Intermediate I: CH11 Depreciation, Goodwill,

1
Intermediate ICH11 Depreciation, Goodwill,
Impairments
2
What is Depreciation?

• An allocation of cost of LT assets to expense in
  a systematic rational manner
• Theory Matching
• Not
• Decline in Market Value

3
Depr. Vs. Amort. Vs. Depl.

• Depr on PPE
• several methods SL, SYD, DDB, Activity
• Amortization
• Write down of Intangibles
• Almost always use SL, no separate Accum.
• Depletion
• Write down of Natural Resources
• Almost always use Activity Method

4
Issues

• Depreciable base
• Cost Salvage
• Useful life
• Method/pattern of cost allocation
• Activity (Units of Production)
• SL
• SYD
• DDB
• Should follow the pattern of benefits

5
Straight Line

• (C-S)/Useful Life this yrs depre.
• Rationale
• Equal amount each period
• Assumes equal benefits over time
• Example -- Building?

6
Sum of the Years Digits

• If 5 yr life
• SYD denominator n(n1)/2
• 5 (6)/2 15
• Yr 1 5/15 (C- S) depr1
• Yr 2 4/15 (C-S) depr2
• Yr 3 3/15 (C-S) depr3
• Yr 4 2/15 (C-S) depr4
• Yr 5 1/15 (C-S) depr5
• Rationale
• More benefits in early yrs --

7
Double Declining Balance

• Usually 200 of SL rate
• 5 yrs 1/5 20 X 2 40
• Rate is applied first year times COST
• Yr 1 40 X cost Depreciation
• Yr 2 40 X Remaining Book Value.
• . ETC Force the last years depreciation to
  make the ending BV equal salvage value .. P. 524
• Rationale More benefits in early years.

8
Activity Method

• Rate (C S )/ Total Est. Activity
• Rate X This years activity This yrs depr
• OR (C-S) (This yr Activity/Total Activity)
• Rationale
• Good method when usage varies greatly from year
  to year
• Example Truck wears out more gt mileage

9
Group or Composite Depr.

• Group Similar Composite Diverse assets
• Purpose To minimize record keeping
• P. 529 example SL approach.
• Disadv. of GROUP approach
• P. 529 entry
• Record cash and remove Orig Cost
• PLUG figure for A/Depr
• Never any GAIN or LOSS

10
Partial Period Depreciation

• SL Fraction of yr X annual amount
• Activity Method
• Less activity automatic
• SYD -- bought 3/4 into the year
• 1st do table of whole yrs depre
• 2nd year 3/4 of first table line, 1/4 of second
  etc. SEE PAGE 534
• DDB -- can do as above or shortcut in Footnote p.
  534

11
Ex11-3 Bought Oct 1 - SLine

• Cost115,000 Salv 5,000
• 10yrs useful life 220,000 units.
• (115,000 5,000) 110,000/10 11,000 /yr.
• 1st year 11,000 3/12 2750
• 2nd yr 11,000

12
Ex11-3 Bought Oct 1 - SYD

• Cost115,000 Salv 5,000
• 10yrs useful life 220,000 units.
• (10 11) /2 55
• IF FULL YRS
• 1st yr 10/55 X 110,000 20,000
• 2nd yr 9/55 X 110,000 18,000
• PARTIAL
• 1st ¼ X 20,000 5,000
• 2nd ¾ X 20,000 (1/4 18,000)
• 15,000 4,500 19,500

13
Ex11-3 Bought Oct 1 - DDB

• Cost115,000 Salv 5,000
• 10yrs useful life 220,000 units.
• 1/10 times 2 20
• 
  REM BV
• 1st yr 20 X 115,000 X ¼ 5750 109,250
• 2nd yr 20 X 109,250 21850

14
Ex11-3 Bought Oct 1 - 150DB

• Cost115,000 Salv 5,000
• 10yrs useful life 220,000 units.
• 1/10 times 1.5 15
• 
  REM BV
• 03 15 X 115,000 X ¼ 4312.50 110,687.50
• 04 15 X 110,687.50 16603
• 
  (rounded)
• This is short cut approach.

