Chapter 11: Depreciation, Impairments and Depletion

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Chapter 11 Depreciation, Impairments and
Depletion
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Depreciation Concept

• Depreciation is a means of cost allocation
• It is not a method of valuation
• Depreciation involves
• Allocating cost of tangible assets
• To expense
• In a systematic and rational manner
• To periods expected to benefit from use of the
  asset

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Factors in the Depreciation Process

• Questions to be answered
• What is the depreciable base of the asset?
• What is the assets useful life?
• What method of depreciation is best for the asset
  in question?

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Depreciable Base

• Depreciable base
• Dollar amount subject to depreciation
• Determined as
• Original cost of the asset less
• Estimated salvage or disposal value

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Estimated Service Lives

• Service life physical life not the same
• Service life affected by
• Physical factors
• Economic factors
• Inadequacy
• Asset can not meet current demand
• Supercession
• By a better asset
• Obsolescence
• Other factors

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Depreciation Methods Overview
Depreciation Methods
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Depreciation Methods Straight-Line

• Function of time rather than usage
• Results in equal amount of depreciation expense
  for a given period
• Depreciation Expense is computed as
• Cost Salvage Value
• Estimated Life

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Depreciation Methods Activity

• Function of usage rather than time
• Estimated life is in terms of total input/output
  of asset
• Depreciation expense is computed as
• Cost Salvage Value x Input/Output this period
• Total Estimated Input/Output

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Depreciation Methods Decreasing Charge
(Accelerated)

• Methods result in
• Higher depreciation expense in earlier years
• Lower charges in the later years
• Decreasing charge methods
• Declining balance (DDB)
• Sum-of-the-years-digits (SYD)

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Depreciation Methods Declining Balance

• Salvage value not deducted from base
• Depreciation rate
• Some multiple of SL rate
• Depreciation rate X assets book value (BOP)
  depreciation expense
• Book value decreases over time
• Result decreasing amount of depreciation
  expense
• Assets book value can never be less than
  estimated salvage value

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Depreciation Methods Sum-of-the-Years Digits

• Use fraction multiplied by base to arrive at
  depreciation expense
• Fraction is
• Numerator
• Number years remaining in assets life at BOP.
• Denominator
• Sum of years in the life
• Example 1st year depreciation expense for 5
  year life property
• (Cost Salvage value) X 5 (years remaining)
  / 15
• 15 54321

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Group and Composite Depreciation Methods

• Group method
• Collection of similar assets
• Approximate same useful lives
• Composite method
• Applied to a collection of dissimilar assets
• Different useful lives
• Composite depreciation rate
• Total of annual depreciation for all assets
• Total cost of all assets

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Partial Year Depreciation

• Asset bought sometime during period
• Partial depreciation charge is required.
• Procedure
• Determine depreciation for full period
• Allocate amount between periods affected

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Partial Year Depreciation

• Conventions
• Half-year
• First of month
• End of month

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Revision of Depreciation Estimates

• Determination involves initial estimates
• Life
• Salvage value
• Revise estimates re-compute depreciation
• Remaining BV Estimated Salvage Value
• Remaining Estimated Life
• Revised depreciation expense applied
  prospectively to remaining life of asset
• Accounting change in estimate disclosure

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Impairments

• Impairment occurs when
• Carrying amount of asset is not recoverable AND
• Write-off is needed.
• Recoverability test determines if an impairment
  has occurred

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Impairments The Recoverability Test
Impairment?
Sum of expected future net cash flows from use
and disposal of asset is less than the carrying
amount
Sum of expected future net cash flows from use
and disposal of asset is equal to or more than
the carrying amount
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Impairments Measuring Loss
Loss Carrying amount less Fair value of asset
Does an active market exist for the asset?
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Impairment Accounting
Impairment has occurred
1. Loss Carrying value less Fair value 2.
Depreciate new cost basis 3. Restoration of loss
is NOT permitted
1. Loss Carrying value less Fair Value
less cost of disposal 2. No depreciation
taken 3. Restoration of loss is permitted
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Graphic of Accounting for Impairments
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Exercises Problems

• E11-1 E11-4
• E11-9 E11-12
• E11-16 E11-18