Intermediate Accounting

Intermediate Accounting
Chapter 11
Depreciation, Impairments,
and Depletion
This slide deck contains animations. Please disable animations if
they cause issues with your device.
Learning Objectives
After studying this chapter, you should be able to:
1. Understand depreciation concepts and methods of
depreciation.
2. Discuss special depreciation methods and other
depreciation issues.
3. Identify the accounting issues related to asset impairment.
4. Explain the accounting procedures for depletion of natural
resources.
5. Demonstrate how to report and analyze property, plant,
equipment, and natural resources.
Copyright ©2019 John Wiley & Sons, Inc. 2
Learning Objective 1
Describe Depreciation Concepts and
Methods of Depreciation
LO 1 Copyright ©2019 John Wiley & Sons, Inc. 3

Depreciation—A Method of Cost
Allocation
Depreciation is the accounting process of allocating the
cost of tangible assets to expense in a systematic and
rational manner to those periods expected to benefit
from the use of the asset.
Allocating costs of long-lived assets:
• Fixed assets = Depreciation expense
• Intangibles = Amortization expense
• Natural resources = Depletion expense
Factors Involved in the Depreciation
Process
Three basic questions:
1) What depreciable base is to be used?
2) What is the asset’s useful life?
3) What method of cost apportionment is best for this
asset?

Factors Involved in Depreciation
Depreciable Base for the Asset
Original cost $10,000

Less: Salvage value 1,000
Depreciation base $ 9,000

Factors Involved in Depreciation
Estimation of Service Lives
• Service life often differs from physical life
• Companies retire assets for two reasons:
1. Physical factors (casualty or expiration of
physical life).
2. Economic factors (inadequacy, supersession,
and obsolescence).

Methods of Depreciation
The profession requires the method employed be “systematic
and rational.” Methods used include:
1. Activity method (units of use or production).
2. Straight-line method.
3. Decreasing-charge methods (accelerated)
a. Sum-of-the-years’-digits.
b. Declining-balance method.
4. Special depreciation methods:
a. Group and composite methods.
b. Hybrid or combination methods.
Activity Method
Cost of crane $500,000
Stanley Coal Estimated useful life 5 years
Mines Facts Estimated salvage value $ 50,000
Productive life in hours 30,000 hours
Illustration: If Stanley uses the crane for 4,000 hours the first year,
the depreciation charge is:

Straight-Line Method
Illustration: Stanley computes depreciation as follows:

Decreasing-Charge Methods
Sum-of-the-Years’-Digits. Each fraction uses the sum of the years

as a denominator (5 + 4 + 3 + 2 + 1 = 15). The numerator is the
number of years of estimated life remaining as of the beginning of
the year.
Alternate sum-of-the-
years’ calculation

Sum-of-the-Years’-Digits
Depreciation Schedule
Depreciation Remaining Depreciation Depreciation Book Value,
Year Base Life in Years Fraction Expense End of Year
1 $450,000 5 5/15 $150,000 $350,000
2 450,000 4 4/15 120,000 230,000
3 450,000 3 3/15 90,000 140,000
4 450,000 2 2/15 60,000 80,000
5 450,000 1 1/15 30,000 50,000a
15 15/15 $450,000
aSalvage value.

Decreasing-Charge Methods
Declining-Balance Method
• Utilizes a depreciation rate (percentage) that is some multiple of

the straight-line method.
• Does not deduct the salvage value in computing the depreciation
base.

Declining-Balance Method
Depreciation Schedule
Book Value Rate on Balance
of Asset Declining Depreciation Accumulated Book Value,
Year First of Year Balancea Expense Depreciation End of Year
1 $500,000 40% $200,000 $200,000 $300,000
2 300,000 40% 120,000 320,000 180,000
3 180,000 40% 72,000 392,000 108,000
4 108,000 40% 43,000 435,200 64,800
5 64,800 40% 14,800b 450,000 50,000
a Based on twice the straight-line rate of 20% ($90,000/$450,000 = 20%; 20% × 2 = 40%).
b Limited to $14,800 because book value should not be less than salvage value.

