Depreciation and Depletion C hapter 11 COPYRIGHT © 2010 South-Western/Cengage Learning Intermediate...
-
Upload
dana-janel-snow -
Category
Documents
-
view
217 -
download
1
Transcript of Depreciation and Depletion C hapter 11 COPYRIGHT © 2010 South-Western/Cengage Learning Intermediate...
Depreciation and Depletion
Chapter11
COPYRIGHT © 2010 South-Western/Cengage Learning
Intermediate Accounting 11th editionIntermediate Accounting 11th edition
Nikolai Bazley JonesNikolai Bazley Jones
An electronic presentationAn electronic presentationBy Norman SundermanBy Norman Sundermanand Kenneth Buchananand Kenneth BuchananAngelo State University
2
1. Identify the factors involved in depreciation.
2. Explain the alternative methods of cost allocation, including time-based and activity-based methods.
3. Record depreciation.
4. Explain the conceptual issues regarding depreciation methods.
5. Understand the disclosure of depreciation.
6. Understand additional depreciation methods, including group and composite methods.
Objectives
3
7. Compute depreciation for partial periods.
8. Explain the impairment of property, plant, and equipment.
9. Understand depreciation for income tax purposes.
10. Explain changes and corrections of depreciation.
11. Understand and record depletion.
Objectives
4
Depreciation
Depreciation is the process of allocating the cost of an asset in a
systematic and rational manner over the periods benefited.
Depreciation is the process of allocating the cost of an asset in a
systematic and rational manner over the periods benefited.
Land is not depreciated because it generally does not have a limited life.
Land is not depreciated because it generally does not have a limited life.
5
Factors Involved in Depreciation
Asset cost Service life Residual value Method of cost
allocation
6
Asset CostAsset Cost
The cost of an asset includes all the acquisition costs a company incurs
to obtain the benefits from the asset.
The cost of an asset includes all the acquisition costs a company incurs
to obtain the benefits from the asset.
Factors Involved in Depreciation
7
Service LifeService Life
The service life of an asset is the measure of the service units expected
from the asset before its disposal.
The service life of an asset is the measure of the service units expected
from the asset before its disposal.
Factors Involved in Depreciation
8
Service LifeService Life
The factors that limit the service life of an asset can be divided into
two general categories:
The factors that limit the service life of an asset can be divided into
two general categories:
Physical causes Functional causes
Factors Involved in Depreciation
9
Residual ValueResidual Value
Residual, or salvage, value is the net amount that can be expected to be obtained when the asset is disposed at the end of its service
life.
Residual, or salvage, value is the net amount that can be expected to be obtained when the asset is disposed at the end of its service
life.
Factors Involved in Depreciation
10
Methods of Cost Allocation
Time-based methodsa. Straight-line
b. Accelerated (declining charge)1) Sum-of-the-years’-digits
2) Declining balance
Activity (or use) methods
11
Depreciation
Problem Information
12
Depreciation Rate =Cost – Residual Value
Service Life
= $120,000 – $20,000
5
Time-Based Method: Straight LineTime-Based Method: Straight Line
Methods of Cost Allocation
= $20,000 per year
13
Time-Based Method: Sum of the Years’ DigitsTime-Based Method: Sum of the Years’ Digits
Years of service Years of service Year Year remainingremaining atat
Number beginning of yearNumber beginning of year 11 5 5
22 4 4 3 3 3 3 4 4 2 2 5 5 1 1
Sum of the Years’ Digits = Sum of the Years’ Digits = 15 15
Years of service Years of service Year Year remainingremaining atat
Number beginning of yearNumber beginning of year 11 5 5
22 4 4 3 3 3 3 4 4 2 2 5 5 1 1
Sum of the Years’ Digits = Sum of the Years’ Digits = 15 15
Methods of Cost Allocation
n(n + 1) 30 2 2
n(n + 1) 30 2 2
= = 15
14
Depreciation Book Value at Year Base Fraction Depreciation Year-End
2009 $100,000 5/15 $ 33,333 $86,6672010 100,000 4/15 26,667 60,0002011 100,000 3/15 20,000 40,0002012 100,000 2/15 13,333 26,6672013 100,000 1/15 6,667 20,000
$100,000
