1 investments in noncurrent operating assets-- utilization and retirement
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Investments in Investments in Noncurrent Noncurrent Operating Operating Assets--Assets--
Utilization and Utilization and RetirementRetirement
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Use straight-line, accelerated, use-factor, and group depreciation methods to compute annual depreciation expense.
Discuss the issues impacting proper amortization of intangible assets.
Apply the productive-output method to the depletion of natural resources.
Learning Objectives
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Incorporate changes in estimates into the computation of depreciation for current and future periods.
Identify whether an asset is impaired and measure the amount of the impairment loss, using U.S. GAAP and international accounting standards.
Account for the sale of depreciable assets in exchange for cash and in exchange for other depreciable assets.
Learning Objectives
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Learning Objectives
EXPANDED MATERIAL Compute depreciation for partial periods, using
both straight-line and accelerated methods. Understand the depreciation methods underlying
the MACRS income tax depreciation system.
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ACQUIRE long-term
operating assets
Time Line of Business Issues
CHANGE estimates
related to an asset’s life
ESTIMATE and RECOGNIZE an
asset’s use (depreciation,
amortization, and depletion)
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Time Line of Business Issues
MONITOR asset value for
possible declines
DISPOSE of a
depreciable asset
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7Factors Affecting the Periodic Depreciation Charge
• Asset cost
• Residual or salvage value
• Useful life
• Pattern of use
• Asset cost
• Residual or salvage value
• Useful life
• Pattern of use
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8Depreciation--Financial Statement Impacts
Depreciation
Balance Sheet
C. Assets XXP P & E XXXXAcc. Dep. (XX)Total XXXXLiab. XXXOE XXXTotal XXXX
IncomeStatement
Revenue XXXXCOGS XXXGr. Profit XXXDep. Exp. (XX)Net Inc. XXX
Statement ofCash Flows
From Oper. Net Inc. XXX Dep. Exp. XXNet Cash XXX
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9Depreciation--Financial Statement Impacts
Depreciation
Balance Sheet
C. Assets XXP P & E XXXXAcc. Dep. (XX)Total XXXXLiab. XXXOE XXXTotal XXXX
IncomeStatement
Revenue XXXXCOGS XXXGr. Profit XXXDep. Exp. (XX)Net Inc. XXX
Statement ofCash Flows
From Oper. Net Inc. XXX Dep. Exp. XXNet Cash XXX
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10Depreciation--Financial Statement Impacts
Indirect Method
Depreciation
Balance Sheet
C. Assets XXP P & E XXXXAcc. Dep. (XX)Total XXXXLiab. XXXOE XXXTotal XXXX
IncomeStatement
Revenue XXXXCOGS XXXGr. Profit XXXDep. Exp. (XX)Net Inc. XXX
Statement ofCash Flows
From Oper. Net Inc. XXX Dep. Exp. XXNet Cash XXX
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Depreciation Vocabulary
• Book Value: Historical cost of the asset less accumulated depreciation.
• Depreciation: Periodic charge for cost allocation of long-term assets.
• Accumulated Depreciation: Total depreciation recorded since acquisition.
• Asset Cost: Purchase cost plus any capitalized expenditures.
• Residual Value: Estimated resale value of the asset upon retirement.
• Useful Life: Estimated life of asset in years, hours of service, or per unit of output.
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Depreciation Illustration
Costs incurred are deferred Costs incurred are deferred until future periods. They until future periods. They
are recorded as an asset and are recorded as an asset and the costs are assigned to the costs are assigned to
future periods.future periods.
Costs incurred are deferred Costs incurred are deferred until future periods. They until future periods. They
are recorded as an asset and are recorded as an asset and the costs are assigned to the costs are assigned to
future periods.future periods.
Cost(Asset)
Cost(Asset)
Depreciable
Period 2Period 2Period 2Period 2 Period 3Period 3Period 3Period 3Period 1Period 1Period 1Period 1
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Cost(Asset)
Cost(Asset)
Period 2Period 2Period 2Period 2 Period 3Period 3Period 3Period 3
A depreciation method is A depreciation method is selected to assign these selected to assign these costs to future periods.costs to future periods.
A depreciation method is A depreciation method is selected to assign these selected to assign these costs to future periods.costs to future periods.
Depreciable
Depreciation Illustration
Period 1Period 1Period 1Period 1Period 1Period 1
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Period 2Period 2Period 2Period 2 Period 3Period 3Period 3Period 3
Depreciation Illustration
Period 1Period 1
Cost(Asset)
Cost(Asset)Cost A depreciation method is A depreciation method is
selected to assign these selected to assign these costs to future periods.costs to future periods.
A depreciation method is A depreciation method is selected to assign these selected to assign these costs to future periods.costs to future periods.
