Chap 011

Chapter 11 - Property, Plant, and Equipment and Intangible Assets: Utilization and Impairment

Question 11-1 The terms depreciation, depletion, and amortization all refer to the process of allocating the

cost of property, plant, and equipment and finite-life intangible assets to periods of use. The only difference between the terms is that they refer to different types of these long-lived assets; depreciation for plant and equipment, depletion for natural resources, and amortization for intangibles.

Question 11-2 The term depreciation often is confused with a decline in value or worth of an asset.

Depreciation is not measured as decline in value from one period to the next. Instead, it involves the distribution of the cost of an asset, less any anticipated residual value, over the asset's estimated useful life in a systematic and rational manner that attempts to match revenues with the use of the asset.

Question 11-3 The process of cost allocation for plant and equipment and finite-life intangible assets requires

that three factors be established at the time the asset is put into use. These factors are:1. Service (useful) life — The estimated use that the company expects to receive from the asset.2. Allocation base — The value of the usefulness that is expected to be consumed.3. Allocation method — The pattern in which the usefulness is expected to be consumed.

Question 11-4 Physical life provides the upper bound for service life. Physical life will vary according to the

purpose for which the asset is acquired and the environment in which it is operated. Service life may be less than physical life for several reasons. For example, the expected rate of technological changes may shorten service life. Management intent also may shorten the period of an asset’s usefulness below its physical life. For instance, a company may have a policy of using its delivery trucks for a three-year period before trading the trucks for new models.

Question 11-5 The total amount of depreciation to be recorded during an asset’s service life is called its

depreciable base. This amount is the difference between the initial value of the asset at its acquisition (its cost) and its residual value. Residual or salvage value is the amount the company expects to receive for the asset at the end of its service life less any anticipated disposal costs.

11-1

Chapter 11 Property, Plant, and Equipment and Intangible Assets: Utilization and Impairment

QUESTIONS FOR REVIEW OF KEY TOPICS


Answers to Questions (continued)

Question 11-6 Activity-based allocation methods estimate service life in terms of some measure of

productivity. Periodic depreciation or depletion is then determined based on the actual productivity generated by the asset during the period. Time-based allocation methods estimate service life in years. Periodic depreciation or amortization is then determined based on the passage of time.

Question 11-7 The straight-line depreciation method allocates an equal amount of depreciable base to each

year of an asset’s service life. Accelerated depreciation methods allocate higher portions of depreciable base to the early years of the asset’s life and lower amounts of depreciable base to later years. Total depreciation is the same by either approach.

Question 11-8 Theoretically, the use of activity-based depreciation methods would provide a better matching

of revenues and expenses. Clearly, the productivity of a plant asset is more closely associated with the benefits provided by that asset than the mere passage of time. However, activity-based methods quite often are either infeasible or too costly to use. For example, buildings do not have an identifiable measure of productivity. For assets such as machinery, there may be an identifiable measure of productivity, such as machine hours or units produced, but it is more costly to determine the amount each period than it is to simply measure the passage of time. For these reasons, most companies use time-based depreciation methods.

Question 11-9 Companies might use the straight-line method because they consider that the benefits derived

from the majority of plant assets are realized approximately evenly over these assets’ useful lives. It also is the easiest method to understand and apply. The effect on net income also could explain why so many companies prefer the straight-line method to the accelerated methods. Straight line produces a higher net income in the early years of an asset’s life. Net income can affect bonuses paid to management, or debt agreements with lenders. Income taxes are not a factor in determining the depreciation method because a company is not required to use the same depreciation method for both financial reporting and income tax purposes.

Question 11-10 The group approach to aggregation is applied to a collection of depreciable assets that share

similar service lives and other attributes. For example, group depreciation could be used for fleets of vehicles or collections of machinery. The composite approach to aggregation is applied to dissimilar operating assets, such as all of the depreciable assets in one manufacturing plant. Individual assets in the composite may have diverse service lives. Both approaches are similar in that they involve applying a single straight-line rate based on the average service lives of the assets in the group or composite.

11-2



Question 11-11 The allocation of the cost of a natural resource to periods of use is called depletion. The

process otherwise is identical to depreciation. The activity-based units-of-production method is the predominant method used to calculate depletion, not the time-based straight-line method.

Question 11-12 The amortization of finite-life intangible assets is based on the same concepts as depreciation

and depletion. The capitalized cost of an intangible asset that has a finite useful life must be allocated to the periods the company expects the asset to contribute to its revenue generating activities. Intangibles, though, generally have no residual values, so the amortizable base is simply cost. Also, intangibles possess no physical life to provide an upper bound to service life. However, most intangibles have a legal or contractual life that limits useful life. Intangible assets that have indefinite useful lives, including goodwill, are not amortized.

Question 11-13 A company can calculate depreciation based on the actual number of days or months the asset

was used during the year. A common simplifying convention is to record one-half of a full year’s expense in the years of acquisition and disposal. This is known as the half-year convention. The modified half-year convention records a full year’s expense when the asset is acquired in the first half of the year or sold in the second half. No expense is recorded when the asset is acquired in the second half of the year or sold in the first half.

Question 11-14 A change in the service life of plant and equipment and finite-life intangible assets is

accounted for as a change in an estimate. The change is accounted for prospectively by simply depreciating the remaining depreciable base of the asset (book value at date of change less estimated residual value) over the revised remaining service life.

Question 11-15 A change in depreciation method is accounted for prospectively by simply depreciating the

remaining depreciable base of the asset (book value at date of change less estimated residual value) over the revised remaining service life using the new depreciation method, exactly as we would account for a change in estimate. One difference is that most changes in estimate do not require a company to justify the change. However, this change in estimate is a result of changing an accounting principle and therefore requires a clear justification as to why the new method is preferable. A disclosure note reports the effect of the change on net income and earnings per share along with clear justification for changing depreciation methods.

11-3



Question 11-16 If a material error is discovered in an accounting period subsequent to the period in which the

error is made, previous years’ financial statements that were incorrect as a result of the error are retrospectively restated to reflect the correction. Any account balances that are incorrect as a result of the error are corrected by journal entry. If retained earnings is one of the incorrect accounts, the correction is reported as a prior period adjustment to the beginning balance in the statement of shareholders’ equity. In addition, a disclosure note is needed to describe the nature of the error and the impact of its correction on net income, income before extraordinary item, and earnings per share.

Question 11-17 Impairment in the value of property, plant, and equipment and intangible assets results when

there has been a significant decline in value below carrying value (book value). For property, plant, and equipment and intangible assets with finite useful lives, GAAP requires an entity to recognize an impairment loss only when the undiscounted sum of estimated future cash flows from an asset is less than the asset’s book value. The loss recognized is the amount by which the book value exceeds the fair value of the asset or group of assets when the fair value is readily determinable. If fair value is not determinable, it must be estimated. One method of estimating fair value is to compute the present value of estimated future cash flows from the asset or group of assets.

For intangible assets with indefinite useful lives other than goodwill, if book value exceeds fair value, an impairment loss is recognized for the differences. For goodwill, an impairment loss is indicated if the fair value of the reporting unit is less than its book value. A goodwill impairment loss is measured as the excess of book value of goodwill over its “implied” fair value.

For property, plant, and equipment and intangible assets held for sale, if book value exceeds fair value, an impairment loss is recognized for the difference.

Question 11-18 Repairs and maintenance are expenditures made to maintain a given level of benefits provided

by the asset and do not increase future benefits. Expenditures for these activities should be expensed in the period incurred.

Additions involve adding a new major component to an existing asset. These expenditures usually are capitalized.

Improvements are expenditures for the replacement of a major component of plant and equipment. The costs of improvements usually are capitalized.

Rearrangements are expenditures to restructure plant and equipment without addition, replacement, or improvement. The objective is to create a new capability for the asset and not necessarily to extend useful life. The costs of material rearrangements should be capitalized if they clearly increase future benefits.

11-4


Answers to Questions (concluded)

Question 11-19 IFRS allows a company to value property, plant and equipment (PP&E) and intangible assets

subsequent to initial valuation at (1) cost less accumulated depreciation/amortization or (2) fair value (revaluation). If a company chooses revaluation, all assets within a class of PP&E must be revalued on a regular basis. U.S. GAAP prohibits revaluation.

Question 11-20 Under U.S. GAAP, an impairment loss for property, plant, and equipment and finite-life

intangible assets is measured as the difference between book value and fair value. Under IFRS, an impairment loss is measured as the difference between book value and the recoverable amount. The recoverable amount is the higher of the asset’s value in use (present value of estimated future cash flows) and fair value less costs to sell.

Question 11-21Under U.S. GAAP, the measurement of an impairment loss for goodwill is a two-step process.

In Step 1 we compare the fair value of the reporting unit with its book value. A loss is indicated if fair value is less than book value. In step 2, we measure the impairment loss as the excess of book value over implied fair value.

Under IFRS, the measurement of an impairment loss for goodwill is a one-step process that compares the recoverable amount of the cash-generating unit to book value. If the recoverable amount is less, reduce goodwill first, then other assets. The recoverable amount is the higher of fair value less costs to sell and value in use (present value of estimated future cash flows).

Question 11-22Under IFRS, litigation costs to successfully defend an intangible right are expensed, except in

rare situations when the expenditure increases future benefits.

11-5


BRIEF EXERCISES

Depreciation is a process of cost allocation, not valuation. Koeplin should not record depreciation expense of $18,000 for year one of the machine’s life. Instead, it should distribute the cost of the asset, less any anticipated residual value, over the estimated useful life in a systematic and rational manner that attempts to match revenues with the use of the asset, not the periodic decline in its value.

a. Straight-line:

$30,000 - 2,000 = $7,000 per year 4 years

b. Sum-of-the-years’ digits:

Sum-of-the-digits is ([4 (4 + 1)] ÷ 2) = 10

2011 $28,000 x 4/10 = $11,2002012 $28,000 x 3/10 = $ 8,400

c. Double-declining balance:

Straight-line rate is 25% (1 ÷ 4 years) x 2 = 50% DDB rate

2011 $30,000 x 50% = $15,0002012 ($30,000 - 15,000) x 50% = $ 7,500

d. Units-of-production:

$30,000 - 2,000 = $2.80 per unit depreciation rate 10,000 hours

2011 2,200 hours x $2.80 = $6,160 2012 3,000 hours x $2.80 = $8,400

11-6

Brief Exercise 11-1

Brief Exercise 11-2


a. Straight-line:

$30,000 - 2,000 = $7,000 per year 4 years

2011 $7,000 x 9/12 = $5,2502012 $7,000 x 12/12 = $7,000

b. Sum-of-the-years’ digits:


2011 $28,000 x 4/10 x 9/12 = $8,400

2012 $28,000 x 4/10 x 3/12 = $2,800 +$28,000 x 3/10 x 9/12 = 6,300

$9,100

c. Double-declining balance:


2011 $30,000 x 50% x 9/12 = $11,250

2012 $30,000 x 50% x 3/12 = $ 3,750 + ($30,000 – 15,000) x 50% x

9/12 = 5,625 $ 9,375

or,2012 ($30,000 – 11,250) x 50% = $ 9,375

Annual depreciation will equal the group rate multiplied by the depreciable base of the group:

11-7

Brief Exercise 11-3

Brief Exercise 11-4


($425,000 – 40,000) x 18% = $69,300

Since depreciation records are not kept on an individual asset basis, dispositions are recorded under the assumption that the book value of the disposed item exactly equals any proceeds received and no gain or loss is recorded. Any actual gain or loss is implicitly included in the accumulated depreciation account.