15
Ex11-3 Bought Oct 1 - Activity

• Cost115,000 Salv 5,000
• 10yrs useful life 220,000 units.
• 110,000/ 220,000 units .50/unit
• Yr 1 10,000 x .50 5000
• Yr 2 25,000 x .50 12500

16
Ex11-9 Coal Mine Depl.

• Cost of Mine 3,600,000
• Max tons 900,000 tons over 4 yrs
• Extracted this yr 220,000 tons
• 3,600,000/ 900,000 tons 4/ton
• 220,000 X 4/ton 880,000
• OR 3,600,000 X 220/900
• 3,600,000 X .24444 880,000
• Depletion Exp. 880,000
• Accum. Depletion 880,000

17
Revising depreciation

• What if life, salvage or both later appear to be
  unreasonable based on new evidence
• To revise
• Take remaining BV over remaining future life.
• Do NOT revise prior years depreciation.

18
Revising depreciation (2)

• Orig Cost of 220,000 Salvage 20,000
• Life est 10 yrs
• Do depreciation for 3 yrs SLine
• 200,000/ 10 20,000 per year for 3 yrs
• What is CV?
• Orig cost of 220 60 160,000
• Now think total life only 5 yrs, 10,000 Salv.
• (160,000-10,000)/2 75,000
• If knew 5 yrs all along -gt 210,000/5 42000/yr
• PROSPECTIVE NO RETROACTIVE FIX

19
PPE Impairments

• PPE at H/Cost less Accum. Depre
• Write down the asset ONLY when Materially
  Impaired, not temporary
• SCREENING Do write down until BV gt than all
  future cash flows, undiscounted.
• No way, Jose test .. Will never recover cost
• Not recoverable? -- write down to MV.
• Impairment Loss is NOT extraordinary.
• Dr. Impairment loss Cr. A/Depr.

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Vs. Intangible Impairments p. 544

• Tangibles When obviously piece of junk
• Intangibles other than goodwill MV only test
  every year
• Goodwill .. Annually look at PV discounted cash
  flows, new MV
• Items to be sold .. Write down, stop
  depreciating, move to Current Assets or Other
  assets

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Subsequent expenditures

• Ordinary repair keeps in good repair, doesnt
  really add to overall value
• Dr. Repairs Expense
• Betterments/additions/improvements
• Dr. Asset directly
• Replacement / Extraordinary repair extends life
  beyond typical
• Choice 1 Remove old BV .. Dr. new to Asset
• Choice 1 Move common Dr. Accum Depr
• Rearrangement? Expense vs. Asset??

22
Accounting Changes

• Change in estimate
• Prospectively
• Change in Acct Prin
• Old Cum. Effect Retroactive in future
• Error
• Retroactive Restatement .. Adj R/E bal
• Change from XXX to FIFO?
• Change from ridiculous to accurate est?

23
Ex11-13 Change in Estimate

• Bought Patent for 18M beg. of 1999
• Now end 2003. Orig used 9 yr life.
• 18M/ 9 2M /yr times ?? Years
• 4 past yrs .. Dont count 03 depr entry not
  done yet New total 6. 2 more
• Cost 18 M less 8M Rem. BV of 10M
• RULE Remaining DBase over Remain. yrs
• 10 M / 2 yrs 5M
• Patent Amortization 5M
• Patent
  5M

24
Ex11-14 (1) 1/1/01 Computer

• Cost 40,000 SL, 5 yr life, 4000 Salvage
• 1/1/03 life changed to total of 10 yrs
• Prior Depr (40,000 4000)/ 5 7200/yr
• 7200 X 2 yrs 14,400
• Current BV 40,000 -14,400 25,600
• New (25,600 900)/ 8 yrs 3087.50
• Entry Depr Exp 3087.50
• A/Depr 3087.50

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Ex11-14 (2) SYD Revision

• Cost 40,000 SYD, 5 yr , 4000 Salvage
• 1/1/03 life changed to total of 10 yrs
• 5/15 X 36,000 12,000
• 4/15 X 36,000 9,600 21,600
• Bvalue 40,000 21,600 18,400
• Depr base 18,400 900 17,500--gt8yrs
• N(N1)/2 8(9)/2 36
• 8/36 X 17,500 3889
• Dr. Depr Ex 3889 cr. A/Depr 3889

