Post on 23-Dec-2015
Depreciation and Depletion
Chapter11
An electronic presentation by Norman Sunderman Angelo State University
An electronic presentation by Norman Sunderman Angelo State University
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.
Intermediate AccountingIntermediate Accounting 10th edition 10th edition
Nikolai Bazley JonesNikolai Bazley Jones
3
Service LifeService Life
Service life is the measure of the number of units of service expected from the asset before its disposal.
Service life is the measure of the number of units of service expected from the asset before its disposal.
Factors Involved in Depreciation
4
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 causesFunctional causes
Factors Involved in Depreciation
5
Residual ValueResidual Value
Residual, or salvage value, is the net amount that can be
expected to be obtained when the asset is disposed.
Residual, or salvage value, is the net amount that can be
expected to be obtained when the asset is disposed.
Factors Involved in Depreciation
6
Methods of Cost Allocation
Activity (or use) methodsTime-based methods
a. Straight-lineb. Accelerated (declining charge)
(1) Sum-of-the-years’-digits (2) Declining balance
7
Depreciation Rate =Cost - Residual Value
Service Life
= $120,000 - $20,000
5 Years
Time-Based Method: Straight LineTime-Based Method: Straight Line
= $20,000 per year
Methods of Cost Allocation
8
Time-Based Method: Sum-of-the-Years’ Digits
Time-Based Method: Sum-of-the-Years’ Digits
Years of service remaining at beginning of year Years Years of service remaining at beginning of year Years RemainingRemaining
11 5 522 4 433 3 344 2255 11
Sum-of-the-Years’-Digits = Sum-of-the-Years’-Digits = 1515 15 15
Years of service remaining at beginning of year Years Years of service remaining at beginning of year Years RemainingRemaining
11 5 522 4 433 3 344 2255 11
Sum-of-the-Years’-Digits = Sum-of-the-Years’-Digits = 1515 15 15
(n + 1) n = 30 = 15
2 2
(n + 1) n = 30 = 15
2 2
Methods of Cost Allocation
9
Time-Based Method: Sum-of-the-Years’ Digits
Time-Based Method: Sum-of-the-Years’ Digits
Depreciation Book Value at Year Base Fraction Depreciation Year-End
2006 $100,000 5/15 $ 33,333 $86,6672007 100,000 4/15 26,667 60,0002008 100,000 3/15 20,000 40,0002009 100,000 2/15 13,333 26,6672010 100,000 1/15 6,667 20,000
$100,000
Residual Residual ValueValue
Residual Residual ValueValue
Methods of Cost Allocation
10
Time-Based Method: Declining-BalanceTime-Based Method: Declining-Balance
Book Value at Book Value atYear Beginning of Year Rate Depreciation Year-End
2006 $120,000 40% $ 48,000 $72,0002007 72,000 40% 28,800 43,2002008 43,200 40% 17,280 25,9202009 25,920 --- 5,920 20,0002010 20,000 --- --- 20,000
$100,000
Double-Declining BalanceDouble-Declining Balance
Residual Residual ValueValue
Residual Residual ValueValue
Methods of Cost Allocation
PlugPlugPlugPlug
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Time-Based Method: Declining-BalanceTime-Based Method: Declining-Balance
Book Value at Book Value atYear Beginning of Year Rate Depreciation Year-End
2006 $120,000 30% $ 36,000 $84,0002007 84,000 30% 25,200 58,8002008 58,800 30% 17,640 41,1602009 41,160 30% 12,348 28,8122010 28,812 --- 8,812 20,000
$100,000
150%-Declining Balance150%-Declining Balance
Residual Residual ValueValue
Residual Residual ValueValue
Methods of Cost Allocation
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Activity MethodActivity Method
Depreciation Rate =Cost - Residual Value
Total Lifetime Activity Level
= $120,000 - $20,000
10,000 hours
Assume the asset is used for 2,100 hours.Depreciation = $21,000 (2,100 hours x $10)Depreciation = $21,000 (2,100 hours x $10)
= $10 per hour
Methods of Cost Allocation
13
The credit to depreciation is usually called Accumulated Depreciation or Allowance
for Depreciation.