Period 2Period 2
DepreciableDepreciable
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The allocation of a deferred cost, in The allocation of a deferred cost, in this case depreciation expense, has this case depreciation expense, has
no direct effect on cash. The no direct effect on cash. The allocation is based on the allocation is based on the
depreciable cost, useful life, and depreciable cost, useful life, and depreciation method.depreciation method.
The allocation of a deferred cost, in The allocation of a deferred cost, in this case depreciation expense, has this case depreciation expense, has
no direct effect on cash. The no direct effect on cash. The allocation is based on the allocation is based on the
depreciable cost, useful life, and depreciable cost, useful life, and depreciation method.depreciation method.
Depreciation Illustration
Period 1Period 1 Period 2Period 2
Cost(Asset)
Cost(Asset)Cost
DepreciableDepreciable
(Asset)
Period 3Period 3Period 3Period 3Period 3Period 3Period 3Period 3Period 3
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Depreciation Methods
• Straight-line: This method recognizes equal periodic depreciation charges over the asset’s life.
Time-Factor MethodsTime-Factor MethodsTime-Factor MethodsTime-Factor Methods
• Accelerated methods: – Sum-of-the-years’-digits--This method yields decreasing depreciation
in each successive year.– Declining-balance--This method provides decreasing charges by
applying a constant percentage rate to a declining asset book value.
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Depreciation Methods
• Service hours: This depreciation method is based on the theory that purchase of an asset represents the purchase of a number of hours of direct service.
Use-Factor MethodsUse-Factor MethodsUse-Factor MethodsUse-Factor Methods
• Productive output: This method is based on the theory that an asset is acquired for the service it can provide in the form of production output.
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Depreciation Methods
Group and Composite Group and Composite MethodsMethods
Group and Composite Group and Composite MethodsMethods
• Group: Used when the assets in the group are similar.• Composite: Used when the assets in the group are
related, but dissimilar.
This approach treats an entire group of assets as if the group were one asset.
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Depreciation MethodsSchuss Boom Ski Manufacturing acquired a polyurethane plastic-
molding machine at the beginning of 2002 for $100,000.
It has an estimated life of five years, 20,000 hours, or 25,000 units. The estimated residual value is $5,000. In 2002, the
equipment was used 3,000 hours to produce 3,500 units.
Schuss Boom Ski Manufacturing acquired a polyurethane plastic-
molding machine at the beginning of 2002 for $100,000.
It has an estimated life of five years, 20,000 hours, or 25,000 units. The estimated residual value is $5,000. In 2002, the
equipment was used 3,000 hours to produce 3,500 units.
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Time-Factor Methods
Straight-Line Method
Depreciation =Cost - Residual Value
Number of Years
Depreciation =$100,000 - $5,000
5
Depreciation = $19,000
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$35,000
$28,000
$21,000
$14,000
$7,000
$0
Depreciation Expense
Straight-Line Method
Time-Factor Methods
2002 2003 2004 2005 2006
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SYD = [n (n + 1)]2
Time-Factor Methods
SYD = [5 (5 + 1)]2
SYD = 15
Sum-of-the-Years’-Digits Method
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Sum-of-the-Years’-Digits Method
tDepreciation = SYD x (Cost - Residual Value)
t = years remaining in n atthe beginning of the period
t = years remaining in n atthe beginning of the period
Depreciation (2002) = 5 15 x $95,000
Depreciation (2002) = $31,667
Time-Factor Methods
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$35,000
$28,000
$21,000
$14,000
$7,000
$0
Depreciation Expense
Sum-of-the-Years’-Digits Method
Time-Factor Methods
2002 2003 2004 2005 2006
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F = declining balance factor(e.g., 150% or 200%)
F = declining balance factor(e.g., 150% or 200%)
Declining-Balance Method
Note:• Do not depreciate below salvage value.• Optional: Switch to straight-line when it
yields higher depreciation.
Note:• Do not depreciate below salvage value.• Optional: Switch to straight-line when it
yields higher depreciation.
Depreciation = F x (Cost - Accum. Depr.)
Depreciation (2002) = .40 x $100,000
Depreciation (2002) = $40,000
Time-Factor Methods
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$42,000
$35,000
$28,000
$21,000
$14,000
$7,000
$0
Depreciation Expense
Declining-Balance Method
Time-Factor Methods
2002 2003 2004 2005 2006
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Service Hours Method
Depreciation = Cost - Residual ValueNumber of Hours
Use Factor Methods
Depreciation = $100,000 - $5,00020,000 hours
Total Estimated Service Life of Asset
Depreciation = $4.75 per hour
Depreciation (2002) = $14,250
Depreciation (2002) = $4.75 x 3,000
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Productive-Output Method
r (per unit) = Cost - Residual ValueTotal Number of Units
Use Factor Methods
r (per unit) = $100,000 - $5,000 25,000 units
r (per unit) = $3.80 per unit
Depreciation (2002) = $3.80 x 3,500
Depreciation (2002) = $13,300
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Group Depreciation
Group similar assets into depreciation accounts.