Discuss Special Depreciation Methods
and Other Depreciation Issues

Special Depreciation Methods and
Other Issues
Special Depreciation Methods
Two methods of depreciating multiple-asset accounts exist:
• Group method used when the assets are similar in nature and
have approximately the same useful lives.
• Composite method used when the assets are dissimilar and
have different lives.
Choice of method depends on the nature of the assets involved.
The computation for group or composite methods is essentially the
same: find an average and depreciate on that basis.
Group and Composite Methods
Depreciation Calculation
Illustration: Mooney Motors establishes the composite
depreciation rate for its fleet of vehicles as shown below.

Group and Composite Methods
Journal Entry
If Mooney retires an asset before or after the average service
life of the group is reached, it buries the resulting gain or loss
in the Accumulated Depreciation account.
Illustration: Suppose that Mooney Motors sold one of the
campers with a cost of $5,000 for $2,600 at the end of the
third year. The entry is:
Accumulated Depreciation 2,400
Cash 2,600
Cars, Trucks, and Campers 5,000
Hybrid or Combination Methods
Companies are also free to develop tailor-made depreciation
methods, provided the method results in the allocation of an
asset’s cost over the asset’s life in a systematic and rational
manner.

Other Depreciation Issues
1. How should companies See slides for
compute depreciation for LO 1
partial periods?
2. Does depreciation provide for Funds for the
the replacement of assets? replacement of
assets come from
revenues.
3. How should companies
handle revisions in
depreciation rates?

Other Depreciation Issues
Revision of Depreciation Rates
• Changes in estimates are a continual and inherent
part of any estimation process.
• Accounted for in the current period and prospective
periods.
• No change to previously reported results.

Arcadia HS, purchased equipment for $510,000 which was
estimated to have a useful life of 10 years with a residual
value of $10,000 at the end of that time. Depreciation has
been recorded for 7 years on a straight-line basis. In 2020
(year 8), it is determined that the total estimated life should
be 15 years with a residual value of $5,000 at the end of that
time.
Questions:
• What is the journal entry to correct the No Entry
prior years’ depreciation? Required
• Calculate depreciation expense for 2020.
Calculation of Book Value After 7 Years
Equipment cost $510,000
Salvage value − 10,000
Depreciable base 500,000
Useful life (original) ÷ 10 years
Annual depreciation $ 50,000 × 7 years = $350,000
First, establish net book value at date of change in estimate.
Balance Sheet (Dec. 31, 2019)

Equipment $510,000
Accumulated depreciation 350,000
Net book value (NBV) $160,000

Calculation of Depreciation Expense for 2020
Net book value $160,000
Salvage value (new) − 5,000
Depreciable base 155,000
Useful life (original) ÷ 8 years
Annual depreciation $ 19,375
Journal entry for 2020

Depreciation Expense 19,375

Identify the Accounting Issues Related
to Asset Impairment

Impairments
Recognizing Impairments
Write-off of long-lived assets.
Events leading to an impairment:
• A significant decrease in the fair value of an asset.
• A significant change in the manner in which an asset is used.
• A significant adverse change in legal factors or in the business
climate that affects the value of an asset.
• An accumulation of costs in excess of the amount originally
expected to acquire or construct an asset.
• A projection or forecast that demonstrates continuing losses
associated with an asset.
Impairments
Measuring Impairments
1. Review events for possible impairment.
2. If the review indicates impairment, apply the recoverability
test. If the sum of the expected future net cash flows from
the long-lived asset is less than the carrying amount of the
asset, an impairment has occurred.
3. Assuming an impairment, the impairment loss is the
amount by which the carrying amount of the asset exceeds
the fair value of the asset. The fair value is the market
value or the present value of expected future net cash
flows.

Accounting for Impairments
Loss reported as part of

income from continuing
operations, in the “Other
expenses and losses”
section.