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Ex11-15 Machine purc 2000

• Cost 1,200,000 Salvage 200,000
• Used SYD over 10 yrs
• (10)(11)/2 55 Depr Base 1M
• 01 10/55 X 1,000,000 181,818
• 02 9/55 X 1,000,000 163,636
• 03 8/55 X 1,000,000 145,455
• 27/55 X 1,000,000 490,909 vs SL
  300,000
• Past Depreciation Overstated .. NI Under
• A/Depr 190,909
• Cumulative Effect of Change 190,909 ????
• cr. R/Earnings Retro new approach

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Ex11-15 Machine purc 2000

• Answer 490,909 vs SL 300,000
• A/Depr 190,909
• REarnings 190,909
• And,
• Depr Expense 100,000
• A/Depr 100,000
• 1m/ 10 yrs

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Goodwill

• Common Sense Customers really like you
• Never on books unless bought another Co.
• Definition Excess of Purchase Price over FV of
  Net Identifiable Assets
• Paid 10M BV Assets 9M Liab 1M MV of
  Assets 8M
• GOODWILL
• Paid 10M
• Net FV 7M Goodwill 3M
• True Asset or Overpmt?

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Goodwill Amortization

• Used to amortize over 40 yrs
• New rules say life is indefinite (like land)
• Write down only if IMPAIRED
• New FV vs. BValue
• Lumpy writeoffs vs. smooth SLine amortization
  under old system

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Tax Issues

• Depreciation method (MACRS) used for tax purposes
  is not the same method used for financial
  reporting purposes.
• Tax allows depletion based on times the value
  of the resource instead of the cost---
• May have more depletion over time than the
  original cost
• NOT allowed for book purposes.

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E11-18(1) Impairment of Tangible PPE

• 3 restaurants with declining profit
• BV 6.2M
• Estimated Undiscounted future cash 4M
• Fair Value 3.5M
• Step one Recoverability test
• IS IMPAIRED 4M will not return full cost
• Step two IF impaired write down to FV
• 6.2 less 3.5M 2.7M impairment loss

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E11-18(2) Impairment of Tangible PPE

• BV 6.2M
• Est. Undiscounted future cash 6.5M
• Fair Value 5M
• Step one Recoverability test
• IS NOT IMPAIRED 6.5 will return full cost
• Step two No write-down if not impaired
• Doesnt matter that BV of 6.2M is greater than
  FV of 5M by 1.2M do not record this as 1.2M
  loss

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E11-19(1) Impairment of Goodwill

• Alliant bought Centerpoint for 300M of which
  50M was allocated to G/Will
• Tests for impairment end of each yr
• FV of Centerpoint 220M
• FV of n/assets excluding G/will 200M
• BV of Centerpoint including G/will 250M
• Implied value of Gwill 220-200 20M
• BV of Gwill 50M
• Write down by 30M

34
E11-19(2) Impairment of Goodwill

• Alliant bought Centerpoint for 300M of which
  50M was allocated to G/Will
• Tests for impairment end of each yr
• FV of Centerpoint 270M
• FV of n/assets excluding G/will 200M
• BV of Centerpoint including G/will 250M
• Implied value of Gwill 270-200 70M
• BV of Gwill 50M
• Gwill is not Impaired no write down

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Costs after acquisition Revenue vs. Capital
Expenditure

• ORDINARY REPAIRS
• Revenue Expenditures -- dr. to EXPENSE
• EXTRAORDINARY REPAIRS
• Extends life beyond normal -- dr. A/Depr.
• BETTERMENTS or ADDITIONS
• -- dr. Asset account
• REARRANGEMENTS
• Expense Or Dr. Intangible Asset if Probable
  Future Benefits???