Journal entry (not required):

Cash.............................................................................. 35,000Accumulated depreciation (difference) ........................... 7,000

Equipment (account balance)......................................... 42,000

$8,250,000Depletion per ton = = $2.75 per foot

3,000,000 cubic feet

Year 1 depletion = $2.75 x 700,000 feet = $1,925,000Year 2 depletion = $2.75 x 800,000 feet = $2,200,000

Expenses for the year include:Amortization of the patent † = 400,000 Amortization of the developed technology* = 300,000 Total $700,000

Goodwill is not amortized. In-process research and development is not amortized.

†Amortization of the patent: ($4,000,000 5) x 6/12 = $400,000

*Amortization of the developed technology: ($3,000,000 5) x 6/12 = $300,000

Calculation of annual depreciation after the estimate change:

11-8

Brief Exercise 11-5

Brief Exercise 11-6

Brief Exercise 11-7


$9,000,000 Cost $320,000 Previous annual depreciation ($8 million ÷ 25 years) x 2 years 640,000 Depreciation to date (2009-2010)

8,360,000 Undepreciated cost 500,000 Revised residual value7,860,000 Revised depreciable base 18 Estimated remaining life - 18 years (20-2)$ 436,667 2011 depreciation

In general, we report voluntary changes in accounting principles retrospectively. However, a change in depreciation method is considered a change in accounting estimate resulting from a change in accounting principle. In other words, a change in the depreciation method reflects a change in the (a) estimated future benefits from the asset, (b) the pattern of receiving those benefits, or (c) the company’s knowledge about those benefits, and therefore the two events should be reported the same way. Accordingly, Robotics reports the change prospectively; previous financial statements are not revised. Instead, the company simply employs the double-declining balance method from now on. The undepreciated cost remaining at the time of the change would be depreciated DDB over the remaining useful life. A disclosure note should justify that the change is preferable and should describe the effect of the change on any financial statement line items and per share amounts affected for all periods reported.

Asset’s cost $9,000,000Accumulated depreciation to date* (640,000 ) Undepreciated cost, Jan. 1, 2011 $8,360,000

x 2/23 †

Double-declining balance depreciation for 2011 $ 726,957

*$8,000,000 ÷ 25 = $320,000 x 2 years = $640,000

† Remaining life is 23 years. Twice the straight-line rate is 2/23.

If a material error is discovered in an accounting period subsequent to the period in which the error is made, previous years’ financial statements that were incorrect as a result of the error are retrospectively restated to reflect the correction. Any account balances that are incorrect as a result of the error are corrected by journal entry. If

11-9

Brief Exercise 11-8

Brief Exercise 11-9


retained earnings is one of the incorrect accounts, the correction is reported as a prior period adjustment to the beginning balance in the statement of shareholders’ equity. In addition, a disclosure note is needed to describe the nature of the error and the impact of its correction on net income, income before extraordinary item, and earnings per share.

In this case, depreciation of $32,000 should have been $320,000 ($8,000,000 25 years). Therefore, 2009 income before tax is overstated by $288,000 ($320,000 – 32,000) and accumulated depreciation is understated by the same amount. The following journal entry is needed to record the error correction (ignoring income tax):

Retained earnings.......................................................... 288,000Accumulated depreciation ........................................ 288,000

Depreciation for 2011 would be $320,000.

Because the undiscounted sum of future cash flows of $28 million exceeds book value of $26.5 million, there is no impairment loss.

Because the undiscounted sum of future cash flows of $24 million is less than book value of $26.5 million, there is an impairment loss. The impairment loss is calculated as follows:

Book value $26.5 millionFair value 21 .0 millionImpairment loss $ 5.5 million

Under IFRS, the impairment loss is the difference between book value and the recoverable amount. The recoverable amount is $22 million, the higher of the value-in-use of $22 million (present value of estimated future cash flows) and the $21 million fair value less costs to sell.

Book value $26.5 millionRecoverable amount 22 .0 millionImpairment loss $ 4.5 million

11-10

Brief Exercise 11-10




Recoverability: Because the book value of SCC’s net assets of $42 million exceeds the fair value of $40 million, an impairment loss is indicated.

Determination of implied value of goodwill: Fair value of SCC $40 million Less: Fair value of SCC’s assets (excluding goodwill) 31 million Implied goodwill $ 9 million

Measurement of impairment loss: Book value of goodwill $15 million Less: Implied value of goodwill 9 million Impairment loss $ 6 million

Recoverability: Because the book value of SCC’s net assets of $42 million is less than the fair value of $44 million, an impairment loss is not indicated.

11-11




Under IFRS, the impairment loss is the difference between book value and the recoverable amount of the cash-generating unit. The recoverable amount is $41 million, the higher of the $41 million value-in-use (present value of estimated future cash flows) and the $40 million fair value less costs to sell.

Book value $42 millionRecoverable amount 41 million Impairment loss $ 1 million

Annual maintenance on machinery, $5,400 - This is an example of normal repairs and maintenance. Future benefits are not increased; therefore the expenditure should be expensed in the period incurred.

Remodeling of offices, $22,000 - This is an example of an improvement. The cost of the remodeling should be capitalized and depreciated, either by (1) substitution, (2) direct capitalization of the cost, or (3) a reduction of accumulated depreciation.

Rearrangement of the shipping and receiving area, $35,000 - This is an example of a rearrangement. Because the rearrangement increased productivity, the cost should be capitalized and depreciated.

Addition of a security system, $25,000 - This is an example of an addition. The cost of the security system should be capitalized and depreciated.

11-12




EXERCISES1. Straight-line:

$33,000 - 3,000 = $6,000 per year 5 years

2. Sum-of-the-years’ digits:

YearDepreciable

Base XDepreciation

Rate per Year = Depreciation2011 $30,000 $10,0002012 30,000 8,0002013 30,000 6,0002014 30,000 4,0002015 30,000 2,000

Total $30,000

11-13

Exercise 11-1


Exercise 11-1 (concluded)

3. Double-declining balance:

Straight-line rate of 20% (1 ÷ 5 years) x 2 = 40% DDB rate.

Year

Book Value Beginning

of Year X

DepreciationRate per

Year = DepreciationBook ValueEnd of Year

2011 $33,000 40% $ 13,200 $19,8002012 19,800 40% 7,920 11,8802013 11,880 40% 4,752 7,1282014 7,128 40% 2,851 4,2772015 4,277 * 1,277 * 3,000Total $30,000

* Amount necessary to reduce book value to residual value

4. Units-of-production:

$33,000 - 3,000 = $.30 per mile depreciation rate

100,000 miles

Year

Actual Miles Driven X

DepreciationRate per

Mile = Depreciation

Book ValueEnd of Year

2011 22,000 $.30 $6,600 $26,4002012 24,000 .30 7,200 19,2002013 15,000 .30 4,500 14,7002014 20,000 .30 6,000 8,7002015 21,000 * 5,700 * 3,000Totals 102,000 $30,000

* Amount necessary to reduce book value to residual value

1. Straight-line:

11-14

Exercise 11-2


$115,000 - 5,000 = $11,000 per year 10 years



2011 $110,000 x 10/55 = $20,0002012 $110,000 x 9/55 = $18,000



2011 $115,000 x 20% = $23,0002012 ($115,000 - 23,000) x 20% = $18,400

4. One hundred fifty percent declining balance:

Straight-line rate is 10% (1 ÷ 10 years) x 1.5 = 15% rate

2011 $115,000 x 15% = $17,2502012 ($115,000 - 17,250) x 15% = $14,663


$115,000 - 5,000 = $.50 per unit depreciation rate 220,000 units

2011 30,000 units x $.50 = $15,000 2012 25,000 units x $.50 = $12,500

1. Straight-line:

$115,000 - 5,000 = $11,000 per year 10 years

2011 $11,000 x 3/12 = $ 2,7502012 $11,000 x 12/12 = $11,000

11-15

Exercise 11-3



Sum-of-the-digits is {[10 (10 + 1)]/2} = 55

2011 $110,000 x 10/55 x 3/12 = $ 5,000

2012 $110,000 x 10/55 x 9/12 = $15,000+ $110,000 x 9/55 x 3/12 = 4,500

$19,500



2011 $115,000 x 20% x 3/12 = $5,750

2012 $115,000 x 20% x 9/12 = $17,250+ ($115,000 - 23,000) x 20% x 3/12 = 4,600

$21,850or,2012 ($115,000 - 5,750) x 20% = $21,850

4. One hundred fifty percent declining balance:

Straight-line rate is 10% (1 ÷ 10 years) x 1.5 = 15% rate

2011 $115,000 x 15% x 3/12 = $ 4,313

2012 $115,000 x 15% x 9/12 = $12,937 + ($115,000 - 17,250) x 15% x 3/12 = 3,666

$16,603Or,2012 ($115,000 - 4,313) x 15% = $16,603

11-16




$115,000 - 5,000 = $.50 per unit depreciation rate 220,000 units

2011 10,000 units x $.50 = $ 5,000 2012 25,000 units x $.50 = $12,500

Building depreciation:

$5,000,000 - 200,000 = $160,000 per year 30 years

Building addition depreciation:

Remaining useful life from June 30, 2011 is 27.5 years.

$1,650,000 = $60,000 per year 27.5 years

2011 $60,000 x 6/12 = $30,000

2012 $60,000 x 12/12 = $60,000

Asset A:


$24,000 = $60,000 = Book value at the beginning of year 2

.40

Cost - (Cost x 40%) = $60,000.60Cost = $60,000Cost = $100,000

11-17

Exercise 11-4

Exercise 11-5


Asset B:Sum-of-the-years’ digits is 36 {[8 (8 + 1)]÷2}

($40,000 - residual) x 7/36 = $7,000

$280,000 – 7residual-------------------------- = $7,000 36

$280,000 - 7residual = $252,000

7residual = $28,000

Residual = $4,000

Asset C: $65,000 - 5,000

= $6,000 Life

Life = 10 years

Asset D:$230,000 - $10,000 = $220,000 depreciable base$220,000 ÷ 10 years = $22,000 per year

Method used is straight-line.

