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CHAPTER 11

DEPRECIATION. CHAPTER 11. Depreciation, Impairments, and Depletion. ……..…………………………………………………………. “allocating the cost of tangible assets to those periods expected to benefit”. Depreciable base = Original cost - Salvage value. Estimated service life  physical factors

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CHAPTER 11

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  1. DEPRECIATION CHAPTER 11 Depreciation, Impairments, and Depletion ……..…………………………………………………………... “allocating the cost of tangible assets to those periods expected to benefit” Depreciable base = Original cost - Salvage value Estimated service life  physical factors economic factors

  2. Methods of Depreciation • Units of production • Straight-line • Sum-of-the-years’ digits • Declining-balance method • salvage value in not deducted in determining the depreciable base • Group and composite methods • composite depreciation rate • no gain or loss on disposition

  3. Exercise 11-1 Cost $518,000 Life (in years) 12 Salvage value $50,000 (a) Straight-line (b) Sum-of-the-years’ digits

  4. Exercise 11-1 (continued) (c) Double-declining balance Book value Rate Deprec Exp.

  5. Brief Exercise 11-6 Composite Depreciation Group Cost Salvage Life A $70,000 $7,000 10 years B 50,000 5,000 5 years C 82,000 4,000 12 years Composite rate = Discarded an asset in Group A, $4,000 cost, 7 years old:

  6. Depreciation for Partial Years • Determine depreciation for a full year • Prorate between years Exercise 11-4d: Sum-of-the-years’ digits Total 2010 2011 2012

  7. Depreciation Rate Revisions • No correction of prior years • No adjustments to “catch up” Brief Exercise 11-7 Original estimate: ($8,000 - $1,000)/5 = $1,400 Book value at time of revision: $8,000 - (2 x $1,400) = $5,200 New estimate: ($5,200 - $500)/2 = $2,350

  8. IMPAIRMENTS market value or PV of future net cash flows 1. Recoverability test for impairment future net cash flows (undiscounted) < carrying value 2. If impaired, calculate the amount of the loss carrying value - fair value of the asset 3. Entry: Loss on Impairment 2,700 Accumulated Depreciation 2,700

  9. Impairment Example Equipment: Taffy maker Original cost $1,000,000 Accum depreciation 600,000 Estimated life 4 years Annual rev: taffy production $240,000 Annual cost: taffy production 130,000 Fair value of taffy maker 380,000 Cost of disposal 10,000

  10. Impairment Example Equipment: Taffy maker Original cost $1,000,000 Accum depreciation 550,000 Estimated life 4 years Annual rev: taffy production $240,000 Annual cost: taffy production 130,000 Fair value of taffy maker 380,000 Cost of disposal 10,000

  11. DEPLETION Other Asset Depletion Base Base Exp. • Acquisition costs • Exploration costs • Development costs • tangible equipment • intangible costs • Restoration costs Recording Depletion Inventory 250,000 Accumulated Depletion 250,000

  12. Oil & Gas • Full cost method • all exploration costs are capitalized • costs of unsuccessful exploration added to the cost of successful wells • cannot capitalize more than the present value of the reserves • Successful efforts method • only costs of successful efforts are capitalized

  13. Special Depletion Issues • Change in estimate of reserves • accounting is the same as change in estimate of asset life • Current value of reserves • not recorded (recognized) • must be disclosed by oil & gas companies • increase in value of timber is not recorded • Liquidating dividends • dividends in excess of retained earnings • credit the excess to Paid-in Capital

  14. Exercises 11-16 & 11-17 Carrying amount ($9M - $1M) $8,000,000 Fair value 4,400,000 Net realizable value 4,380,000 11-16 Asset still used 11-17 Asset not used (a) (a)

  15. 11-16 Asset still used 11-17 Asset not used (b) (b) (c) (c)

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