Chapter 11: Depreciation, Impairments and Depletion Intermediate Accounting, 11th ed. Kieso, Weygandt, and Warfield.
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Slide 1 Chapter 11: Depreciation, Impairments and Depletion Intermediate Accounting, 11th ed. Kieso, Weygandt, and Warfield Slide 2 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. After studying this chapter, you should be able to: Chapter 11: Depreciation, Impairments and Depletion Slide 3 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. Chapter 11: Depreciation, Impairments and Depletion Slide 4 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. Depreciation: Concept Slide 5 Questions to be answered: 1. What is the depreciable base of the asset? 2. What is the assets useful life? 3. What method of depreciation is best for the asset in question? Factors in the Depreciation Process Slide 6 Depreciable base is the dollar amount subject to depreciation. It is determined as: Original cost of the asset less Estimated salvage or disposal value Depreciable Base Slide 7 An assets 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) Estimated Service Lives Slide 8 Depreciation Methods Financial Accounting Depreciation Methods Tax Depreciation Special methods 1. Declining Balance 2. Sum-of-the-years digits Straight- line Activity Decreasing Charge 1. Composite method 2. Hybrid methods Depreciation Methods: Overview Slide 9 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: Straight- Line Slide 10 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: Activity Slide 11 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: Decreasing Charge (Accelerated) Slide 12 1. Salvage value is not deducted when computing depreciable base. 2. Utilizes a depreciation rate (%) that is some multiple of the SL rate. 3. The depreciation rate is multiplied by the assets book value at the beginning of the period to get the depreciation expense for the period. 4. Since the book value decreases over time this results in a decreasing amount of depreciation expense over time. 5. An assets book value can never be less than its estimated salvage value. Depreciation Methods: Declining Balance Slide 13 A fraction is multiplied by the depreciable base to arrive at the depreciation expense per period. The fraction is: 1. Numerator: number of years remaining in the assets 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) Depreciation Methods: Sum-of- the-Years Digits Slide 14 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 Group and Composite Depreciation Methods Slide 15 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 Partial Year Depreciation Slide 16 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. Revision of Depreciation Estimates Slide 17 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 Slide 18 Impairment? Sum of expected future net cash flows from use and disposal of asset is less than the carrying amount Sum of expected future net cash flows from use and disposal of asset is equal to or more than the carrying amount Impairment has occurredNo impairment Impairments: The Recoverability Test Slide 19 Impairment has occurred Loss = Carrying amount less Fair value of asset Does an active market exist for the asset? Determine impairment loss Yes No Loss = Carrying amount less present value of expected net cash flows Use companys market rate of interest Impairments: Measuring Loss Slide 20 Impairment has occurred 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 Assets are held for use Assets are held for sale Impairment: Accounting Slide 21 Graphic of Accounting for Impairments Slide 22 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: Terminology Slide 23 Difficulty of estimating recoverable reserves Problems of discovery value Accounting for liquidating dividends Depletion: Special Problems Slide 24 COPYRIGHT Copyright 2004 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. 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