Residual Residual ValueValue
Residual Residual ValueValue
Methods of Cost Allocation
Time-Based Method: Sum of the Years’ DigitsTime-Based Method: Sum of the Years’ Digits
15
Time-Based Method: Declining-BalanceTime-Based Method: Declining-Balance
Book Value at Book Value atYear Beginning of Year Rate Depreciation Year-End
2009 $120,000 40% $ 48,000 $72,0002010 72,000 40% 28,800 43,2002011 43,200 40% 17,280 25,9202012 25,920 — 5,920 20,0002013 20,000 — — 20,000
$100,000
Time-Based Method: Double-Declining BalanceTime-Based Method: Double-Declining Balance
Residual Residual ValueValue
Residual Residual ValueValue
Methods of Cost Allocation
PlugPlugPlugPlug
16
Time-Based Method: Declining-BalanceTime-Based Method: Declining-Balance
Residual Residual ValueValue
Residual Residual ValueValue
Methods of Cost Allocation
Book Value at Book Value atYear Beginning of Year Rate Depreciation Year-End
2009 $120,000 30% $ 36,000 $84,0002010 84,000 30% 25,200 58,8002011 58,800 30% 17,640 41,1602012 41,160 30% 12,348 28,8122013 28,812 — 8,812 20,000
$100,000
Time-Based Method: 150%-Declining BalanceTime-Based Method: 150%-Declining Balance
17
Activity MethodActivity Method
Assume the asset is used for 2,100 hours.
Depreciation = $21,000 (2,100 hours × $10)Depreciation = $21,000 (2,100 hours × $10)
Methods of Cost Allocation
Depreciation Rate =Cost – Residual Value
Total Lifetime Activity Level
= $120,000 – $20,000
10,000 hours
= $10 per hour
18
The credit entry to record depreciation is to a contra-asset
account usually called Accumulated Depreciation or Allowance for Depreciation.
The credit entry to record depreciation is to a contra-asset
account usually called Accumulated Depreciation or Allowance for Depreciation.
Recording Depreciation
19
Depreciation Expense
$
2009 2010 2011 2012 2013
During Year
Straight-Line
Sum-of-the-Years’-Digits
Double-Declining-Balance
Conceptual Evaluation of Depreciation Methods
20
Book Value
$
2009 2010 2011 2012 2013
At End of Year
Straight-Line
Sum-of-the-Years’-Digits
Double-Declining-Balance
Conceptual Evaluation of Depreciation Methods
21
If a company expects that repair and maintenance costs and the total
economic benefits of the asset will remain similar each period,…
If a company expects that repair and maintenance costs and the total
economic benefits of the asset will remain similar each period,…
Conceptual Evaluation of Depreciation Methods
22
…a similar total cost each period can be achieved through straight-line
depreciation and the similar repair and maintenance costs.
…a similar total cost each period can be achieved through straight-line
depreciation and the similar repair and maintenance costs.
Conceptual Evaluation of Depreciation Methods
23
If the company expects that benefits of having the asset will decline each year for the life of
the asset,…
If the company expects that benefits of having the asset will decline each year for the life of
the asset,…
Conceptual Evaluation of Depreciation Methods
24
…and repairs and maintenance costs are constant each period, a declining total cost will be achieved by using
accelerated depreciation.
…and repairs and maintenance costs are constant each period, a declining total cost will be achieved by using
accelerated depreciation.
Conceptual Evaluation of Depreciation Methods
25
Selection of Depreciation Method
26
Effect of Depreciation on Rate of Return
Book Value of Asset Rate of Year Net Income at Beginning of Year Return
2009 $12,000 $120,000 10%2010 12,000 100,000 12 2011 12,000 80,000 152012 12,000 60,000 202013 12,000 40,000 30
2009 $12,000 $120,000 10%2010 12,000 100,000 12 2011 12,000 80,000 152012 12,000 60,000 202013 12,000 40,000 30
27
Disclosure of Depreciation
Depreciation expense for the period Balance of major classes of depreciable assets,
by nature or function, at the balance sheet date Accumulated depreciation, either by major
classes of depreciable assets or in total, at the balance sheet date
A general description of the method or methods used in computing depreciation with respect to major classes of depreciable assets
GAAP requires the following:
28
Disclosure of Depreciation
29
IFRS vs. U.S. GAAP
IFRS require that depreciation be “systematic,” rather than “systematic and rational.”
