intermediate accounting,17e stice | stice | skousen powerpoint presented by: douglas cloud professor...

Intermediate Accounting,17E

Stice | Stice | Skousen

PowerPoint presented by: Douglas Cloud Professor Emeritus of Accounting, Pepperdine University© 2010 Cengage Learning

Investments in Noncurrent Operating Assets—

Utilization and Retirement

11-2

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)

11-3

• Depreciation is not a process through which a company accumulates a cash fund to replace its long-lived assets.

Depreciation

11-4

Factors Affecting the Periodic Depreciation Charge

• Asset cost• Residual or salvage value• Useful life• Pattern of use

11-5

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.

11-6

Pattern of Use

Costs incurred are deferred until future periods. They are recorded as an asset and the costs are assigned to future periods.

DepreciableDepreciableCostCost

(Asset)(Asset)

DepreciableDepreciableCostCost

(Asset)(Asset)

Period 2Period 2Period 2Period 2 Period 3Period 3Period 3Period 3Period 1Period 1Period 1Period 1

11-7

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.

11-8

Straight-Line Depreciation

Time-Factor MethodsTime-Factor MethodsTime-Factor MethodsTime-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.

11-9


Schuss Boom Ski Manufacturing acquired a polyurethane plastic-molding 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)

11-10

Depreciation =Cost – Residual Value

Number of Years

Depreciation =$100,000 – $5,000

5

Depreciation = $19,000


11-11

Sum-of-the-Years’ Digits Method

SYD =[n (n + 1)]

2

SYD =[5 (5 + 1)]

2

SYD = 15

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):

(continues)

11-12


tDepreciation =

SYD (Cost – Residual value)

Depreciation =5

15 ($100,000 – $5,000)


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.

(continues)

11-13


For the second year, we reduce the numerator by one.

tDepreciation =

SYD (Cost – Residual value)

Depreciation =4

15 ($100,000 – $5,000)


11-14

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.

11-15

Declining-Balance Method

S/L rate = 1n

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%.

11-16

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.

11-17

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.

11-18

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.


11-19

Depreciation =Cost – Residual value

Number of hours

Depreciation = $4.75 per hour


Depreciation =$100,000 – $5,000

20,000 hours

11-20

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.

11-21

Productive-Output Depreciation

Rate per unit =Cost – Residual valueTotal number of units

Rate per unit =$100,000 – $5,000 25,000 units

Rate per unit = $3.80 per unit

2011: 3,200 units $3.80 = $12,160

Annual depreciation for 2011 and 2012:

2012: 5,400 units $3.80 = $20,520

11-22

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.

11-23


The rate of 12.5%, applied to the cost of existing assets, $20,000, results in annual depreciation of $2,500.

11-24


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 3,500Accumulated Depreciation 2,500

Equipment 6,000

11-25

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].

11-26


The journal entries to record the purchase of the oil platform and the recognition of the asset retirement obligation are as follows:

Oil Platform 750,000Cash 750,000

Oil Platform 46,319Asset Retirement Obligation 46,319

(continues)

11-27


The cost of the oil platform asset, including the estimated retirement obligation, is depreciated just like any other long-term asset.Depreciation Expense 79,632*

Accumulated Depreciation— Oil Platform 79,632

*Assuming straight-line depreciation [($750,000 + $46,319)/10]

11-28

•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.

Depletion of Natural Resources

11-29


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)

11-30

Depletion charge per ton

$5,500,000 – $250,000

1,000,000 tons=

Depletion charge per ton

= $5.25

Depletion for 2011 = $5.25 80,000 tons

= $420,000


(continues)

$450,000 – $200,000

11-31

Record the initial purchase as follows:

Mineral Deposits 5,500,000Cash 5,500,000

Record the depletion for 2011 as follows:Depletion Expense 420,000

Accumulated Depletion (or Mineral Deposits) 420,000


11-32

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)

11-33

Change in Estimated Life

After four years, the book value is $30,000 ($50,000 $20,000)

Divide the book value by the new estimated remaining life

11-34

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.

11-35


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)

11-36


Cost assignable to recoverable tons as of the beginning of 2012:

Deduct: Depletion charge for 2011

420,000Balance of cost subject to depletion $4,830,000

$5,250,000

Original costs applicable to depletable resources

(continues)

11-37

Estimated recoverable tons as of the beginning of 2012:

Number of tons withdrawn in 2011 100,000Estimated recoverable tons as of

the end of 2012 950,000

Total recoverable tons as of the beginning of 2012

1,050,000


Depletion charge per ton for 2012: $4,830,000/1,050,000 = $4.60

(continues)

Depletion charge for 2012: 100,000 $4.60 = $460,000

11-38


Cost assignable to recoverable tons as of the beginning of 2012:

Original costs applicable to depletableresources

$5,250,000Add: Additional costs incurred in 2012

525,000

$5,775,000Deduct: Depletion charge for 2011

420,000Balance of cost subject to depletion

$5,355,000Estimated recoverable tons as of the

beginning of 2012

1,050,000Depletion charge per ton for 2012: $5,355,000/1,050,000 = $5.10Depletion for 2012: 100,000 × $5.10 = $510,000

11-39

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)

11-40

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)

11-41

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)

11-42

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.