Impairment—Example 1
M. Alou Inc. has equipment that it reviews for possible impairment.
The equipment’s carrying amount is $600,000 ($800,000 cost less
$200,000 accumulated depreciation). Alou determines the
expected future net cash flows (undiscounted) from the use of the
equipment and its eventual disposal to be $650,000. Determine
whether an impairment has occurred.
Expected future cash flows $650,000
Carrying value of asset:
Cost $800,000
Accumulated depreciation − 200,000 600,000
$ 50,000
No Impairment
M. Alou Inc. has equipment that, due to changes in its use, it reviews
for possible impairment. The equipment’s carrying amount is
$600,000 ($800,000 cost less $200,000 accumulated depreciation).
Alou determines the expected future net cash flows (undiscounted)
from the use of the equipment and its eventual disposal to be
$580,000. Determine whether an impairment has occurred.
Expected future cash flows $580,000
Cost $800,000
− $ 20,000
Impairment
Measurement of Loss
The recoverability test indicates that the expected future net cash
flows of $580,000 from the use of the asset are less than its carrying
amount of $600,000. Therefore, an impairment has occurred.
Assume this asset has a fair value of $525,000. Determine the
impairment loss, if any.
Fair value of equipment $525,000
Cost $800,000
− $ 75,000
Impairment Loss
Loss Journal Entry
Fair value of equipment $525,000
Cost $800,000
− $ 75,000
M. Alou records the impairment loss as follows:

Loss on Impairment 75,000

Impairments
Restoration of Impairment Loss
After recording an impairment loss:
• Reduced carrying amount becomes its new cost basis
• No change in new cost basis except for depreciation
or amortization in future periods or for additional
impairments
• No restoration of impairment loss for an asset held
for use as new cost basis puts impaired asset on an
equal basis with other assets that are unimpaired

Impairments
Impairment of Assets to Be Disposed Of
Assets held for disposal are like inventory; companies
• Should report at lower-of-cost-or-net realizable value
• Can write up or down an asset held for disposal in
future periods, as long as carrying value after write-
up never exceeds carrying amount of asset before
impairment
• Should report losses or gains related to impaired
assets as part of income from continuing operations

Explain the Accounting Procedures for
Depletion of Natural Resources

Depletion
Natural resources, often called wasting assets, include
petroleum, minerals, and timber.
They have two main features:
1. complete removal (consumption) of the asset, and
2. replacement of the asset only by an act of nature.
Depletion is the process of allocating the cost of natural
resources.

Depletion
Establishing a Depletion Base
Computation of the depletion base involves four factors:
1) Acquisition cost.
2) Exploration costs.
3) Development costs.
4) Restoration costs.

Depletion
Write-off of Resource Cost
Normally, companies compute depletion (cost depletion)
on a units-of-production method (activity approach).
Depletion is a function of the number of units extracted
during the period.
Calculation:

Depletion
Illustration
MaClede Co. acquired the right to use 1,000 acres of land in
Alaska to mine for silver. The lease cost is $50,000, and the
related exploration costs on the property are $100,000.
Intangible development costs incurred in opening the mine are
$850,000. MaClede estimates that the mine will provide
approximately 100,000 ounces of silver.
1.000.000
10
100.000

Depletion
Illustration Journal Entries
If MaClede extracts 25,000 ounces in the first year, then the
depletion for the year is $250,000 (25,000 ounces x $10).
Inventory (silver) 250,000
Silver Mine 250,000
Some companies use an Accumulated Depletion account. In that
case, MaClede’s balance sheet would presented as follows:
Silver mine (at cost) $1,000,000
Less: Accumulated depletion 250,000 $750,000
MaClede debits Cost of Goods Sold when the silver is sold.

Depletion
Estimating Recoverable Reserves
• Same as accounting for changes in estimates.
• Revise the depletion rate on a prospective basis.
• Divide the remaining cost by the new estimate of the
recoverable reserves.

Depletion Khi dividend paid > Retained earning --> ly paid - in surplus
Liquidating Dividends
Dividends greater than the amount of accumulated net income.
Illustration: Callahan Mining had a retained earnings balance of
$1,650,000, accumulated depletion on mineral properties of
$2,100,000, and paid-in capital in excess of par of $5,435,493.
Callahan’s board declared a dividend of $3 a share on the
1,000,000 shares outstanding. It records the $3,000,000 cash
dividend as follows.
Retained Earnings 1,650,000
Paid-in Capital in Excess of Par 1,350,000
Cash 3,000,000
Depletion
Continuing Controversy
Oil and Gas Industry:
Full Cost Concept
• Cost of drilling a dry hole is a cost needed to find the
commercially profitable wells
Successful efforts concept
• Companies should capitalize only the costs of
successful projects

Demonstrate How to Report and
Analyze Property, Plant, Equipment,
and Natural Resources

Presentation and Analysis
Presentation of Property, Plant, Equipment, and
Natural Resources
Companies should disclose the following.
1. Depreciation expense for the period.
2. Balances of major classes of depreciable assets, by nature
and function.
3. Accumulated depreciation.
4. A general description of the method or methods used in
computing depreciation with respect to major classes of
depreciable assets.
Presentation and Analysis
Analysis of Property, Plant, and Equipment
Asset Turnover Ratio
Kellogg (in millions)
Net sales $ 12,923
Total assets, 12/28/17 16,350
Total assets, 12/24/16 15,111
Net income 1,269
Measure of a firm’s ability to

generate sales from a particular
investment in assets.