Calculate annual depreciation charge at the straight-line rate times the group’s book value.
Recognize gains and losses only when all assets in the group have been retired.
Referred to as composite depreciation when the assets in the group are related but dissimilar.
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Depletion
Land containing mineral deposits is purchased at a cost
of $5,500,000. The cost to restore the land to its original
state after removal of the resources is estimated to be
$200,000 (then it can be sold for $450,000). In 2002, 80,000 tons of the estimated 2,000,000
tons are removed.
Land containing mineral deposits is purchased at a cost
of $5,500,000. The cost to restore the land to its original
state after removal of the resources is estimated to be
$200,000 (then it can be sold for $450,000). In 2002, 80,000 tons of the estimated 2,000,000
tons are removed.
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Depletion
Depletion charge per ton
$5,500,000 - $250,0001,000,000 tons
=
Depletion charge per ton
= $5.25
Depletion for 2002 = $5.25 x 80,000 tons
Depletion for 2002 = $420,000
$450,000 - $200,000
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Impairment
Before the end of an asset’s useful life, events occur that impair its
value. This requires an immediate write-down of the asset.
Before the end of an asset’s useful life, events occur that impair its
value. This requires an immediate write-down of the asset.
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Impairment
1. When should an asset be reviewed for possible impairment?
An impairment review should be conducted whenever there has been a material change in the way an asset is used or in the business environment.
An impairment review should be conducted whenever there has been a material change in the way an asset is used or in the business environment.
Also, if management obtains information suggesting that the market
value of the asset has declined.
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Impairment
2. When is an asset impaired?
An asset is impaired when the undiscounted sum of estimated future
cash flows from an asset is less than the book value of the asset.
An asset is impaired when the undiscounted sum of estimated future
cash flows from an asset is less than the book value of the asset.
The sum of the undiscounted future cash flows will always be greater than
the fair value of the asset.
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Impairment
3. How should an impairment loss be measured?
The impairment loss is the difference between the book value of the asset and
the asset’s fair value.
The impairment loss is the difference between the book value of the asset and
the asset’s fair value.
The fair value can be approximated using the present value of estimated
future cash flows from the asset.
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Impairment
4. What information should be disclosed about an impairment?
Disclosure should include a description of the impaired asset, reasons for the
impairment, a description of the measurement assumptions, and the
business segment or segments affected.
Disclosure should include a description of the impaired asset, reasons for the
impairment, a description of the measurement assumptions, and the
business segment or segments affected.
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37Asset Retirement--General Procedure
• Remove old asset from books: debit Accumulated Depreciation; credit the asset.
• Record new asset at fair market value: debit asset
• Record any cash received or paid: debit or credit Cash as appropriate.
• Record any gain or loss: debit loss account or credit gain account.
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38Asset Retirement--Determining Gain or Loss
• Gain or Loss =
(FMV New Asset + Cash Received) less
(Book Value Old Asset + Cash Paid)
• If answer is greater than zero, record a gain.
• If answer is less than zero, record a loss.
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39Asset Retirement--Unusual Considerations
Are assetssimilar in nature?
Record transactionaccording to generalprocedure.
Record transactionaccording to generalprocedure.
Record transactionaccording to generalprocedure.
Record transactionaccording to generalprocedure.
Record transactionaccording to generalprocedure.
Record transactionaccording to generalprocedure.
YES
YES
YES
NO
NO
NO
Are the partiesin the same line
of business?
Does thetransaction
create a gain?
Zero
Defer all
gains
25% or more
Recordtransaction
using generalprocedure.
Recordtransaction
using generalprocedure.
What percentageof the transaction’s
FMV is in cash?
Less than 25%
Party paying cashdefers all gains.
Party receiving cashdefers a portion
of all gains
Let’s take a closer look at this
last section.
Let’s take a closer look at this
last section.
Less than 25%
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What percentageof the transaction’s
FMV is in cash?
25% or moreRecord
transactionusing general
procedure.
Defer all
gains.
Defer all
gains.
Zero
Less than 25%
Party paying cashdefers all gains.
Party receiving cashdefers a portion
of all gains
Asset Retirement--Unusual Considerations
Yes
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Partial Periods
Nearest whole month. Nearest whole year. Half-year convention. No depreciation in year of acquisition; full
year depreciation in year of retirement. Full year depreciation in year of acquisition;
no depreciation in year of retirement.
Nearest month makes the most intuitive sense.
Nearest month makes the most intuitive sense.
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The EndThe End