11-43

• 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)


11-44

• 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 150,000Loss on Impairment of Building 220,000

Building ($600,000 $230,000) 370,000


11-45

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 150,000 Revaluation Equity Reserve 90,000

Building ($600,000 $540,000) 60,000

International Accounting for Asset Impairment: IAS 16

11-46

Immediately after revaluing the building to $540,000, Guangzhou Company sells it for $540,000 in cash. The disposal would be recorded as follows:

Recording the Disposal of Revalued Asset

Cash 540,000 Building 540,000Revaluation Equity Reserve 90,000 Retained Earnings 90,000

Note that because Guangzhou Note that because Guangzhou chose to revalue the asset, the chose to revalue the asset, the “gain” is never reported as a gain.“gain” is never reported as a gain.

11-47

• 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.

Amortization and Impairment of Intangible Assets

11-48

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 7,500 Accumulated Amortization—

Customer List 7,500(continues)


11-49

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 10,500Accumulated Amortization— Customer List 7,500

Customer List 18,000


11-50

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.

11-51

• 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)


11-52


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) 8,000 Broadcast License 8,000

11-53

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)

11-54

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.

Procedures in Testing Goodwill for Impairment

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 straight-line rate.Depreciation Expense—Machinery 4,180 Accumulated Depreciation—

Machinery 4,180

($83,600 0.10 6/12)(continues)

11-56

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. 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 43,600 Accumulated Depreciation—Machinery 54,780

Machinery 83,600Gain on Sale of Machinery 14,780

[$43,600 – ($83,600 – $54,780)]

11-57

Asset Classified as Held for Sale

• 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.

Special accounting is required if the following conditions are satisfied:

11-58

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).


11-59

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)

11-60

Building—Held for Sale 37,000Loss on Held-for-Sale Classification 28,000 Accumulated Depreciation—Building 35,000

Building 100,000

The following entry would be made on July 1:


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.

11-61

Building—Held for Sale 18,000Gain on Recovery Value—Held for Sale 18,000

($58,000 – $3,000) – $37,000


On December 31, 2011, the estimated selling price was $58,000 (with $3,000 estimated selling costs), the following journal entry would be necessary:

11-62

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.

Asset Retirement by Exchange for Other Nonmonetary Assets

11-63

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 43,600Accumulated Depreciation—Machinery 54,780

Machinery 83,600Gain on Exchange of Machinery 14,780


11-64


Assume the delivery equipment’s fair market value is not determinable, but the machinery has a market value of $25,000.Delivery Equipment 25,000Accumulated Depreciation—Machinery 54,780Loss on Exchange of Machinery 3,820

Machinery 83,600

11-65

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 3,000

Delivery Equipment 22,000Accumulated Depreciation—Machinery 54,780Loss on Exchange of Machinery 3,820

Machinery 83,600 Fair market value

of machine


11-66

Nonmonetary Exchange without Commercial Substance

Example 1—No Cash InvolvedExample 1—No Cash InvolvedExample 1—No Cash InvolvedExample 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)

11-67


The entry on Republic’s books to record the exchange will be:Machinery (new) 14,000Accumulated Depreciation—Machinery (old) 32,000

Machinery 46,000

The entry on Logan’s books to record the exchange will be:Machinery (new) 16,000Accumulated Depreciation—Machinery (old) 37,700Loss on Exchange of Machinery 300

Machinery (old) 54,000

Example 1—No Cash InvolvedExample 1—No Cash InvolvedExample 1—No Cash InvolvedExample 1—No Cash Involved

11-68


Example 2—Small Amount of Cash InvolvedExample 2—Small Amount of Cash InvolvedExample 2—Small Amount of Cash InvolvedExample 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.

(continues)

17,000

11-69


The entry on Republic’s books to record the exchange will be:Machinery (new) 15,000Accumulated Depreciation—Machinery (old) 32,000

Machinery 46,000Cash 1,000

The entry on Logan’s books to record the exchange will be:Cash 1,000Machinery (new) 15,300Accumulated Depreciation—Machinery (old) 37,700

Machinery (old) 54,000

Example 2—Small Amount of Cash InvolvedExample 2—Small Amount of Cash InvolvedExample 2—Small Amount of Cash InvolvedExample 2—Small Amount of Cash Involved

11-70


Example 3—Large Amount of Cash InvolvedExample 3—Large Amount of Cash InvolvedExample 3—Large Amount of Cash InvolvedExample 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

17,000

(continues)

11-71


The entry on Republic’s books to record the exchange will be:Machinery (new) 17,000Accumulated Depreciation—Machinery (old) 32,000Loss on Exchange of Machinery 1,250

Machinery 46,000Cash 4,250

(continues)


11-72

The entry on Logan’s books to record the exchange:Cash 4,250Machinery (new) 12,750Accumulated Depreciation—Machinery (old) 37,700

Machinery (old 54,000Gain on Exchange of Machinery 700


How much cash constitutes an amount large enough How much cash constitutes an amount large enough to require the approach used in Example 3? The to require the approach used in Example 3? The FASB failed to establish a “bright line” test, so the FASB failed to establish a “bright line” test, so the old 25% rule will continue to serve as a guideline.old 25% rule will continue to serve as a guideline.


11-73

1. Nearest whole month.2. Nearest whole year.3. Half-year convention.4. 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.

Makes the Makes the most intuitive most intuitive sensesense

Depreciation for Partial Periods

11-74


From this point, each year’s depreciation will be $6,333 less than the previous year’s depreciation.

11-75


Sum-of-the-Years’-Digits MethodSum-of-the-Years’-Digits Method

11-76


Declining-Balance MethodDeclining-Balance Method

11-77

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.

11-78

Income Tax Depreciation

The MACRS method for personal property also incorporates a half-year convention, meaning that one-half of a year’s depreciation is recognized on all assets purchased or sold during the year.

intermediate accounting,17e stice | stice | skousen powerpoint presented by: douglas cloud professor...

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