IFRS also require that the estimated useful lives and residual values, and the depreciation method, be reviewed at least once a year. U.S. GAAP only requires this review when events or circumstances indicate that the estimate has changed.
30
IFRS vs. U.S. GAAP
IFRS also require that companies disclose the accumulated depreciation for each class of asset, not just the total amount as allowed by U.S. GAAP.
IFRS require that when an operating asset is made up of individual components that are significant with respect to the total cost of the item (e.g., an airplane and its engines) that the initial cost be allocated to the significant components and each component be depreciated separately.
31
IFRS vs. U.S. GAAP
U.S. GAAP neither requires nor prohibits a company from depreciating components.
IFRS allow a company to write up the value of its property, plant, and equipment assets to fair value. Such a write-up would affect the amount of depreciation that the company records each period.
32
A company purchased 10
cars for $20,000 each, and the
average expected service
life is 3 years with a residual value of $5,000
each.
Group Depreciation
33
To record the purchase:To record the purchase:
Cars 200,000 Cash 200,000
To record the first year’s depreciation expense:To record the first year’s depreciation expense:
Depreciation Expense 50,000 Accumulated Depreciation 50,000
This same depreciation entry would be made at the end of the second year.
This same depreciation entry would be made at the end of the second year.
$$200,000 200,000 –– $50,000 $50,00033
Group Depreciation
34
To record the disposal of three cars at the end of the second year for $8,000 each:
To record the disposal of three cars at the end of the second year for $8,000 each:
Cash 24,000Accumulated Depreciation 36,000 Cars 60,000
To record the third year’s depreciation expense:To record the third year’s depreciation expense:
Depreciation Expense 35,000 Accumulated Depreciation 35,000
25% ($200,000 25% ($200,000 –– $60,000) $60,000)
Group Depreciation
35
To record the disposal of five cars at the end of the third year for $6,000 each:
To record the disposal of five cars at the end of the third year for $6,000 each:
Cash 30,000Accumulated Depreciation 70,000 Cars 100,000
To record the fourth year’s depreciation expense:To record the fourth year’s depreciation expense:
Depreciation Expense 1,000 Accumulated Depreciation 1,000
To reduce the $11,000 book To reduce the $11,000 book value to the estimated residual value to the estimated residual
value.value.
Group Depreciation
36
The final two cars were sold for $4,800 each.The final two cars were sold for $4,800 each.
Cash 9,600Accumulated Depreciation 30,000Loss on Disposal 400 Cars 40,000
To record the disposal of two cars at the end of the fourth year for $4,000 each, and the net gain
or loss of the entire group:
To record the disposal of two cars at the end of the fourth year for $4,000 each, and the net gain
or loss of the entire group:
Cash received Cash received $ 9,600 $ 9,600Book value Book value 10,000 10,000
LossLoss $ (400)$ (400)
Group Depreciation
37
Residual Annual Asset Cost Value Life Depreciation
A $25,000 $5,000 10 years $2,000B 13,000 1,000 6 2,000C 12,000 — 4 3,000
$50,000 $6,000 $7,000
Depreciation Rate = = 14%7,000
$50,000
Composite Depreciation
38
A company purchases a $6,000 asset with a three-year life and no residual value on August 18. The firm uses the double-declining-balance
method.
A company purchases a $6,000 asset with a three-year life and no residual value on August 18. The firm uses the double-declining-balance
method.
Depreciation for Partial Periods
39
Declining-Balance-MethodDeclining-Balance-Method
Depreciation for Partial Periods
Year Computation Annual Depreciation
1 4/12 × $4,000$1,333
2 0.667 × ($6,000 – $1,333)3,113
3 0.667 × ($4,667 – $3,113)1,037
4 Remaining balance 517
$6,000
Two times straight-line rate = 2 × 1/3
40
Impairment of Property, Plant, and Equipment
GAAP requires a company to review its property, plant, and equipment
for impairment.
GAAP requires a company to review its property, plant, and equipment
for impairment.
41
Impairment occurs whenever events or changes in circumstances indicate that the book value of the property,
plant, and equipment may not be recoverable.
