Operational Asset Utilization and Impairment

1. Chapter 11 Operational Assets: Utilization and Impairment

2. Some of the cost is expensed each period. AcquisitionCost Expense (Balance Sheet) (Income Statement) Cost Allocation – An Overview The matching principlerequires that part of the acquisition cost of operational assets be expensed in periods when the future revenues are earned.

3. Some of the cost is expensed each period. AcquisitionCost Expense (Balance Sheet) (Income Statement) Cost Allocation – An Overview Depreciation, depletion, and amortization are cost allocation processes used to help meet the matching principle requirements.

4. Cost Allocation – An Overview Caution! Depreciation, depletion, and amortization are used for cost allocation, not valuation!

5. The systematic approach used for allocation. The estimated expected use from an asset. Total amount of cost to be allocated. Cost - Residual Value (at end of useful life) Measuring Cost Allocation Cost allocation requires three pieces of information for each asset: Service Life Allocation Base Allocation Method

6. Depreciation of Operational Assets Group andcomposite methods • Time-based Methods • Straight-line (SL) • Accelerated Methods • Sum-of-the-years’-digits (SYD) • Declining Balance (DB) Taxdepreciation Activity-based methods Units-of-production method (UOP).

7. Depreciation on theBalance Sheet Net property, plant, & equipment is the undepreciated cost (book value)of plant assets.

8. Straight-Line (SL) The most widely used and most easily understood method. Results in the same amount of depreciation expense in each year of the asset’s service life.

9. Straight-Line (SL) On January 1, we purchase equipment for $50,000 cash. The equipment has an estimated service life of 5 years and residual value of $5,000. What is the annual straight-line depreciation?

10. Straight-Line (SL)

11. Straight-Line (SL) Residual Value Note that at the end of the asset’s useful life, BV = Residual Value

12. Straight-Line (SL) Depreciation Life in Years

13. Accelerated Methods Accelerated methods result inmoredepreciation expense in the early years of an asset’s useful life andless depreciation expense in later years of an asset’s useful life. Note that total depreciation over the asset’s useful life is the same as the SL Method.

14. Sum-of-the-Years’ Digits (SYD) SYD depreciation is computed as follows:

15. Sum-of-the-Years’ Digits (SYD) On January 1, we purchase equipment for $50,000 cash. The equipment has a service life of 5 years and an estimated residual value of $5,000.Using SYD, compute depreciation expense for the first two years.

16. Sum-of-the-Years’ Digits (SYD) Use this in your computation of SYD Depreciation Expense for Years 1 & 2.

17. Sum-of-the-Years’ Digits (SYD)

18. Sum-of-the-Years’ Digits (SYD) Residual Value

19. Sum-of-the-Years’ Digits (SYD) Depreciation Life in Years

20. Declining-Balance (DB) Methods DB depreciation • Based on the straight-line rate multiplied by an acceleration factor. • Computations initially ignore residual value. Stop depreciating when: BV=Residual Value

21. Double-Declining-Balance (DDB) DDB depreciation is computed as follows: Note that the Book Value will get lower each time depreciation is computed!

22. Double-Declining-Balance (DDB) On January 1, we purchase equipment for $50,000 cash. The equipment has a service life of 5 years and an estimated residual value of $5,000.What is depreciation expense forthe first two years usingdouble-declining-balance?

23. Double-Declining-Balance (DDB)

24. Double-Declining-Balance (DDB) We usually have to force depreciation expense in the latter years to an amount that brings BV = Residual Value.

25. Double-Declining-Balance (DDB) Depreciation Life in Years

26. Activity-Based Depreciation This approach looks different. • Depreciation can also be based on measures of input or output like: • Service hours, or • Units-of-Production • Depreciation is not taken for idle assets.

27. Units-of-Production

28. Units-of-Production On January 1, we purchased equipment for $50,000 cash. The equipment is expected to produce 100,000 units during its life and has an estimated residual value of $5,000.If 22,000 units were produced this year, what is the amount of depreciation expense?