The credit to depreciation is usually called Accumulated Depreciation or Allowance
for Depreciation.
Recording Depreciation
14
Depreciation Expense
$
2006 2007 2008 2009 2010
During Year
Straight-Line
Sum-of-the-Years-Digits
Double-Declining-Balance
Conceptual Evaluation of Depreciation Methods
15
Book Value
$
2006 2007 2008 2009 2010
At End of Year
Straight-Line
Sum-of-the-Years-Digits
Double-Declining-Balance
Conceptual Evaluation of Depreciation Methods
16
If a company expects that repairs and maintenance costs and the total economic benefits of the asset will remain similar
each period,...
If a company expects that repairs and maintenance costs and the total economic benefits of the asset will remain similar
each period,...
Conceptual Evaluation of Depreciation Methods
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…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
18
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
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…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
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Effect of Depreciation on Rate of Return
Book Value of Asset Rate ofYear Net Income at Beginning of Year Return
2006 $12,000 $120,000 10%2007 12,000 100,000 12 2008 12,000 80,000 152009 12,000 60,000 202010 12,000 40,000 30
2006 $12,000 $120,000 10%2007 12,000 100,000 12 2008 12,000 80,000 152009 12,000 60,000 202010 12,000 40,000 30
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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.
APB Opinion No. 12 requires the following:
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A company purchased ten
cars for $20,000 each, and the
average expected life is 3
years with a residual value of $5,000 each.
Group Depreciation
23
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 in the end of the second year.
This same depreciation entry would be made at in the end of the second year.
$$200,000 200,000 –– $50,000 $50,000
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Group Depreciation
24
Three cars were sold after 2 years for $8,000 each.
Three cars were sold after 2 years 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
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Five cars were sold after 3 years for $6,000 each.Five cars were sold after 3 years 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 salvage value.value to the salvage value.
Group Depreciation
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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
Two cars were sold after 3 years for $4,800 each.Two cars were sold after 3 years for $4,800 each.
Book value = Book value = $10,000$10,000Cash received =Cash received = 9,600 9,600 LossLoss $ 400$ 400
Group Depreciation
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AnnualAsset Cost Residual Value Life Depreciation
A $25,000 $5,000 10 yrs. $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
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A company purchases a $6,000 asset with a 3-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 3-year life and no residual value on August 18. The firm uses the double-declining-balance
method.
Depreciation for Partial Periods
29
1 $6,000 x 2/3 x 4/12 = $1,3332 ($6,000-$1,333) x 2/3 = $3,111
3 ($4,667-$3,111) x 2/3 = 1,037
4 Remaining balance = $ 518
Annual Year Depreciation
Declining-Balance-MethodDeclining-Balance-Method
Depreciation for Partial Periods
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Impairment of Noncurrent Assets
The FASB issued FASB Statement No. 144 which
requires a company to review its property, plant, and
equipment for impairment.
The FASB issued FASB Statement No. 144 which
requires a company to review its property, plant, and
equipment for impairment.
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Impairment of Noncurrent Assets
Impairment occurs whenever events or changes in
circumstances indicate that the book value of a noncurrent
asset may not be recoverable.
Impairment occurs whenever events or changes in
circumstances indicate that the book value of a noncurrent
asset may not be recoverable.
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Impairment of a Noncurrent Asset
Impairment Test
If the total undiscounted cash flows are less than the book value of the asset, an
impairment loss is recognized.
Impairment Test
If the total undiscounted cash flows 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.
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Impairment of a Noncurrent Asset
On January 1, 2004, the Hall Company purchased a factory for $1 million (20-year life) and machinery for $3 million (10-year
life).
On January 1, 2004, the Hall Company purchased a factory for $1 million (20-year life) and machinery for $3 million (10-year
life).