Analysis of PP&E
Profit Margin on Sales
Kellogg (in millions)
Net sales $ 12,923
Total assets, 12/28/17 16,350
Total assets, 12/24/16 15,111
Net income 1,269
Measure of the ability to generate

operating income from a particular
level of sales.

Analysis of PP&E
Return on Assets
Kellogg (in millions) Measures a firm’s
Net sales $ 12,923 success in using assets
Total assets, 12/28/17 16,350 to generate earnings.
Total assets, 12/24/16 15,111
Net income 1,269

Return on Assets
Return on assets (ROA) is computed directly by dividing
net income by average total assets. Using the Kellogg
data, we compute the ratio as shown

Intermediate Accounting

Uploaded by

Copyright:

Available Formats

Intermediate Accounting

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Intermediate Accounting

Uploaded by

Copyright:

Available Formats

Intermediate Accounting

LO 1 Copyright ©2019 John Wiley & Sons, Inc. 3

LO 1 Copyright ©2019 John Wiley & Sons, Inc. 5

Original cost $10,000

LO 1 Copyright ©2019 John Wiley & Sons, Inc. 6

LO 1 Copyright ©2019 John Wiley & Sons, Inc. 7

LO 1 Copyright ©2019 John Wiley & Sons, Inc. 9

Illustration: Stanley computes depreciation as follows:

LO 1 Copyright ©2019 John Wiley & Sons, Inc. 10

Sum-of-the-Years’-Digits. Each fraction uses the sum of the years

LO 1 Copyright ©2019 John Wiley & Sons, Inc. 11

LO 1 Copyright ©2019 John Wiley & Sons, Inc. 12

• Utilizes a depreciation rate (percentage) that is some multiple of

LO 1 Copyright ©2019 John Wiley & Sons, Inc. 13

LO 1 Copyright ©2019 John Wiley & Sons, Inc. 14

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 15

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 17

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 19

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 20

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 21

First, establish net book value at date of change in estimate.

Balance Sheet (Dec. 31, 2019)

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 23

Journal entry for 2020

LO 2 Copyright ©2019 John Wiley & Sons, Inc. 24

LO 3 Copyright ©2019 John Wiley & Sons, Inc. 25

LO 3 Copyright ©2019 John Wiley & Sons, Inc. 27

Loss reported as part of

LO 3 Copyright ©2019 John Wiley & Sons, Inc. 28

M. Alou records the impairment loss as follows:

LO 3 Copyright ©2019 John Wiley & Sons, Inc. 32

LO 3 Copyright ©2019 John Wiley & Sons, Inc. 33

LO 3 Copyright ©2019 John Wiley & Sons, Inc. 34

LO 4 Copyright ©2019 John Wiley & Sons, Inc. 35

LO 4 Copyright ©2019 John Wiley & Sons, Inc. 36

LO 4 Copyright ©2019 John Wiley & Sons, Inc. 37

LO 4 Copyright ©2019 John Wiley & Sons, Inc. 38

LO 4 Copyright ©2019 John Wiley & Sons, Inc. 39

MaClede debits Cost of Goods Sold when the silver is sold.

LO 4 Copyright ©2019 John Wiley & Sons, Inc. 41

LO 4 Copyright ©2019 John Wiley & Sons, Inc. 43

LO 5 Copyright ©2019 John Wiley & Sons, Inc. 44

Measure of a firm’s ability to

LO 5 Copyright ©2019 John Wiley & Sons, Inc. 46

Measure of the ability to generate

LO 5 Copyright ©2019 John Wiley & Sons, Inc. 47

LO 5 Copyright ©2019 John Wiley & Sons, Inc. 48

LO 5 Copyright ©2019 John Wiley & Sons, Inc. 49

You might also like