Asset E:Straight-line rate is 12.5% (1 ÷ 8 years) x 1.5 = 18.75% rate

Year 1 $200,000 x 18.75% = $37,500Year 2 ($200,000 - 37,500) x 18.75% = $30,469

11-18


Requirement 1

1. Straight-line:

$260,000 - 20,000 = $40,000 per year 6 years

2011 $40,000 x 8/12 = $26,6672012 $40,000 x 12/12 = $40,000


Sum-of-the-years’ digits is ([6 (6 + 1)] ÷ 2) = 21

2011 $240,000 x 6/21 x 8/12 = $45,714

2012 $240,000 x 6/21 x 4/12 = $22,857 +$240,000 x 5/21 x 8/12 = 38,095

$60,952


1/6 (the straight-line rate) x 2 = 1/3 DDB rate

2011 $260,000 x 1/3 x 8/12 = $57,778

2012 $260,000 x 1/3 x 4/12 = $28,889 + ($260,000 – 86,667) x 1/3 x 8/12 = 38,518

$67,407 or,2012 ($260,000 – 57,778) x 1/3 = $67,407

11-19

Exercise 11-6


Requirement 1

U.S. GAAP

2011: $120,000 8 = $15,000 x 6/12 = $7,5002012: $120,000 8 = $15,000

Requirement 2

IFRS:

2011: Truck:$100,000 8 = $12,500 x 6/12 = $6,250

Drill:$ 20,000 4 = $5,000 x 6/12 = 2,500 Total $8,750

2012: Truck:$100,000 8 = $12,500

Drill:$ 20,000 4 = 5,000 Total $17,500

Requirement 1

Depreciation for 2011: $240,000 6 = $40,000 x 9/12 = $30,000

Requirement 2

($ in thousands) Before AfterRevaluation Revaluation

Equipment $240 x 220/210 = $251Accumulated depreciation 30 x 220/210 = 31 Book value $ 210 x 220/210 = $ 220

11-20

Exercise 11-7

Exercise 11-8


Equipment ($251,000 – 240,000) 11,000 Accumulated depreciation ($31,000 – 30,000) 1,000

Revaluation surplus–OCI ($220,000 -- 210,000) 10,000

Requirement 3

Depreciation for 2012: $220,000 5.25 years = $41,905

Requirement 4

($ in thousands) Before AfterRevaluation Revaluation

Equipment $240 x 195/210 = $223Accumulated depreciation 30 x 195/210 = 28 Book value $ 210 x 195/210 = $195

Revaluation expense* ($195,000 – 210,000) 15,000Accumulated depreciation ($28,000 – 30,000) 2,000

Equipment ($223,000 – 240,000) 17,000

*If a revaluation surplus account relating to the same asset had existed, that account would have been debited up to the amount of its balance before debiting revaluation expense.

11-21


Requirement 1

Asset CostResidual

ValueDepreciable

BaseEstimatedLife(yrs.)

Depreciationper Year

(straight line)Stoves $15,000 $3,000 $12,000 6 $2,000Refrigerators 10,000 1,000 9,000 5 1,800Dishwashers 8,000 500 7,500 4 1,875 Totals $33,000 $4,500 $28,500 $5,675

$5,675Group depreciation rate = = 17.2% (rounded)

$33,000

Group life = $28,500 = 5.02 years (rounded)

$5,675Requirement 2

To record the purchase of new refrigerators.

Refrigerators................................................................. 2,700Cash.......................................................................... 2,700

To record the sale of old refrigerators.

Cash.............................................................................. 200Accumulated depreciation (difference)............................ 1,300

Refrigerators.............................................................. 1,500

Requirement 1

Cost of the equipment:Purchase price $154,000Freight charges 2,000Installation charges 4,000

$160,000

11-22

Exercise 11-9

Exercise 11-10


Straight-line rate of 12.5% (1 ÷ 8 years) x 2 = 25% DDB rate.

Year

Book Value Beginning

of Year XDepreciation

Rate per Year = DepreciationBook ValueEnd of Year

2011 $160,000 25% $ 40,000 $120,0002012 120,000 25% 30,000 90,0002013 90,000 25% 22,500 67,5002014 67,500 25% 16,875 50,6252015 50,625 * 5,000 45,6252016 45,625 * 5,000 40,6252017 40,625 * 5,000 35,6252018 35,625 * 5,000 30,625Total $129,375

* Switch to straight-line in 2015:

Straight-line depreciation:

$50,625 - 30,625 = $5,000 per year 4 years

Requirement 2For plant and equipment used in the manufacture of a product, depreciation is a

product cost and is included in the cost of inventory. Eventually, when the product is sold, depreciation will be included in cost of goods sold.

Requirement 1

$4,500,000Depletion per ton = = $5.00 per ton

900,000 tons

2011 depletion = $5.00 x 240,000 tons = $1,200,000

Requirement 2Depletion is part of product cost and is included in the cost of the inventory of

coal, just as the depreciation on manufacturing equipment is included in inventory

11-23

Exercise 11-11


cost. The depletion is then included in cost of goods sold in the income statement when the coal is sold.

Timber tract:

$3,200,000 – 600,000 = $.52 per board foot5,000,000 board feet

500,000 x $.52 = $260,000 depletion

Logging roads:

$240,000 5,000,000 tons = $.048 per board foot

500,000 x $.048 = $24,000 depreciation

Requirement 1

Cost of copper mine:Mining site $1,000,000Development costs 600,000Restoration costs 303,939 †

$1,903,939

† $300,000 x 25% = $ 75,000 400,000 x 40% = 160,000 600,000 x 35% = 210,000

$445,000 x .68301* = $303,939*Present value of $1, n = 4, i = 10% (Table 2)

Depletion: $1,903,939

Depletion per pound = = $.1904 per pound 10,000,000 pounds

2011 depletion = $.1904 x 1,600,000 pounds = $304,6402012 depletion = $.1904 x 3,000,000 pounds = $571,200

11-24

Exercise 11-12

Exercise 11-13


Depreciation:

$120,000 - 20,000Depreciation per pound = = $.01 per pound

10,000,000 pounds

2011 depreciation = $.01 x 1,600,000 pounds = $16,0002012 depreciation = $.01 x 3,000,000 pounds = $30,000

Requirement 2Depletion of natural resources and depreciation of assets used in the extraction of

natural resources are part of product cost and are included in the cost of the inventory of copper, just as the depreciation on manufacturing equipment is included in inventory cost. The depletion and depreciation are then included in cost of goods sold in the income statement when the copper is sold.

Requirement 1

a. To record the purchase of a patent.

January 1, 2009Patent............................................................................ 700,000

Cash.......................................................................... 700,000

To record amortization on the patent.

December 31, 2009 and 2010Amortization expense ($700,000 ÷ 10 years)..................... 70,000

Patent........................................................................ 70,000

b. To record the purchase of a franchise.

2011Franchise....................................................................... 500,000

Cash.......................................................................... 500,000

11-25

Exercise 11-14


c. To record research and development expenses.

2011Research and development expense.............................. 380,000

Cash.......................................................................... 380,000

11-26



Year-end adjusting entries

Patent: To record amortization on the patent.

December 31, 2011Amortization expense (determined below)........................ 112,000

Patent........................................................................ 112,000

Calculation of annual amortization after the estimate change: ($ in thousands)

$700 Cost $70 Previous annual amortization ($700 ÷ 10 years)

x 2 years 140 Amortization to date (2009-2010)560 Unamortized cost (balance in the patent account)

÷ 5 Estimated remaining life $112 New annual amortization

Franchise: To record amortization of franchise.

December 31, 2011Amortization expense ($500,000 ÷ 10 years)..................... 50,000

Franchise................................................................... 50,000

Requirement 2

Intangible assets:

Patent $448,000 [1] Franchise 450,000 [2] Total intangibles $898,000

[1] $560,000 - 112,000[2] $500,000 - 50,000

11-27


To record the purchase of a patent.

January 2, 2011Patent............................................................................ 500,000

Cash.......................................................................... 500,000

To record amortization of a patent for the year 2011.

Amortization expense ($500,000 ÷ 8 years)....................... 62,500Patent........................................................................ 62,500

To record amortization of the patent for the year 2012.

Amortization expense ($500,000 ÷ 8 years)....................... 62,500Patent........................................................................ 62,500

To record costs of successfully defending a patent infringement suit.

January, 2013Patent............................................................................ 45,000

Cash.......................................................................... 45,000

11-28

Exercise 11-15



To record amortization of patent for the year 2013.

Amortization expense (determined below)........................ 70,000Patent........................................................................ 70,000

Calculation of revised annual amortization: ($ in thousands)

$500 Cost$62.5 Previous annual amortization ($500 ÷ 8 years)

x 2 years 125 Amortization to date (2011-2012)375 Unamortized cost (balance in the patent account) 45 Add420 New unamortized cost

÷ 6 Estimated remaining life (8 years – 2 years)$ 70 New annual amortization

($ in millions)Amortization expense (determined below)........................ 2.5

Patent........................................................................ 2.5

Calculation of annual amortization after the estimate change: $ in millions)

$9 Cost$1 Previous annual amortization ($9 ÷ 9 years)

x 4 years 4 Amortization to date (2007-2010)5 Unamortized cost (balance in the patent account)

÷ 2 Estimated remaining life (6 years – 4 years)$2.5 New annual amortization

Requirement 1

2011 amortization: $1,200,000 ÷ 10 = $120,000 x 6/12 = $60,000

11-29

Exercise 11-16

Exercise 11-17


Requirement 2

Franchise ($1,180,000 – [1,200,000 – 60,000]) 40,000 Revaluation surplus–OCI 40,000

Requirement 3

2012 amortization: $1,180,000 ÷ 9.5 = $124,211

Requirement 1

Depreciation expense (determined below)......................... 3,088Accumulated depreciation - computer....................... 3,088


$40,000 Cost$7,200 Previous annual depreciation ($36,000 ÷ 5 years)

x 2 years 14,400 Depreciation to date (2009-2010)25,600 Undepreciated cost 900 Revised residual value24,700 Revised depreciable base÷ 8 Estimated remaining life (10 years - 2 years)

$ 3,088 New annual depreciation

Requirement 2

Depreciation expense (determined below)......................... 3,889Accumulated depreciation - computer....................... 3,889


$40,000 Cost Previous depreciation:

$12,000 2009 - ($36,000 x 5/15) 9,600 2010 - ($36,000 x 4/15)

11-30

Exercise 11-18


21,600 Depreciation to date (2009-2010)18,400 Undepreciated cost 900 Revised residual value17,500 Revised depreciable basex 8 /36 Estimated remaining life - 8 years

$ 3,889 2011 depreciationSYD depreciation

[10+9+8 x ($1.5 - .3) million] = $589,09155

$1,500,000 Cost 589,091 Depreciation to date, SYD (2008 - 2010)

910,909 Undepreciated cost as of 1/1/11 300,000 Less residual value

610,909 Depreciable base ÷ 7 yrs. Remaining life (10 years - 3 years)$ 87,273 New annual depreciation

Adjusting entry (2011 depreciation):

Depreciation expense (calculated above)........................... 87,273Accumulated depreciation......................................... 87,273

Requirement 1

In general, we report voluntary changes in accounting principles retrospectively. However, a change in depreciation method is considered a change in accounting estimate resulting from a change in accounting principle. In other words, a change in the depreciation method reflects a change in the (a) estimated future benefits from the asset, (b) the pattern of receiving those benefits, or (c) the company’s knowledge about those benefits, and therefore the two events should be reported the same way. Accordingly, Clinton reports the change prospectively; previous financial statements are not revised. Instead, the company simply employs the straight-line method from now on. The undepreciated cost remaining at the time of the change would be depreciated straight-line over the remaining useful life. A disclosure note should justify that the change is preferable and should describe the effect of the change on any financial statement line items and per share amounts affected for all periods reported.

