78