29. Units-of-Production

30. Use of Various Depreciation Methods

31. Depreciation Disclosures • Depreciation expense. • Balances of major classes of depreciable assets. • Accumulated depreciation by asset or in total. • General description ofdepreciation methods used.

32. Group and Composite Methods • Assets are grouped by common characteristics. • A “composite rate” is calculated. • Annual depreciation is determined by: the composite rate × the total group acquisition cost. • Accumulated depreciation records are not maintained for individual assets.

33. Group and Composite Methods • Apply the composite rate to the total cost of the assets. • If assets in the group are sold, or new assets added, the composite rate remains the same. • When an asset in the group is sold or retired, debit Accumulated Depreciation for the difference between the asset’s cost and the proceeds.

34. Depletion of Natural Resources As natural resources are “used up”, or depleted, the cost of the natural resources must be expensed. The approach is based on the units-of-production method.

35. Depletion of Natural Resources

36. Depletion of Natural Resources ABC Mining acquired a tract of land containing ore deposits. Total costs of acquisition and development were $1,000,000. ABC estimated the land contained 40,000 tons of ore.

37. Depletion of Natural Resources What is ABC’s unit depletion rate? a. $40 per ton b. $50 per ton c. $25 per ton d. $20 per ton

38. Depletion of Natural Resources What is ABC’s unit depletion rate? a. $40 per ton b. $50 per ton c. $25 per ton d. $20 per ton Cost / Units $1,000,000 / 40,000 Tons = $25 Per Ton

39. Depletion of Natural Resources For the year ABC mined 13,000 tons and sold 9,000 tons. What is the total depletion cost and the total depletion expense? a. $325,000 & $225,000 b. $325,000 & $325,000 c. $225,000 & $225,000 d. $275,000 & $225,000

40. Depletion of Natural Resources For the year ABC mined 13,000 tons and sold 9,000 tons. What is the total depletion cost and the total depletion expense? a. $325,000 & $225,000 b. $325,000 & $325,000 c. $225,000 & $225,000 d. $275,000 & $225,000 Cost = 13,000 x $25 = $325,000 Expense = 9,000 x $25 = $225,000

41. Economic Life Legal Life Amortization of Intangible Assets The amortization process uses the straight-line method, but assumes residual value = 0. Amortization period is the shorter of: or

42. Amortization of Intangible Assets The amortization entry is: Note that the amortization process does not use a contra-asset account.

43. Amortization of Intangible Assets Torch, Inc. has developed a new device. Patent registration costs consisted of $2,000 in attorney fees and $1,000 in federal registration fees. The device has a useful life of 5 years. The legal life is 20 years. At the end of year 1, what is Torch’s amortization expense?

44. Amortization of Intangible Assets Record the amortization entry.

45. Amortization of Intangible Assets Note that the patent will have a book value of $2,400 after this amortization entry is posted.

46. Not amortized. Subject to assessment for impairmentvalue and may bewritten down. Intangible Assets Not Subjectto Amortization Goodwill

47. May19 Partial-Period Depreciation I bought an asset on May 19 this year. Do I get a full year’s depreciation?

48. Partial-Period Depreciation Pro-rating the depreciation based on the date of acquisition is time-consuming and costly. A commonly used alternative is the . . . Half-Year Convention Take ½ of a year of depreciation in the year of acquisition, and the other ½ in the year of disposal.

49. Changes in Estimates Depreciation Expense is based on . . . ESTIMATED service life ESTIMATED residual value If the estimates change, the book value less any residual value at the date of change is depreciated over the remaining useful life.

50. Changes in Estimates On January 1, equipment was purchased that cost $30,000, has a useful life of 10 years and no salvage value. At the beginning of the fourth year, it was decided that there were only 5 years remaining, instead of 7 years. Calculate depreciation expense for the fourth year using the straight-line method.