Impairment occurs whenever events or changes in circumstances indicate that the book value of the property,
plant, and equipment may not be recoverable.
Impairment of Property, Plant, and Equipment
42
Impairment Test
If the total expected cash flows (undiscounted) are less than the book value of
the asset, an impairment loss is recognized.
Impairment Test
If the total expected cash flows (undiscounted) are less than the book value of
the asset, an impairment loss is recognized.
Measurement of the Loss
The loss is measured as the difference between the book value of the asset and the
present value of future cash flows.
Measurement of the Loss
The loss is measured as the difference between the book value of the asset and the
present value of future cash flows.
Impairment of Property, Plant, and Equipment
43
On January 1, 2007, the Hall Company purchased a factory for $1 million (20-year life)
and machinery for $3 million (10-year life).
On January 1, 2007, the Hall Company purchased a factory for $1 million (20-year life)
and machinery for $3 million (10-year life).
Late in 2010, the company believes that its asset(s) may be impaired and the remaining
useful life is five years. The company estimates that the asset will produce cash inflows of
$700,000 and will incur cash outflow of $300,000 each year for the next five years.
Late in 2010, the company believes that its asset(s) may be impaired and the remaining
useful life is five years. The company estimates that the asset will produce cash inflows of
$700,000 and will incur cash outflow of $300,000 each year for the next five years.
Impairment of Property, Plant, and Equipment
44
December 31, 2010Factory cost $ 1,000,000 Less: Accumulated depreciation
(4 years × $50,000) (200,000)Book value $ 800,000Machinery cost $ 3,000,000 Less: Accumulated depreciation
(4 years × $300,000) (1,200,000)Book value 1,800,000Total Book Value $2,600,000
Impairment TestImpairment Test
Impairment of Property, Plant, and Equipment
45
= 5 × $400,000
= $2,000,000
Undiscounted expected net cash flows = 5 × ($700,000 – $300,000)
Years Years Cash Inflows
Cash Inflows
Cash Outflows
Cash Outflows
Because $2,000,000 is less than $2,600,000 (the book value), an
impairment loss must be recognized.
Because $2,000,000 is less than $2,600,000 (the book value), an
impairment loss must be recognized.
Impairment TestImpairment Test
Impairment of Property, Plant, and Equipment
46
Measurement of the LossMeasurement of the Loss
Present value of the expectednet cash flows (fair value) = $400,000 × 3.274294
= $1,309,718 (rounded)
n = 5, i = 0.16 from
Table 4 in the Time Value of Money Module
n = 5, i = 0.16 from
Table 4 in the Time Value of Money Module
Fair value $(1,309,718) Book value 2,600,000Impairment loss $(1,290,282)
Impairment of Property, Plant, and Equipment
47
GAAP does not specify how to record the write-down. It does indicate that the
reduced book value is to be accounted for as the new cost.
GAAP does not specify how to record the write-down. It does indicate that the
reduced book value is to be accounted for as the new cost.
Impairment of Property, Plant, and Equipment
48
Loss from Impairment 1,290,282Accumulated Depreciation: Factory 200,000Accumulated Depreciation: Machinery 1,200,000Factory (new cost) 327,429Machinery (new cost) 982,289 Factory (old cost)
1,000,000 Machinery (old cost)
3,000,000$1,309,718 $1,309,718 ×× [$1,000,000 ÷ ($3,000,000 + $1,000,000)] [$1,000,000 ÷ ($3,000,000 + $1,000,000)]$1,309,718 $1,309,718 ×× [$1,000,000 ÷ ($3,000,000 + $1,000,000)] [$1,000,000 ÷ ($3,000,000 + $1,000,000)]
$1,309,718 $1,309,718 ×× [$3,000,000 ÷ ($3,000,000 + $1,000,000)] [$3,000,000 ÷ ($3,000,000 + $1,000,000)]$1,309,718 $1,309,718 ×× [$3,000,000 ÷ ($3,000,000 + $1,000,000)] [$3,000,000 ÷ ($3,000,000 + $1,000,000)]
Impairment of Property, Plant, and Equipment
49
The recognition of an impairment loss is intended to enhance the usefulness of a
company’s financial statements.
The recognition of an impairment loss is intended to enhance the usefulness of a
company’s financial statements.