11-31

Exercise 11-19

Exercise 11-20


Requirement 2 Asset’s cost $2,560,000Accumulated depreciation to date (given) (1,801,000 ) Undepreciated cost, Jan. 1, 2011 $ 759,000Estimated residual value (160,000 ) To be depreciated over remaining 3 years $ 599,000

÷ 3 yearsAnnual straight-line depreciation 2011-2013 $ 199,667 (rounded)

Adjusting entry:

Depreciation expense (calculated above)............ 199,667Accumulated depreciation ......................... 199,667

11-32


Requirement 1

Analysis:Correct Incorrect

(Should Have Been Recorded) (As Recorded)

2008 Machine 350,000 Expense 350,000 Cash 350,000 Cash 350,000

2008 Expense 70,000 Depreciation entry omitted Accum. deprec. 70,000



During the three-year period, depreciation expense was understated by $210,000, but other expenses were overstated by $350,000, so net income during the period was understated by $140,000, which means retained earnings is currently understated by that amount.

During the three-year period, accumulated depreciation was understated, and continues to be understated by $210,000.

To correct incorrect accountsMachine ............................................................ 350,000

Accumulated depreciation ($70,000 x 3 years)... 210,000 Retained earnings ($350,000 – 210,000)............. 140,000

Requirement 2Correcting entry:

Assuming that the machine had been disposed of, no correcting entry would be required because, after five years, the accounts would show appropriate balances.

Requirement 1

Book value $6.5 millionFair value 3 .5 million

11-33

Exercise 11-21

Exercise 11-22


Impairment loss 3.0 million

Requirement 2Because the undiscounted sum of future cash flows of $6.8 million exceeds book

value of $6.5 million, there is no impairment loss.

Requirement 1

IFRS requires an impairment loss to be recognized when an asset’s book value exceeds the higher of the asset’s value-in-use (present value of estimated future cash flows) and fair value less costs to sell. In this case, value-in-use and fair value less costs to sell are the same, $3.5 million. Because book value ($6.5 million) exceeds this amount, a loss is indicated. The loss is the difference between book value and the recoverable amount, which also is the higher of the asset’s value-in-use (present value of estimated future cash flows) and fair value less costs to sell. Therefore, the amount of impairment loss is the same as under U.S. GAAP, $3 million.

Book value $6.5 millionFair value 3 .5 millionImpairment loss 3.0 million

Requirement 2An impairment loss also is indicated because book value ($6.5 million) exceeds

fair value less costs to sell/value-in-use ($5 million). The amount of impairment loss is $1.5 million.

Book value $6.5 millionFair value 5 .0 millionImpairment loss 1.5 million

Under U.S. GAAP, because the undiscounted sum of future cash flows of $6.8 million exceeds book value of $6.5 million, there is no impairment loss.

Requirement 1

An impairment loss is indicated because the estimated undiscounted sum of future cash flows of $15 million is less than the book value of $18.3 million.

The amount of the loss to be reported is calculated using the estimated fair value rather than the undiscounted future cash flows:

11-34

Exercise 11-23

Exercise 11-24


Book value $18,300,000Estimated fair value 11,000,000Impairment loss $ 7,300,000

Requirement 2The loss would appear in the income statement along with other operating

expenses.

Requirement 3

Loss on impairment ........................................... 7,300,000Accumulated depreciation ................................. 14,200,000

Plant assets..................................................... 21,500,000

Requirement 4An impairment loss is indicated because the estimated undiscounted sum of

future cash flows of $12 million is less than the book value of $18.3 million.

The amount of the loss to be reported is calculated using the estimated fair value rather than the undiscounted future cash flows:

Book value $18,300,000Estimated fair value 11,000,000Impairment loss $ 7,300,000

Requirement 5Because the estimated undiscounted sum of future cash flows of $19 million

exceeds the book value of $18.3 million, no impairment loss is indicated.

11-35


Requirement 1

Determination of implied goodwill:Fair value of Centerpoint, Inc. $220 millionFair value of Centerpoint’s net assets (excluding goodwill) 200 millionImplied value of goodwill $ 20 million

Measurement of impairment loss:Book value of goodwill $50 millionImplied value of goodwill 20 millionImpairment loss $30 million

Requirement 2Because the fair value of the reporting unit, $270 million, exceeds book value,

$250 million, there is no impairment loss.

Under IFRS, the impairment loss is the difference between book value and the recoverable amount of the cash-generating unit. The recoverable amount is $225 million, the higher of the $225 million value-in-use (present value of estimated future cash flows) and the $220 million fair value less costs to sell.

Book value $250 millionRecoverable amount 225 millionImpairment loss $ 25 million

11-36

Exercise 11-25

Exercise 11-26


Requirement 1

Calculation of goodwill:

Consideration exchanged $420 millionLess fair value of net assets:

Assets $512 millionLess: Liabilities assumed (150) million (362) million

Goodwill $ 58 million

Requirement 2

Because the book value of the net assets ($410 million) exceeds fair value ($400 million) an impairment loss is indicated.

Determination of implied goodwill:Fair value of Harman, Inc. $400 millionFair value of Harman’s net assets (excluding goodwill) 370 million Implied value of goodwill $ 30 million

Measurement of impairment loss:Book value of goodwill (determined in requirement 1) $ 58 millionImplied value of goodwill 30 million

Impairment loss $ 28 million

Requirement 3

Entry to record the impairment loss:($ in millions)

Loss on impairment of goodwill ........................ 28Goodwill ....................................................... 28

Requirement 1

The Codification topic number that provides guidance on accounting for the impairment of long-lived assets is FASB ASC 360: “Property, Plant, and Equipment.”

Requirement 2

11-37

Exercise 11-27

Exercise 11-28


The specific citation that discusses the disclosures required in the notes to the financial statements for the impairment of long-lived assets classified as held and used is FASB ASC 360–10–50–2: “Property, Plant, and Equipment–Overall–Disclosure–Impairment or Disposal of Long-Lived Assets.”

Requirement 3

All of the following information shall be disclosed in the notes to financial statements that include the period in which an impairment loss is recognized:

a. A description of the impaired long-lived asset (asset group) and the facts and circumstances leading to the impairment

b. If not separately presented on the face of the statement, the amount of the impairment loss and the caption in the income statement or the statement of activities that includes that loss

c. The method or methods for determining fair value (whether based on a quoted market price, prices for similar assets, or another valuation technique)

d. If applicable, the segment in which the impaired long-lived asset (asset group) is reported under Topic 280.

The FASB Accounting Standards Codification represents the single source of authoritative U.S. generally accepted accounting principles. The specific citation for each of the following items is:

1. Depreciation involves a systematic and rational allocation of cost rather than a process of valuation:

FASB ASC 360–10–35–4: “Property, Plant, and Equipment–Overall–Subsequent Measurement–Depreciation.”The cost of a productive facility is one of the costs of the services it renders during its useful economic life. Generally accepted accounting principles (GAAP) require that this cost be spread over the expected useful life of the facility in such a way as to allocate it as equitably as possible to the periods during which services are obtained from the use of

11-38

Exercise 11-29


the facility. This procedure is known as depreciation accounting, a system of accounting which aims to distribute the cost or other basic value of tangible capital assets, less salvage (if any), over the estimated useful life of the unit (which may be a group of assets) in a systematic and rational manner. It is a process of allocation, not of valuation.

2. The calculation of an impairment loss for property, plant, and equipment:

FASB ASC 360–10–35–17: “Property, Plant, and Equipment–Overall–Subsequent Measurement.”An impairment loss shall be recognized only if the carrying amount of a long-lived asset (asset group) is not recoverable and exceeds its fair value. The carrying amount of a long-lived asset (asset group) is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset (asset group). That assessment shall be based on the carrying amount of the asset (asset group) at the date it is tested for recoverability, whether in use or under development. An impairment loss shall be measured as the amount by which the carrying amount of a long-lived asset (asset group) exceeds its fair value.

11-39

http://asc.fasb.org/glossarysection&trid=2155835&id=SL2269320-110224



3. Accounting for a change in depreciation method:

FASB ASC 250–10–45–18: “Accounting Changes and Error Correction–Overall–Other Presentation Matters.”Distinguishing between a change in an accounting principle and a change in an accounting estimate is sometimes difficult. In some cases, a change in accounting estimate is effected by a change in accounting principle. One example of this type of change is a change in method of depreciation, amortization, or depletion for long-lived, nonfinancial assets (hereinafter referred to as depreciation method). The new depreciation method is adopted in partial or complete recognition of a change in the estimated future benefits inherent in the asset, the pattern of consumption of those benefits, or the information available to the entity about those benefits. The effect of the change in accounting principle, or the method of applying it, may be inseparable from the effect of the change in accounting estimate. Changes of that type often are related to the continuing process of obtaining additional information and revising estimates and, therefore, shall be considered changes in estimates for purposes of applying this Subtopic.

4. Goodwill should not be amortized:

FASB ASC 350–20–35–1: “Intangibles-Goodwill and Other–Goodwill–Subsequent Measurement.”Goodwill shall not be amortized. Instead, goodwill shall be tested for impairment at a level of reporting referred to as a reporting unit.

1. To record the replacement of the heating system.

Accumulated depreciation - building............................. 250,000Cash.......................................................................... 250,000

2. To record the addition to the building.

Building........................................................................ 750,000

11-40

Exercise 11-30





Cash.......................................................................... 750,000

3. To expense annual maintenance costs.

Maintenance expense.................................................... 14,000Cash.......................................................................... 14,000

4. To capitalize rearrangement costs.

Machinery..................................................................... 50,000Cash.......................................................................... 50,000

Requirement 1

2009 amortization: $6,000,000 10 = $600,000 x 3/12 = $150,0002010 amortization: $6,000,000 10 = $600,000

Requirement 2

Patent 500,000 Cash 500,000

Requirement 3

Calculation of revised annual amortization:

$6,000,000 Cost 750,000 Amortization to date (above)

5,250,000 Unamortized cost (balance in the patent account) 500,000 Add5,750,000 New unamortized cost

÷ 8 3/4 Estimated remaining life (10 years – 1 1/4 years) $ 657,143 New annual amortization

11-41

Exercise 11-31


Requirement 4

Requirement 2:

Litigation expense 500,000 Cash 500,000

Requirement 3:

2011 amortization: $6,000,000 10 = $600,000

Requirement 1

Cash.............................................................................. 17,000Accumulated depreciation - lathe (determined below)....... 56,250Loss on sale (difference).................................................. 6,750

Lathe (balance)............................................................ 80,000

Accumulated depreciation:

$80,000 - 5,000Annual depreciation = = $15,000

5 years

2007 $15,000 x 1/2 = $ 7,5002008 15,0002009 15,0002010 15,0002011 $15,000 x 1/4 = 3,750 Total $56,250

11-42

Exercise 11-32



Requirement 2

Cash.............................................................................. 17,000Accumulated depreciation - lathe (determined below)....... 67,500

Gain on sale (difference).............................................. 4,500Lathe (balance)............................................................ 80,000

Accumulated depreciation:

Sum-of-the-digits is ([5 (5 + 1)]/2) = 15

2007 $75,000 x 5/15 x 6/12 = $12,500

2008 $75,000 x 5/15 x 6/12 = $12,500 + $75,000 x 4/15 x 6/12 = 10,000 22,500

2009 $75,000 x 4/15 x 6/12 = $10,000 + $75,000 x 3/15 x 6/12 = 7,500 17,500

2010 $75,000 x 3/15 x 6/12 = $ 7,500 + $75,000 x 2/15 x 6/12 = 5,000 12,500

2011 $75,000 x 2/15 x 3/12 = 2,500Total $67,500

11-43

Exercise 11-33


List A List B

g 1. Depreciation a. Cost allocation for natural resource. d 2. Service life b. Accounted for prospectively. f 3. Depreciable base c. When there has been a significant

decline in value. e 4. Activity-based method d. The amount of use expected from

plant and equipment and finite-life intangible assets. m 5. Time-based method e. Estimates service life in units of output. h 6. Double-declining balance f. Cost less residual value. j 7. Group method g. Cost allocation for plant and equipment. k 8. Composite method h. Does not subtract residual value from cost. a 9. Depletion i. Accounted for the same way as a change in

estimate. l 10. Amortization j. Aggregates assets that are similar. b 11. Change in useful life k. Aggregates assets that are physically

unified. i 12. Change in depreciation l. Cost allocation for an intangible asset.

method c 13. Write-down of asset m. Estimates service life in years.