Late in 2007, the company believes that its asset(s) may be impaired and the remaining useful life is 5 years. The company estimates
that the asset will produce cash inflows of $700,000 and incur cash outflow of $300,000
each year for the next 5 years.
Late in 2007, the company believes that its asset(s) may be impaired and the remaining useful life is 5 years. The company estimates
that the asset will produce cash inflows of $700,000 and incur cash outflow of $300,000
each year for the next 5 years.
34
December 31, 2007Factory cost $1,000,000 Less: Accumulated depreciation(4 x $50,000) (200,000)Book value $ 800,000Machinery cost $3,000,000 Less: Accumulated depreciation(4 x $300,000) (1,200,000)Book value 1,800,000Total Book Value $2,600,000
Impairment TestImpairment Test
Impairment of a Noncurrent Asset
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= 5 x $400,000
= $2,000,000
Impairment TestImpairment TestUndiscounted expected net cash flows = 5 x ($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 of a Noncurrent Asset
36
Measurement of the LossMeasurement of the Loss
Undiscounted annual cash flowsPresent value of the expectedcash flows (fair value)
= $400,000 x 3.274294
= $1,309,718 (rounded)n= 5, i = 0.16
from Table 4 in
Appendix
n= 5, i = 0.16 from Table
4 in Appendix
Book value $2,600,000 Fair value (1,309,718)Impairment loss $1,290,282
Impairment of a Noncurrent Asset
37
FASB Statement No. 121 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.
FASB Statement No. 121 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 a Noncurrent Asset
38
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 x [$1,000,000 ÷ ($3,000,000 + $1,000,000)]$1,309,718 x [$1,000,000 ÷ ($3,000,000 + $1,000,000)]$1,309,718 x [$1,000,000 ÷ ($3,000,000 + $1,000,000)]$1,309,718 x [$1,000,000 ÷ ($3,000,000 + $1,000,000)]
$1,309,718 x [$3,000,000 ÷ ($3,000,000 + $1,000,000)]$1,309,718 x [$3,000,000 ÷ ($3,000,000 + $1,000,000)]$1,309,718 x [$3,000,000 ÷ ($3,000,000 + $1,000,000)]$1,309,718 x [$3,000,000 ÷ ($3,000,000 + $1,000,000)]
Impairment of a Noncurrent Asset
39
Although FASB Statement No. 121 has been replaced by FASB Statement No. 144, the
principles it established have only changed slightly.
Although FASB Statement No. 121 has been replaced by FASB Statement No. 144, the
principles it established have only changed slightly.
Although the Statement narrows GAAP, it still allows for significant management flexibility.
Although the Statement narrows GAAP, it still allows for significant management flexibility.
Conceptual Evaluation of Asset Impairment
40
1. A mandated tax life, which is usually shorter than the economic life.
2. The acceleration of the cost recovery (except for buildings).
3. The elimination of residual value.
For an asset purchased in 1987 and later, the Modified Accelerated Cost Recovery System (MACRS) is required for tax purposes. A company’s computation of depreciation for income tax and financial reporting differ in three major respects:
Depreciation for Tax Purposes
41
On January 1, 2006, 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, 2006, 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 Exhibit l1-3 to determine the annual depreciation rate for 2006.
Examine Exhibit l1-3 to determine the annual depreciation rate for 2006.
20%20%Determine depreciation for 2006-2011.Determine depreciation for 2006-2011.
MACRS Principles
42
Changes and Corrections of Depreciation
A change in an estimate of the residual value or the service life of a currently owned asset is accounted for prospectively.
A change in the depreciation method for currently owned assets is accounted for prospectively.
Correction of an error in depreciation is treated as prior period adjustment (restatement).
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Depletion
Depletion of natural resources is calculated using the units of activity method
Any environmental costs at the end of the project are added to the cost in determining depletion per unit
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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
45
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 x 80,000 = $224,000
Depletion