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E11-20Subsequent Expenditures

• Heating system replaced for 300,000
• Extraordinary repair
• A/Depr 300,000
• Cash 300,000
• Replaces benefits, doesnt increase overall
  value
• New wing added for 750,000 Betterment or
  addition
• Building 750,000
• Cash 750,000
• Increases value of overall asset

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E11-20 Continued

• Annual Building maintenance
• Basic repairs
• Repairs Expense 12,000
• Cash 12,000
• Maintains but does not increase future service
  potential
• Rearrangement of machinery increases productive
  capacity
• Rearrangement (Intangible Asset) 50,000
• Cash 50,000

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Asset Retire. Oblig. P. 467-8

• Common ex Environmental Cleanup
• Put liab on now and dr. Asset ?? too
• Recent FASB concept of Expected Cash flow .. P.
  468 more than one guess
• Probability weighted liab. then take PValue using
  credit adj risk free rate. (DISCUSS)
• Dr. to Asset is then depr/amortized over asset
  life ..
• Impairment write-off??

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Retirement Replacement Depr. In Appendix

• No longer allowed unless immaterial
• Utilities .. Phone lines
• No systematic depreciation when poles replaced
  either original cost to depreciation (retirement
  approach) OR
• Net Cost of New pole to depreciation (rep.)
• Similar to same effect as SLine IF replace equal
  each yr otherwise could manipulate NI

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Questions?
41
Ex11-22(1)

• 500,000 100,000/ 8 yrs 50,000 X 2
• Cost 500,000
• A/Depr 100,000 BV 400,000
• Write down to 175,000 January 2003
• 175,000 25,000/ 2 75,000
• D. 175,000 BV less another 75,000 A/dep
  100,000 BV

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Ex11-22(2)

• 100,000 10,000/10 9000/yr
• 9000 X 4 yrs 36,000
• Book Value
• Cost 100,000
• A/Depr (36,000) 64,000
• Remaining BV 64,000 4000 / 4 15000 depre
• B. NEW BV 64,000 15000 49,000

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Ex11-22(3)

• 714000/15 47,600 X 3 yrs 142,800
• Book value 714,000 142,800 571,200
• 571,200 divided by 7 REMAINING YRS
• 81,600
• B. 571,200 81,600 489,600

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Ex11-22(4)

• Machine and cost to install is capitalized
• So are all rearrangement costs if you really
  believe they provide probable future benefits in
  excess of cost.
• A. Total of costs listed 147,000

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P10-6

• Southern Building FV 1.4M
• Cost of 2M A/depr of 1.2 .8 M BValue
• Exchanges for Eastern Building
• Eastern Cost of 1.6M 650,000 950,000 BV
• Eastern gives Southern 140,000 to complete
  exchange.
• IMPLIED Eastern FV must be
• 1,400,000 less 140,000 1,260,000

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P10-6 Southern Entries

• Cash 140,000
• New Bldg 1,260,000
• A/depr 1,200,000
• Old Bldg 2,000,000
• GAIN??? 600,000
• What fraction of transaction is for cashgt
• 140,000/1,400,000 10
• Leave 60,000 gain on books
• New Bldg 1,260,000 540,000 720,000

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P10-6 Eastern Entries

• New Bldg 1,400,000
• A/depr 650,000
• Old Bldg 1,600,000
• Cash 140,000
• Gain 310,000
• Boot given similar trade dont recognize any
  of the gain collapse into new asset
• 1,400,000 310,000 1,090,000

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Costs after acquisition Revenue vs. Capital
Expenditure

• ORDINARY REPAIRS
• Revenue Expenditures -- dr. to EXPENSE
• EXTRAORDINARY REPAIRS
• Extends life beyond normal -- dr. A/Depr.
• BETTERMENTS or ADDITIONS
• -- dr. Asset account
• REARRANGEMENTS
• Expense Or Dr. Intangible Asset if Probable
  Future Benefits???

49
Asset Retire. Oblig. P. 468

• Common ex Environmental Cleanup
• Put liab on now and dr. Asset too
• Recent FASB concept of Expected Cash flow
• Probability weighted liab. then take PValue.
• Dr. to Asset is then depr/amortized over asset
  life ..
• Hopefully charge fees to accum. funds to pay for
  this before closed.