Requirement 1

To record the acquisition of small tools.

2009Small tools ................................................................... 8,000

Cash.......................................................................... 8,000

To record additional small tool acquisitions.

2011Small tools.................................................................... 2,500

Cash.......................................................................... 2,500

11-44

Exercise 11-34


To record the sale/depreciation of small tools.

2011Cash ............................................................................. 250Depreciation expense (difference).................................... 1,750

Small tools................................................................ 2,000

11-45



Requirement 2To record the acquisition of small tools.

2009Small tools ................................................................... 8,000

Cash.......................................................................... 8,000

To record the replacement/depreciation of small tools.

2011Depreciation expense ................................................... 2,500

Cash.......................................................................... 2,500

To record the sale of small tools.

2011Cash ............................................................................. 250

Depreciation expense................................................ 250

CPA Exam Questions

1. a. Double declining balance depreciation rate = 2 x 1/8 = ¼ or 25%

First year depreciation will be $7,500 x 0.25 = $1,875

Second year depreciation will be ($7,500 - $1875) x 0.25 = $1,406

2. b. The depreciation method used must be straight line because year 1 depreciation is $7,400 (($40,000 - $3,000) / 5 = $7,400). Year 2 depreciation would also be $7,400.

3. b. $20,000/5,000,000 gallons = $0.004/gallon

11-46

CPA / CMA REVIEW QUESTIONS


($0.004/gallon) x (250,000 gallons) = $1,000

4. d. Goodwill is an indefinite life intangible asset and is therefore not amortized.

5. c. $50,000 10 years = $5,000 per year in amortization. $50,000 – 5,000 = $45,000. The 3% franchise fee is a period expense and is not capitalized.

6. c. First two years = ($60,000 – 0)10 = $6,000 per year

Year 2011 = [$60,000 – (2 x $6,000) – 3,000] 3 = $15,000

7. d. The book value of the stamping machine is its cost less accumulated depreciation. Depreciation taken through 2011 was (($22,000,000 - $4,000,000) / 12 x 7 =) $10,500,000 so book value is ($22,000,000 - $10,500,000 =) $11,500,000. Because the $11,500,000 book value is more than expected future cash flows of ((5 x $1,500,000) + $1,000,000 =) $8,500,000, the stamping machine is impaired.

8. d. $147,000. All of the expenditures are capitalized.

1. d. Because 50% of the original estimate of quality ore was recovered during the years 2002 through 2009, recorded depletion of $250,000 [50% x ($600,000 - $100,000 salvage value)]. In 2010, the earlier depletion of $250,000 is deducted from the $600,000 cost along with the $100,000 salvage value. The remaining depletable cost of $250,000 will be allocated over the 250,000 tons believed to remain in the mine. The $1 per ton depletion is then multiplied times the tons mined each year.

2. a. Given that the company paid $6,000,000 for net assets acquired with a fair value of $5,496,000, goodwill was $504,000. According to GAAP, purchased goodwill is not amortized but is tested annually for impairment.

3. a. The cost should be amortized over the remaining legal life or useful life, whichever is shorter. In addition to the initial costs of obtaining a patent, legal fees incurred in the successful defense of a patent should be capitalized as part of the cost, whether it was internally developed or purchased from an inventor. The legal fees capitalized then should be amortized over the remaining useful life of the patent.

11-47

CMA Exam Questions


PROBLEMSRequirement 1

Determine useful life: $200,000 depreciable base = 20-year useful life$10,000 annual depreciation

Determine age of assets: $40,000 accumulated depreciation = 4 years old $10,000 annual depreciation

Double-declining balance in 4th year of life:Year 1 (2008) $200,000 x 10% = $20,000Year 2 (2009) 180,000 x 10% = 18,000Year 3 (2010) 162,000 x 10% = 16,200Year 4 (2011) 145,800 x 10% = 14,580

Requirement 2

Depreciation expense (below) ...................... 20,000 Accumulated depreciation .................... 20,000

$200,000 Cost 30,000 Depreciation to date, SL 3 years (2008-2010)

$170,000 Undepreciated cost as of 1/1/11

Seventeen-year remaining life, or 1/17 x 2 = 2/17 = x $170,000 = $20,000

A disclosure note reports the effect of the change on net income and earnings per share along with clear justification for changing depreciation methods.

Requirement 1

Cord CompanyANALYSIS OF CHANGES IN PLANT ASSETS

For the Year Ending December 31, 2011

Balance Balance12/31/10 Increase Decrease 12/31/11

11-48

Problem 11-1

Problem 11-2


Land $ 175,000 $ 312,500 [1] $ -- $ 487,500Land improvements -- 192,000 -- 192,000Buildings 1,500,000 937,500 [1] -- 2,437,500Machinery and equipment 1,125,000 385,000 [2] 17,000 1,493,000Automobiles and trucks 172,000 12,500 24,000 160,500Leasehold improvements 216,000 -- -- 216,000

$3,188,000 $1,839,500 $41,000 $4,986,500

Explanations of Amounts:

[1] Plant facility acquired from King 1/6/11 — allocation to Land and Building: Fair value — 25,000 shares of Cord common stock at $50 per share fair value $1,250,000

Allocation in proportion to appraised values at date of exchange:% of

Amount TotalLand $187,500 25Building 562,500 75

$750,000 100

Land $1,250,000 x 25% = $ 312,500Building $1,250,000 x 75% = 937,500

$1,250,000

[2] Machinery and equipment purchased 7/1/11: Invoice cost $325,000 Delivery cost 10,000 Installation cost 50,000 Total acquisition cost $385,000

11-49


Problem 11-2 (continued)

Requirement 2Cord Company

DEPRECIATION AND AMORTIZATION EXPENSEFor the Year Ended December 31, 2011

Land Improvements:Cost $192,000Straight-line rate (1 ÷ 12 years) x 8 1/3 % Annual depreciation 16,000Depreciation on land improvements for 2011: (3/25 to 12/31/11) x 3 /4 $ 12,000

Buildings:Book value, 1/1/11 ($1,500,000 - 328,900) $1,171,100Building acquired 1/6/11 937,500Total amount subject to depreciation 2,108,600150% declining balance rate: (1 ÷ 25 years = 4% x 1.5) x 6 % 126,516

Machinery and equipment:Balance, 1/1/11 $1,125,000Straight-line rate (1 ÷ 10 years) x 10 % 112,500

Purchased on 7/1/11 385,000Depreciation for one-half year x 5 % 19,250 Depreciation on machinery and equipment for 2011 131,750

Automobiles and trucks:Book value, 1/1/11 ($172,000 - 100,325) $71,675 Deduct 1/1/11 book value of truck sold on 9/30 ($9,100 + 2,650) (11,750 ) Amount subject to depreciation 59,925 150% declining balance rate: (1 ÷ 5 years = 20% x 1.5) x 30 % 17,978

Automobile purchased 8/30/11 12,500 Depreciation for 2011 (30% x 4/12) x 10 % 1,250Truck sold on 9/30/11 - depreciation (given) 2,650 Depreciation on automobiles and trucks 21,878

11-50


Problem 11-2 (concluded)

Leasehold improvements:Book value, 1/1/11 ($216,000 - 108,000) $108,000Amortization period (1/1/11 to 12/31/15) ÷ 5 years Amortization of leasehold improvements for 2011 21,600

Total depreciation and amortization expense for 2011 $313,744

Pell CorporationDEPRECIATION EXPENSE

For the Year Ended December 31, 2011

Land improvements:Cost $ 180,000Straight-line rate (1 ÷ 15 years) x 6 2/3 % $ 12,000

Building:Book value 12/31/10 ($1,500,000 - 350,000) $1,150,000150% declining balance rate: (1 ÷ 20 years = 5% x 1.5) x 7 .5% 86,250

Machinery and Equipment:Balance, 12/31/10 $1,158,000Deduct machine sold (58,000 ) $1,100,000Straight-line rate (1 ÷ 10 years) x 10 % 110,000

Purchased 1/2/11 287,000Depreciation x 10 % 28,700

Machine sold 3/31/11 58,000Depreciation for three months x 2 .5% 1,450 Total depreciation on machinery and equipment 140,150

Automobiles:Book value on 12/31/10 ($150,000 - 112,000) $38,000150% declining balance rate: (1 ÷ 3 years = 33.333% x 1.5) x 50 % 19,000

Total depreciation expense for 2011 $257,4001. Depreciation for 2009 and 2010.

11-51

Problem 11-3

Problem 11-4


December 31, 2009Depreciation expense ($48,000 ÷ 8 years x 9/12)................. 4,500

Accumulated depreciation - equipment...................... 4,500

December 31, 2010Depreciation expense ($48,000 ÷ 8 years)......................... 6,000


2. The year 2011 expenditure.

January 4, 2011Repair and maintenance expense................................... 2,000Equipment..................................................................... 10,350

Cash.......................................................................... 12,350

3. Depreciation for the year 2011.

December 31, 2011Depreciation expense (determined below)......................... 5,800



$ 48,000 Cost 10,500 Depreciation to date ($4,500 + 6,000) 37,500 Undepreciated cost

10,350 Asset addition 47,850 New depreciable base÷ 8 1/4 Estimated remaining life (10 years - 1 3/4 years)

$ 5,800 New annual depreciation

11-52


(1) $65,000

Allocation in proportion to appraised values at date of exchange:% of

Amount TotalLand $72,000 8Building 828,000 92

$900,000 100

Land $812,500 x 8% = $ 65,000Building $812,500 x 92% = 747,500

$812,500(2) $747,500

(3) 50 years $747,500 - 47,500 $14,000 annual depreciation

(4) $ 14,000 Same as prior year, since method used is straight-line.