All these issues could result in earnings management. For example, management
might prefer to recognize as large a loss as possible, thereby reducing the book value to
the lowest possible amount. This would result in lower depreciation expense and
higher net income in the future.
All these issues could result in earnings management. For example, management
might prefer to recognize as large a loss as possible, thereby reducing the book value to
the lowest possible amount. This would result in lower depreciation expense and
higher net income in the future.
Conceptual Evaluation of Asset Impairment
50
IFRS vs. U.S. GAAP
IFRS use a “trigger” value, which is the (1) higher of the asset’s fair value (less costs to sell), or (2) its usage value to determine if an asset is impaired. U.S. GAAP uses undiscounted cash flows.
Typically, this should mean that international companies will recognize impairment losses earlier than U.S. companies. Under IFRS, the impairment loss is the difference between the book value and the “trigger” value defined above.
IFRS allow an impairment loss to be reversed if the value is recovered, which is not allowed under GAAP.
51
1. A mandated tax life, which is usually shorter than the economic life
2. Acceleration of the cost recovery (except for buildings)
3. Elimination of the residual value
For assets purchased in 1987 and later, the Modified Accelerated Cost Recovery System (MACRS) is required for tax purposes. A company’s computations of depreciation for income tax purposes and financial reporting purposes differ in three major respects:
Depreciation for Tax Purposes
On January 1, 2009, Melville Company purchased an asset for $200,000. The estimated economic life
and MACRS life are 8 years and 5 years, respectively. The estimated residual value is
$20,000.
On January 1, 2009, Melville Company purchased an asset for $200,000. The estimated economic life
and MACRS life are 8 years and 5 years, respectively. The estimated residual value is
$20,000.
Examine the next slide to determine the annual depreciation rates for 2009
through 2014
Examine the next slide to determine the annual depreciation rates for 2009
through 2014
MACRS Principles
52
MACRS Percentages
Determine depreciation for 2009–2014.Determine depreciation for 2009–2014.
53
54
2009 $200,000 × 20% = $ 40,0002010 $200,000 × 32% = $ 64,0002011 $200,000 × 19.20% = $ 38,4002012 $200,000 × 11.52% = $ 23,0402013 $200,000 × 11.52% = $ 23,0402014 $200,000 × 5.76% = $ 11,520
$200,000
MACRS Principles
Annual Tax Year Cost MACRS % Depreciation
55
Changes and Corrections of Depreciation
1. A change in an estimate of the residual value or the service life of a currently owned asset is accounted for prospectively.
2. A change in the depreciation method for currently owned assets is also accounted for prospectively.
3. A correction of an error in depreciation is accounted for as a prior period adjustment (restatement).
56
Depletion
Depletion of natural resources is calculated using an activity method.
Any environmental costs at the end of the project are added to the cost in determining depletion per unit.
57
Depletion
Unit Depletion Rate =Cost – Residual Value
Units
Reggio Company purchases land for $3,000,000 from which it expects to extract 1,000,000 tons of
coal, the estimated residual value is $200,000, and it mines 80,000 tons of coal in the first year.
Reggio Company purchases land for $3,000,000 from which it expects to extract 1,000,000 tons of
coal, the estimated residual value is $200,000, and it mines 80,000 tons of coal in the first year.
Unit Depletion Rate =$3,000,000 – $200,000
1,000,000 tons
58
Unit Depletion Rate =Cost – Residual Value
Units
Unit Depletion Rate =$3,000,000 – $200,000
1,000,000 tons
Unit Depletion Rate = $2.80 per ton
Depletion for Year = $2.80 × 80,000 tons = $224,000
Depletion
59
Revised Depletion Estimate
Suppose that at the beginning of the second year of operation, a new estimate indicates that the
mine has a capacity to produce another 1,600,000 tons (for a lifetime production of 1,680,000 tons).
What is the new depletion rate?
Suppose that at the beginning of the second year of operation, a new estimate indicates that the
mine has a capacity to produce another 1,600,000 tons (for a lifetime production of 1,680,000 tons).
What is the new depletion rate?
Unit Depletion Rate =($3,000,000 – $224,000) – $200,000
1,600,000 tons
= $1.61 per ton
Unit Depletion Rate =Book Value – Residual Value
Remaining Units
60
Chapter 11
Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.