chapter 11 investments in noncurrent operating assets ... · assets 6. the sale of depreciable...

11-1

1. The annual depreciation expense

2. The depletion of natural resources

3. The changes in estimates and methods in the

computation of depreciation

4. The impairment of asset

5. The amortization or impairment for intangible

assets

6. The sale of depreciable assets in exchange for

cash and in exchange for other depreciable assets

7. The depreciation for partial periods

8. The MACRS income tax depreciation system

Chapter 11 Investments in Noncurrent Operating

Assets—Utilization and Retirement

11-211-2

11-3

What is depreciation?

• Depreciation is not a process through which a

company accumulates a cash fund to replace

its long-lived fixed assets.

• Depreciation is not a way to compute the

current value of long-lived assets.

• Depreciation is the systematic allocation of the

cost of an asset over the different periods

benefited by the use of the asset.

1. Use straight-line, accelerated, use-factor,

and group depreciation methods to

compute annual depreciation

11-4

Factors Affecting the Periodic

Depreciation Charge

• Asset cost

• Residual or salvage value

• Useful life

• Pattern of use

Four factors are taken into consideration in

determining the appropriate amount of annual

depreciation expense.

11-5

Depreciation Vocabulary

• Asset cost is the purchase cost plus any

capitalized expenditures.

• Residual (salvage) value of property is an

estimate of the amount for which the asset can

be sold when it is retired.

• Useful life is the expected life of the asset in

years, hours of service, or per unit of output.

11-6

Useful Life

The physical factors that limit the service life of

an asset are—

1) wear and tear,

2) deterioration and decay, and

3) damage or destruction.

The primary functional factor limiting the

useful life of assets is obsolescence.

11-7

To match asset cost against

revenue, periodic depreciation

charges should reflect as

closely as possible the pattern

of use.

Depreciable

Cost

(Asset)

Period 2 Period 3Period 1

Pattern of Use

11-8

Period 2 Period 3

A depreciation method is

selected to assign these

costs to future periods.

Period 1Period 1

Depreciable

Cost

(Asset)

Pattern of Use

11-9

Period 2

Depreciable

Cost

(Asset)

Period 2 Period 3Period 1Period 1

Pattern of Use

11-10

Period 3

Depreciable

Cost

(Asset)

Period 2 Period 3Period 1Period 1

Pattern of Use

11-11

Recording Periodic Depreciation

The general form of the journal entry used to

recognize depreciation is as follows:

Depreciation Expense xx

Accumulated Depreciation xx

The accumulation of expired cost in a

separate account rather than crediting the

asset account permits identification of the

original cost of the asset and the

accumulated depreciation.

11-12

Depreciation Formula Symbols

The examples that follow assume the acquisition

of a polyurethane plastic-molding machine at

the beginning of 2013 by Schuss Boom Ski

Manufacturing, Inc., at a cost of $100,000 with

an estimated residual value of $5,000.C = Asset cost

R = Estimated residual value

n = Estimated life in years, hours of service, or

units of output

r = Depreciation rate per period, per hour of

service, or per unit of output

D = Periodic depreciation charge

11-13

Time-Factor Methods

Straight-Line

• Of the time-factor methods, straight-line

depreciation is by far the most popular.

• Straight-line depreciation relates to the

passage of time and recognizes equal

depreciation in each year of the life of the

asset.

• This method assumes the asset is equally

useful during each time period.

11-14

Straight-Line Depreciation

Using data for the machine acquired by Schuss

Boom Ski Manufacturing and assuming a 5-year

life, annual depreciation is computed as follows:

C – R

ND = =

$100,000 – $5,000

5 years

= $19,000 per year

11-15

Equals the

projected residual

value

Straight-Line Depreciation

11-16

Sum-of-the-Years’ Digits Method

SYD =[n (n + 1)]

2

SYD =[5 (5 + 1)]

2

SYD = 15

The sum-of-the-years’-digits depreciation

method yields decreasing depreciation in each

successive year. To determine the denominator,

use the following formula (assuming 5 years):

Or, simple add 1

+ 2 + 3 + 4 + 5

11-17

tD =

SYD (C – R)

D =5

15 ($100,000 – $5,000)

D = $31,667

Now that we know the denominator, we can

determine the depreciation for the year using

the following formula, where “t” equals years

remaining at the beginning of the period.