(5) $ 85,400 3,000 shares x $25 per share = $75,000Plus demolition of old building 10,400

$85,400(6) None No depreciation before use.

(7) $ 16,000 Fair value.

(8) $ 2,400 $16,000 x 15% (1.5 x Straight-line rate of 10%).

(9) $ 2,040 ($16,000 - 2,400) x 15%.

(10) $ 99,000 Total cost of $110,000 - $11,000 in normal repairs.

(11) $ 17,000 ($99,000 - 5,500) x 10/55.

(12) $ 5,100 ($99,000 - 5,500) x 9/55 x 4/12.

(13) $ 30,840 PVAD = $4,000 (7.71008 ) Present value of an annuity due of $1: n = 11, i = 8% (from Table 6)

(14) $ 2,056 $30,840

15 years

11-53

Problem 11-5


Requirement 1

Building:

$500,000 = $20,000 per year x 9/12 = $15,000 25 years

Machinery:

$240,000 - (10% x $240,000) = $27,000 per year x 9/12 = $20,250 8 years

Equipment:

Sum-of-the-digits is ([6 (6 + 1)]÷2) = 21

($160,000 - 13,000) x 6/21 = $42,000 x 9/12 = $31,500

Requirement 2

(1)

June 29, 2012Depreciation expense (determined below)......................... 5,625

Accumulated depreciation - machinery...................... 5,625

$100,000 - (10% x $100,000) = $11,250 x 6/12 = $5,625 8 years

11-54

Problem 11-6



(2)

June 29, 2012Cash.............................................................................. 80,000Accumulated depreciation - machinery (below).............. 14,063Loss on sale of machinery (difference)............................. 5,937

Machinery................................................................. 100,000

Accumulated depreciation on machinery sold:

2011 depreciation = $11,250 x 9/12 = $ 8,4382012 depreciation = $11,250 x 6/12 5,625 Total $14,063

Requirement 3Building:

$500,000 = $20,000 25 years

Machinery:

$140,000 - (10% x $140,000) = $15,750 8 years

Equipment:

($160,000 - 13,000) x 6/21 = $42,000 x 3/12 = $10,500 + ($160,000 - 13,000) x 5/21 = $35,000 x 9/12 = 26,250

$36,750

Requirement 1

Cost of mineral mine:

Purchase price $1,600,000Development costs 600,000

11-55

Problem 11-7


$2,200,000

Depletion:

$2,200,000 - 100,000Depletion per ton = = $5.25 per ton

400,000 tons

2011 depletion = $5.25 x 50,000 tons = $262,500

2012 depletion:Revised depletion rate = ($2,200,000 - 262,500) - 100,000

= $4.20 487,500 - 50,000 tons

2012 depletion = $4.20 x 80,000 tons = $336,000

Depreciation:

Structures: $150,000

Depreciation per ton = = $.375 per ton 400,000 tons

2011 depreciation = $.375 x 50,000 tons = $18,750

2012 depreciation:Revised depreciation rate = $150,000 - 18,750

= $.30 487,500 - 50,000 tons


11-56



Equipment: $80,000 - 4,000

Depreciation per ton = = $.19 per ton 400,000 tons


2012 depreciation:Revised depreciation rate = ($80,000 - 9,500) - 4,000

= $.152 487,500 - 50,000 tons


Requirement 2Mineral mine:Cost $ 2,200,000Less accumulated depletion: 2011 depletion $262,500 2012 depletion 336,000 598,500 Book value, 12/31/12 $1,601,500

Structures:Cost $ 150,000Less accumulated depreciation: 2011 depreciation $18,750 2012 depreciation 24,000 42,750 Book value, 12/31/12 $107,250

Equipment:Cost $ 80,000Less accumulated depreciation: 2011 depreciation $ 9,500 2012 depreciation 12,160 21,660 Book value, 12/31/12 $58,340

11-57




natural resources are part of product cost and are included in the cost of the inventory of the mineral, just as the depreciation on manufacturing equipment is included in inventory cost. The depletion and depreciation are then included in cost of goods sold in the income statement when the mineral is sold.

In 2011, since all of the ore was sold, all of 2011’s depletion and depreciation is included in cost of goods sold. In 2012, since not all of the extracted ore was sold, a portion of both 2012’s depletion and depreciation remains in inventory.

Requirement 1

Calculation of goodwill:

Consideration exchanged $2,000,000Less: Fair value of net identifiable assets 1,700,000

$ 300,000

The cost of goodwill is not amortized.

To record amortization of patent.

Amortization ($80,000 ÷ 8 years x 6/12).............................. 5,000Patent........................................................................ 5,000

To record amortization of franchise.

Amortization expense ($200,000 ÷ 10 years x 3/12)............. 5,000Franchise................................................................... 5,000

11-58

Problem 11-8



Requirement 2Intangible assets:

Goodwill $300,000 [1] Patent 75,000 [2]Franchise 195,000 [3] Total intangibles $570,000

[1] $300,000 [2] $ 80,000 - 5,000[3] $200,000 - 5,000

Requirement 1

Machine 101:

$70,000 - 7,000 = $6,300 per year x 3 years = $ 18,900 10 years

Machine 102:

$80,000 - 8,000 = $9,000 per year x 1.5 years = 13,500 8 years

Machine 103:

$30,000 - 3,000 = $3,000 per year x 4/12 = 1,000 9 years

Accumulated depreciation, 12/31/10 $33,400

Requirement 2To record depreciation on machine 102 through date of sale.

March 31, 2011Depreciation expense ($9,000 per year x 3/12).................... 2,250

11-59

Problem 11-9



To record sale of equipment.

March 31, 2011Cash.............................................................................. 52,500Accumulated depreciation ($13,500 + 2,250).................... 15,750Loss on sale of equipment (determined below).................. 11,750

Equipment................................................................. 80,000

11-60



Loss on sale of machine 102:Proceeds $52,500Less book value on 3/31/11: Cost $80,000 Less accumulated depreciation: Depreciation through 12/31/10 $13,500 Depreciation from 1/1/11 to 3/31/11 ($9,000 x 3/12) 2,250 15,750 64,250 Loss on sale $11,750

Requirement 3Building:

Useful life of the building:

$200,000 = $40,000 in depreciation per year 5 years(2006-2010)

$840,000 - 40,000 = 20-year useful life $40,000

To record depreciation on the building.

Depreciation expense [($840,000 - 40,000) ÷ 20 years]........ 40,000Accumulated depreciation - building......................... 40,000

11-61



To record depreciation on the equipment.

Depreciation expense (determined below)......................... 15,775Accumulated depreciation - equipment...................... 15,775

Equipment:Machine 103 (determined above) $ 3,000Machine 101: Cost $70,000 Less: Accumulated depreciation 18,900 Book value, 12/31/10 51,100 Revised remaining life (7 years - 3 years) ÷ 4 years 12,775

$15,775

a. This is a change in estimate.

No entry is needed to record the change.

2011 adjusting entry:Depreciation expense (determined below) ........................ 370,000

Accumulated depreciation ........................................ 370,000


$10,000,000 Cost$250,000 Previous depreciation ($10,000,000 ÷ 40 years)

x 3 yrs (750,000 ) Depreciation to date (2008-2010) 9,250,000 Undepreciated cost

÷ 25 yrs. Estimated remaining life (25 years: 2011-2035)$ 370,000 New annual depreciation

A disclosure note should describe the effect of a change in estimate on income before extraordinary items, net income, and related per-share amounts for the current period.

11-62

Problem 11-10



b. This is a change in accounting principle that is accounted for as a change in estimate.

Depreciation expense (below) ......................21,000 Accumulated depreciation ............ 21,000

SYD2007 depreciation $ 60,000 ($330,000 x 10/55)

2008 depreciation 54,000 ($330,000 x 9/55)

2009 depreciation 48,000 ($330,000 x 8/55)

2010 depreciation 42,000 ($330,000 x 7/55)

Accumulated depreciation $204,000

$330,000 Cost 204,000 Depreciation to date, SYD (above) 126,000 Undepreciated cost as of 1/1/11 0 Less residual value126,000 Depreciable base

÷ 6 yrs. Remaining life (10 years - 4 years)$ 21,000 New annual depreciation

A disclosure note reports the effect of the change on net income and earnings per share along with clear justification for changing depreciation methods.

c. This is a change in accounting principle accounted for as a change in estimate.

Because the change will be effective only for assets placed in service after the date of change, depreciation schedules do not require revision because the change does not affect assets depreciated in prior periods. A disclosure note still is required to provide justification for the change and to report the effect of the change on current year’s income.

Requirement 1

11-63

Problem 11-11


Analysis:Correct Incorrect

(Should Have Been Recorded) (As Recorded)

2009 Equipment 1,900,000 Equipment 2,000,000Expense 100,000 Cash 2,000,000

Cash 2,000,000

2009 Expense 475,000 [1] Expense 500,000 [2]Accum. deprec. 475,000 Accum. deprec. 500,000

2010 Expense 356,250 [3] Expense 375,000 [4]Accum. deprec. 356,250 Accum. deprec. 375,000

[1] $1,900,000 x 25% (2 times the straight-line rate of 12.5%)[2] $2,000,000 x 25%[3] ($1,900,000 - 475,000) x 25%[4] ($2,000,000 - 500,000 ) x 25%

During the two-year period, depreciation expense was overstated by $43,750, but other expenses were understated by $100,000, so net income during the period was overstated by $56,250, which means retained earnings is currently overstated by that amount.

During the two-year period, accumulated depreciation was overstated, and continues to be overstated by $43,750.

To correct incorrect accountsRetained earnings................................................ 56,250Accumulated depreciation .............................................. 43,750

Equipment....................................................... 100,000

11-64



Requirement 2This is a change in accounting principle accounted for as a change in estimate.

No entry is needed to record the change.

2011 adjusting entry:Depreciation expense (determined below).................. 178,125

Accumulated depreciation ...................................... 178,125

A change in depreciation method is considered a change in accounting estimate resulting from a change in accounting principle. Accordingly, the Collins Corporation reports the change prospectively; previous financial statements are not revised. Instead, the company simply employs the straight-line method from now on. The undepreciated cost remaining at the time of the change is depreciated straight-line over the remaining useful life.

Asset’s cost (after correction) $1,900,000Accumulated depreciation to date ($475,000 + 356,250) (831,250 ) Undepreciated cost, Jan. 1, 2011 1,068,750Estimated residual value (0 ) To be depreciated over remaining 6 years 1,068,750

÷ 6 yearsAnnual straight-line depreciation 2011-2016 $ 178,125

Requirement 1

Plant and equipment:Depreciation to date:

$150 million 10 years = $15 million per year x 3 years = $45 million

Book value: $150 million – $45 million = $105 million

Patent:Amortization to date:

$40 million 5 years = $8 million per year x 3 years = $24 million

11-65

Problem 11-12


Book value: $40 million – $24 million = $16 million

Requirement 2Property, plant, and equipment and finite-life intangible assets are tested for

impairment only when events or changes in circumstances indicate book value may not be recoverable.

Requirement 3Goodwill should be tested for impairment on an annual basis and in between

annual test dates if events or circumstances indicate that the fair value of the reporting unit is below its book value.

Requirement 4Plant and equipment:An impairment loss is indicated because the book value of the assets, $105

million, is greater than the $80 undiscounted sum of future cash flows. The amount of the impairment loss is determined as follows:

Book value $105 millionFair value (60 ) millionImpairment loss 45 million

Patent:There is no impairment loss because the undiscounted sum of future cash flows,

$20 million, exceeds book value of $16 million.

11-66



Goodwill:An impairment loss is indicated because the book value of the assets of the

reporting unit, $470 million, is greater than the $450 million fair value of the reporting unit. The amount of the impairment loss is determined as follows:

Determination of implied goodwill:Fair value of Ellison Technology $450 millionFair value of Ellison’s net assets (excluding goodwill) (390 ) millionImplied value of goodwill $ 60 million

Measurement of impairment loss:Book value of goodwill $100 millionImplied value of goodwill (60 ) millionImpairment loss $40 million

Requirement 1

Hecala’s cost of the mineral mine is $13,721,871 determined as follows:

Mining site $10,000,000Development costs 3,200,000Restoration costs 521,871 †

$13,721,871

† $600,000 x 30% = $180,000 700,000 x 30% = 210,000 800,000 x 40% = 320,000

$710,000 x .73503* = $521,871*Present value of $1, n = 4, i = 8%

Requirement 2

Depletion:$13,721,871 800,000 tons = $17.1523 per ton

120,000 tons x $17.1523 = $2,058,276

11-67

Problem 11-13


Depreciation of machinery:

$140,000 - 10,000 = $.1625 per ton 800,000 tons

120,000 tons x $.1625 = $19,500

Depreciation of structures:

$68,000 800,000 tons = $.085 per ton

120,000 tons x $.085 = $10,200

11-68




natural resources are part of product cost and therefore are included in the cost of the inventory of the mineral, just as the depreciation on manufacturing equipment is included in inventory cost. The depletion and depreciation are then included in cost of goods sold in the income statement when the mineral is sold.

Requirement 4A change in the service life of plant and equipment and finite-life intangible

assets is accounted for as a change in an estimate. The change is accounted for prospectively by simply depreciating/depleting the remaining depreciable/depletable base of the asset (book value at date of change less estimated residual value) over the revised remaining service life (tons of ore in this case).

2012 Depletion:

Original cost $13,721,871Less: 2011 depletion (2,058,276 )

Remaining depletable cost $11,663,595 Revised estimate of tons

remaining (1,000,000 – 120,000) 880,000 tonsDepletion rate $13.2541 per tonx Tons extracted 150,000 tons2012 Depletion $1,988,115

11-69



2012 Depreciation of machinery:

Original cost $140,000Less: 2011 depreciation (19,500 )

$120,500Less: residual value (10,000)

Remaining depreciable cost $110,500 Revised estimate of tons

remaining (1,000,000 – 120,000) 880,000 tonsDepreciation rate $.1256 per tonx Tons extracted 150,000 tons2012 Depreciation $18,840

2012 Depreciation of structures:

Original cost $68,000Less: 2011 depreciation (10,200 )

Remaining depreciable cost $57,800 Revised estimate of tons

remaining (1,000,000 – 120,000) 880,000 tonsDepreciation rate $.0657 per tonx Tons extracted 150,000 tons2012 Depreciation $9,855

11-70


CASESThe terms depreciation, depletion, and amortization all

refer to the same process of allocating the cost of property and equipment and finite-life intangible assets to the periods

benefited by their use. However, each term is applied to a different type of long-lived asset; depreciation is used for plant and equipment, depletion for natural resources, and amortization for intangibles.

There are differences in determining the factors necessary to calculate depreciation, depletion, and amortization but the concepts involved are the same. The service life of plant and equipment and natural resources is limited to physical life, while the service life of intangible assets is limited to the asset’s legal or contractual life, or 40 years, whichever is shorter.

The majority of companies use straight-line depreciation and straight-line amortization. Natural resources usually are depleted using the units-of-production method.

Suggested Grading Concepts and Grading Scheme:

Content (70%)_______ 50 Explains the concept of depreciation as a process of

cost allocation, not valuation.______ Rational match versus market fluctuations.______ Numerical example.

_______ 10 Purpose of the balance sheet is to provide information about financial position, not to directly measure company value.

_______ 10 Purpose of the income statement is to provide cash flowinformation, not to directly measure the change in company value.

_____________ 70 points

Writing (30%)_______ 6 Terminology and tone appropriate to the audience of

a company president.

_______ 12 Organization permits ease of understanding.______ Introduction that states purpose.______ Paragraphs that separate main points.

11-71

Analysis Case 11-1

Communication Case 11-2


_______ 12 English______ Sentences grammatically clear and well organized, concise.

______ Word selection.______ Spelling.______ Grammar and punctuation.

_____________ 30 points

Requirement 1

Portland should have selected the straight-line depreciation method when approximately the same amount of an asset’s service potential is used up each period. If the reasons for the decline in service potential are unclear, then the selection of the straight-line method could be influenced by the ease of recordkeeping, its use for similar assets, and its use by others in the industry.

Requirement 2a. By associating depreciation with a group of machines instead of each

individual machine, Portland’s bookkeeping process is greatly simplified. Also, since actual machine lives vary from the average depreciable life, unrecognized net losses on early dispositions are expected to be offset by continuing depreciation on machines usable beyond the average depreciable life. Periodic income does not fluctuate as a result of recognizing gains and losses on machine dispositions.

b. Portland should divide the depreciable base of each machine by its estimated life to obtain its annual depreciation. The sum of the individual annual depreciation amounts should then be divided by the sum of the individual capitalized costs to obtain the annual composite depreciation rate.

Requirement 1

a. The capitalized cost for the computer includes all costs reasonable and necessary to prepare it for its intended use. Examples of such costs are the purchase price, delivery, installation, testing, and setup.

b. The objective of depreciation accounting is to allocate the depreciable base of an asset over its estimated useful life in a systematic and rational manner. This process matches the depreciable base of the asset with revenues generated from its use. Depreciable base is the capitalized cost less its estimated residual value.

Requirement 2The rationale for using accelerated depreciation methods is based on the

assumption that an asset is more productive in the earlier years of its estimated useful

11-72

Judgment Case 11-3

Judgment Case 11-4


life. Therefore, larger depreciation charges in the earlier years would be matched against the larger revenues generated in the earlier years. An accelerated depreciation method also would be appropriate when benefits derived from the asset are approximately equal over the asset’s life, but repair and maintenance costs increase significantly in later years. The early years record higher depreciation expense and lower repairs and maintenance expense, while the later years have lower depreciation and higher repairs and maintenance.

There is no necessarily correct answer to the question. The support made for the answer given is more important than the answer itself. Materiality is the critical

consideration. Information is material if it can have an effect on a decision made by users. One

consequence of materiality is that GAAP needs to be followed only if an item is material. The threshold for materiality will depend principally on the relative dollar amount of the transaction.

In this case, is the $70,000 material? Net-of-tax income would be $49,000 higher if the expenditures were capitalized instead of expensed [$70,000 x (1-.30)]. This represents a 4.45% increase in income ($49,000 ÷ $1,100,000). The effect on the balance sheet is small. Shareholders' equity would be higher by $49,000 if the expenditures were capitalized. This represents an increase of less than one-half of one percent. Would these differences have an effect on decision-makers? There is no single answer to this question. The FASB has been reluctant to establish any quantitative materiality guidelines. The threshold for materiality has been left to subjective judgment of the company preparing the financial statement and its auditors.

11-73

Judgment Case 11-5


There is no right or wrong answer to this case. Both views, expense and capitalize, can be defended once consideration is given to the

materiality issue. The process of developing and synthesizing the arguments will likely be more beneficial than any single solution. Each student should benefit from participating in the process, interacting first with his or her partner, then with the class as a whole. It is important that each student actively participate in the process. Domination by one or two individuals should be discouraged.

A significant benefit of this case is that it is forcing students to consider the subjective nature of materiality when applying GAAP.

Requirement 1

a. ($ in millions)

Inventory (understatement of 2012 beginning inventory)........ 10Retained earnings (understatement of 2011 income)......... 10

Note: The 2010 error requires no adjustment because it has self-corrected by 2012.

b.Retained earnings (2010-2011 patent amortization)............. 6

Patent [($18 million ÷ 6 years) x 2]................................. 6

2012 adjusting entry:Patent amortization expense ($18 million ÷ 6 years) ........ 3

Patent ...................................................................... 3

c.2012 adjusting entry:Depreciation expense (below) ........................................ 4

Accumulated depreciation ....................................... 4

($ in millions)

SYD2010 depreciation $10 ($30 x 5/15)

2011 depreciation 8 ($30 x 4/15) Accumulated depreciation $18

$30 Cost 18 Depreciation to date, SYD (above) 12 Undepreciated cost as of 1/1/12

11-74

Communication Case 11-6

Integrating Case 11-7


0 Less residual value12 Depreciable base

÷ 3 yrs. Remaining life (5 years - 2 years)$ 4 New annual depreciation

11-75


Case 11-7 (concluded)

Requirement 2Shareholders’ Net

Assets Liabilities Equity Income Expenses

2010 $640 $330 $310 $210 $1502010 inventory (12) (12) (12) 12Patent amortization (3) (3) (3) 3Depreciation no adjustments to prior years

____ ____ ____ ____ ____$625 $330 $295 $195 $165

2011 $820 $400 $420 $230 $1752010 inventory 12 (12)2011 inventory 10 10 10 (10)Patent amortization (6) (6) (3) 3Depreciation no adjustments to prior years

____ ____ ____ ________$824 $400 $424 $249 $156

Requirement 1

A change from the sum-of-the-years’ digits method of depreciation to the straight-line method for previously recorded assets is a change in accounting principle that is accounted for as a change in estimate. Both the sum-of-the-years’ digits method and the straight-line method are generally accepted. A change in accounting principle results from the adoption of a generally accepted accounting principle different from the generally accepted principle used previously for reporting purposes.

Requirement 2A change in the expected service life of an asset arising because of more

experience with the asset is a change in accounting estimate. A change in accounting estimate occurs because future events and their effects cannot be perceived with certainty. Estimates are an inherent part of the accounting process. Therefore, accounting and reporting for certain financial statement elements requires the exercise of judgment, subject to revision based on experience.

11-76

Judgment Case 11-8


Requirement 1

The reference locations for the impairment of property, plant, and equipment and intangible assets include: FASB ASC 360–10: Property, Plant and Equipment–Overall, and FASB ASC 350-20: Intangibles-Goodwill and Other–Goodwill.

Requirement 2Property, plant, and equipment and finite-life intangible assets are tested for

impairment only when events or changes in circumstances indicate book value may not be recoverable.

Intangible assets with indefinite useful lives, including goodwill, should be tested for impairment on an annual basis and in between annual test dates if events or circumstances indicate that the fair value of the reporting unit is below its book value.

Requirement 3Property, plant, and equipment and finite-life intangible assets:

Determining whether to record an impairment loss and actually recording the loss is a two-step process. The first step is a recoverability test - an impairment loss is required only when the undiscounted sum of estimated future cash flows from an asset is less than the asset’s book value. The measurement of impairment loss—step 2—is the difference between the asset’s book value and its fair value.Intangible assets with indefinite useful lives (other than goodwill):

The measurement of an impairment loss for indefinite-life intangible assets other than goodwill is a one-step process. We compare the fair value of the asset with its book value. If book value exceeds fair value, an impairment loss is recognized for the difference.Goodwill:

Determining whether to record an impairment loss and actually recording the loss is a two-step process. Step 1: A goodwill impairment loss is indicated when the fair value of the reporting unit is less than its book value. Step 2: A goodwill impairment loss is measured as the excess of the book value of the goodwill over its “implied” fair value. The implied fair value of goodwill is calculated in the same way that goodwill is determined in a business combination. That is, it’s a residual amount measured by subtracting the fair value of all identifiable net assets from the consideration exchanged using the unit’s previously determined fair value as the consideration exchanged.

11-77

Research Case 11-9



Requirement 4Property, plant, and equipment and intangible assets to be sold should be

classified as held-for-sale in the period in which all of the following criteria are met:

a. Management, having the authority to approve the action, commits to a plan to sell the asset.

b. The asset or asset group is available for immediate sale in its present condition.c. An active program to locate a buyer and other actions required to complete the

plan to sell the asset or asset group have been initiated.d. The sale is probable.e. The asset or asset group is being actively marketed for sale at a price that is

reasonable in relation to its current fair value.f.Actions required to complete the plan indicate that it is unlikely that significant

changes to the plan will be made or that the plan will be withdrawn.

The specific reference for these criteria is FASB ASC 360–10–45–9.

Requirement 5Property, plant, and equipment and intangible assets or groups of these assets

classified as held-for-sale is measured at the lower of its (a) book value or (b) fair value less cost to sell. An impairment loss is recognized for any write-down to fair value less cost to sell.

Requirement 1

2011 expense using CEO's approach:

$42,000,000 Cost$4,200,000 Previous annual depreciation ($42,000,000 ÷ 10 years) x 2 years 8,400,000 Depreciation to date (2009-2010)

33,600,000 Book value ÷ 3 Estimated remaining life (2011-2013)

$11,200,000 New annual depreciation

2011 income would include only depreciation expense of $11,200,000.

2011 expense using Heather's approach:

$42,000,000 Cost

11-78

Ethics Case 11-10


$4,200,000 Previous annual depreciation ($42,000,000 ÷ 10 years) x 2 years 8,400,000 Depreciation to date (2009-2010)

33,600,000 Book value12,900,000 Write-down20,700,000 New depreciable base

÷ 3 Estimated remaining life (2011-2013)$ 6,900,000 New annual depreciation

2011 income would include depreciation expense of $6,900,000 and an asset write-down of $12,900,000 for a total income reduction of $19,800,000.

Using Heather's approach, 2011's before tax income would be lower by $8,600,000 ($19,800,000 - 11,200,000).

11-79



Requirement 2Discussion should include these elements.

Facts:GAAP provides guidance for recording impairment losses on partial write-downs

of property, plant, and equipment and intangible assets remaining in use. Assets should be written down if there has been a significant impairment of value such as in decreased product demand and full recovery of book value through use or resale is not expected. Although the decision and computation to record an impairment loss often is very subjective and difficult to measure, Heather is able to estimate an equipment impairment of $12,900,000, presumably using the best information available. The simple revision in service life approach is clearly an effort to enhance net income on the part of the CEO.

Ethical Dilemma:Is Heather's obligation to challenge the questionable application of revision in

service life more important than her obligation to her boss and to the company's effort to reflect a favorable net income?

Who is affected?

HeatherCEO and other managersOther employeesShareholdersPotential shareholdersCreditorsCompany auditors

Requirement 1

By changing its depreciation method, a company can shift reported income between periods. For example, a shift from an accelerated method to the straight-line method increases income in the year of the change. However, in some future period or periods, income will be lower than it would have been if the change had not been made.

This is not an effective way to manage earnings because the effect on income of switching from one method to another must be disclosed.

11-80

Judgment Case 11-11


Requirement 2A company can manage earnings by changing the estimated useful lives of

depreciable assets. For example, reducing useful lives causes a decrease in income in one or more years including the year of the change, and increases income in some future years.

This is not an effective way to manage earnings because the effect on income of changing useful lives, if material, must be disclosed.

Requirement 3One possible approach to answering this question is to assume a company

overstates its impairment loss. For example, assume that the book value of depreciable assets is $20 million. The fair value of these assets is estimated to be $13 million, indicating an impairment loss of $7 million. If these assets are written down to $8 million, the company has effectively shifted $5 million in pre-tax income from the current period to future periods. By writing down the assets to $8 million instead of $13 million, future depreciation is $5 million less than it would have been with a more appropriate write-down.

Transaction Disposition

1. Transaction is correctly recorded as repairs and maintenance expense.


3. Transaction is incorrectly recorded. The amount should be capitalized as part of the cost of the plant.

4. Transaction is incorrectly recorded. The amount should becapitalized either as part of the cost of the plant or as a reduction in the accumulated depreciation of the plant.



7. Transaction is incorrectly recorded. The amount should becapitalized as equipment.

8. Transaction is correctly recorded as repairs and maintenance

11-81

Judgment Case 11-12


expense.

Requirement 1($ in millions)Property, plant and equipment (Cost):

Balance, beginning of 2008 $19,208 Add: Acquisitions during 2008 4,597 Less: Balance end of 2008 (23,487) Dispositions during 2008 $ 318

Property, plant and equipment (Accumulated depreciation):

Balance, beginning of 2008 $ 9,211 Add: Depreciation for 2008 1,919 Less: Balance end of 2008 (10,963) Accumulated depreciation of 2008 dispositions $ 167

Gain (loss) on 2008 dispositions:

Cost of dispositions $ 318 Less: Accumulated depreciation of dispositions (167) Book value of dispositions $ 151

Proceeds from dispositions $982 Less: Book value of dispositions (151)Gain on 2008 dispositions $831

Requirement 22008 depreciable assets:

Property, plant and equipment $23,487 Less: Land (575) Cost of depreciable assets $22,912

Assuming that Caterpillar uses the straight-line depreciation method,

$22,912 ÷ $1,919 (2008 depreciation) = 11.94 years.

The approximate average service life of Caterpillar's depreciable assets is 12 years.

11-82

Real World Case 11-13


Requirement 3

The following was taken from the company’s 2008 financial statements. Your results could differ if the company changes any of its policies in years after 2008.

a. The company's depreciation and depletion policies, disclosed in Note 1. Summary of Significant Account Policies, are as follows:Depreciation and depletion of all capitalized costs of proved crude oil and natural gas producing properties, except mineral interests, are expensed using the unit-of-production method generally by individual field as the proved developed reserves are produced. Depletion expenses for capitalized costs of proved mineral interests are recognized using the unit-of-production method by individual field as the related proved reserves are produced. Periodic valuation provisions for impairment of capitalized costs of unproved mineral interests are expensed.

Depreciation and depletion expenses for mining assets are determined using the unit-of-production method as the proven reserves are produced. The capitalized costs of all other plant and equipment are depreciated or amortized over their estimated useful lives. In general, the declining-balance method is used to depreciate plant and equipment in the United States; the straight-line method generally is used to depreciate international plant and equipment and to amortize all capitalized leased assets.

b. Expenditures for maintenance (including those for planned major maintenance projects), repairs and minor renewals to maintain facilities in operating condition are generally expensed as incurred. Major replacements and renewals are capitalized.

Requirement 2

Cadbury Schweppes values its property, plant and equipment at cost less accumulated depreciation. IFRS also allows the valuation of these assets at fair value (revaluation). If revaluation is chosen, all assets within a class of PP&E must be revalued on a regular basis. U.S. GAAP does not allow the revaluation option. Property, plant and equipment must be valued at cost less accumulated depreciation.

Requirement 1

The statement of cash flows reports depreciation and amortization of $769 million.

11-83

Real World Case 11-14

IFRS Case 11-15

Analysis Case 11-16


Requirement 2Dell uses the straight-line depreciation method over the estimated economic lives

of the assets, which range from ten to 30 years for buildings and two to five years for all other assets.

Requirement 1 (£ in millions)

March 31, 2009 Before AfterRevaluation Revaluation

Equipment £783 x 280/266 = £824Accumulated depreciation 517 x 280/266 = 544

Book value £266 x 280/266 = £280

The entry to revalue the equipment and the accumulated depreciation accounts (and thus the book value) is:

Equipment (£824 – 783) 41 Accumulated depreciation (£544 – 517) 27 Revaluation surplus–OCI (£280 – 266) 14

Requirement 2Under U.S. GAAP, property, plant, and equipment is valued at cost less

accumulated depreciation. U.S. GAAP prohibits revaluation.

Requirement 3IFRS requires that each component of an item of property, plant, and equipment

must be depreciated separately if its cost is significant in relation to the total cost of the item. In the U.S., component depreciation is allowed but is not often used in practice.

Requirement 4Per note 2, BA reviews the residual values of its depreciable assets annually.

This annual review is required under IFRS. Under U.S. GAAP, there is no requirement to review residual value each year.

11-84

British Airways Case

http://en.wikipedia.org/wiki/Pound_sign









British Airways Case (continued)

Requirement 5Per note 2, goodwill is tested for impairment annually and at other times when

such indicators exist. Other non-financial assets are tested for impairment when there are indicators that the carrying amount (book value) may not be recoverable.

This approach is similar to U.S. GAAP. However, under IFRS, assets must be assessed for indicators of impairment at the end of each reporting period.

Requirement 6In note 19, BA states that a goodwill impairment review is carried out at the level

of a ‘cash-generating unit,’ defined as the smallest identifiable group of assets, liabilities and associated goodwill that generates cash inflows that are largely independent of the Group’s other cash flows from other assets or groups of assets. The carrying value (book value) of the cash-generating unit is compared to the recoverable amount. If the carrying value exceeds the recoverable amount, goodwill is considered impaired. The amount of impairment loss is measured as the difference between the carrying value and the recoverable amount. The recoverable amount is the higher of fair value less costs to sell and value in use (present value of estimated future cash flows).

Under U.S. GAAP, impairment is assessed at the level of the reporting unit – a segment or a component of an operating segment for which discrete financial information is available. The measurement of an impairment loss is a two-step process. Step 1 compares the fair value of the reporting unit with its book value. A loss is indicated if fair value is less than book value. If step 2 is necessary, an impairment loss is measured as the excess of book value over the implied fair value of goodwill. The implied fair value of goodwill is calculated in the same way that goodwill is determined in a business combination. That is, it’s a residual amount measured by subtracting the fair value of all identifiable net assets from the purchase price using the unit’s previously determined fair value as the purchase price.

11-85


British Airways Case (concluded)

Requirement 7

(£ in millions) Revaluation expense 15 Landing rights (£205 – 190) 15

11-86



Chap 011

Documents

Transcript of Chap 011