11-18

For the second year, we reduce the numerator by

one.


tD =

SYD (C – R)

D =4

15 ($100,000 – $5,000)

D = $25,333

(continued)

11-19

The annual depreciation for all five years:

Equals the

projected residual

value


(continued)

11-20

$35,000

$28,000

$21,000

$14,000

$7,000

$0

2013 2014 2015 2016 2017

Annual Depreciation Expense

Residual Value of $5,000


11-21

Declining-Balance Method

• The declining-balance depreciation method

provides decreasing charges by applying a

constant percentage rate to a declining asset

book value. First, the constant percentage

must be calculated.

• The most popular rate is two times the straight-

line rate, and this method is called double-

declining balance depreciation. The

percentage to be used is calculated as shown

in Slide 11-22.

11-22


11-23

• Thus, the molding machine would have a

straight-line rate of 20% (1/5). This number is

doubled to arrive at the double-declining

percentage of 40%. The chart shown on Slide

11-24 demonstrates how the constant rate is

applied to the remaining asset book value each

year.


• Or you can use the following formula to get the

straight-line rate: 1/n

11-24


11-2611-26

11-27

Factors Suggesting the Use of

an Accelerated Method

1) The anticipation of a significant contribution in

early periods with the extent of the

contribution to be realized in later periods

being less definite.

2) The possibility that inadequacy or

obsolescence may result in premature

retirement of the asset.

11-28

Use-Factor Methods

Use-factor depreciation methods view asset

exhaustion as related primarily to asset use or

output and provide periodic charges varying with

the degree of such services.

• The first use-factor method we will examine is

service-hours depreciation.

• This method is based on the theory that the

purchase of an asset represents the purchase

of a number of hours of direct service.

Service-Hours Depreciation

11-29

Let’s continue with the Schuss Boom Ski

Manufacturing machine. It cost $100,000 and

had a residual value of $5,000. It is estimated

that the machine will perform for an estimated

service life of 20,000 hours. Now we can

determine the rate to be applied to each

service hour.


11-30


D =C – R

n

$100,000 – $5,000

20,000 hours=

D = $4.75 per hour

Equals the projected

residual value

11-31

Productive-Output Depreciation

• Productive-output depreciation is based on

the theory that an asset is acquired for the

service it can provide in the form of

production output.

• The Schuss Boom asset is estimated to have

a productive life of 25,000 units.

• Assume the company produced 3,200 units in

2013 and 5,400 units in 2014.

11-32

2013: 3,200 units $3.80 = $12,160

Annual depreciation for 2013 and 2014:

2014: 5,400 units $3.80 = $20,520

r =C – R

n

$100,000 – $5,000

25,000 units=

r = $3.80 per unit

Productive-Output Depreciation

11-33

Group and Composite Depreciation

• Group depreciation groups similar assets into

depreciation accounts (e.g., all of a company’s

delivery vans).

• Composite depreciation refers to placing

assets in the group that are related but dissimilar

(e.g., all of a company’s desks, chairs, and

computers).

• The group depreciation procedure treats a collection of assets as a single group.

11-34

The rate of 12.5%, applied to the cost of

existing assets, $20,000, results in annual

depreciation of $2,500.


11-35

Because the accumulated depreciation

account applies to the entire group of assets,

no book value can be calculated for any

specific asset. If asset B were sold for $3,500

after two years, the following entry would be as

follows:

Cash 3,500

Accumulated Depreciation 2,500

Equipment 6,000


No gain or loss is recognized.

11-36

Depreciation and IAS 16

The component approach is required under

IASB standards. The following requirement is

contained in IAS 16:

“Each part of an item of property, plant

and equipment with a cost that is

significant in relation to the total cost of

the item shall be depreciated

separately.”

11-37

Depreciation and Accretion of an Asset

Retirement Obligation

• Bryan Beach Company purchases and erects

an oil platform at a total cost of $750,000.

Bryan Beach is legally obligated to dismantle

and remove the platform after 10 years.

• It is estimated that this will cost $100,000.

Assuming an 8% interest rate, the present

value of the obligation is $46,319 [46.319 (n

= 10; i = 8%) $100,000].

11-38

The journal entries to record the purchase of the

oil platform and the recognition of the asset

retirement obligation are as follows:

Oil Platform 750,000

Cash 750,000

Oil Platform 46,319

Asset Retirement Obligation 46,319



11-39

The cost of the oil platform asset, including the

estimated retirement obligation, is depreciated

just like any other long-term asset.

Depreciation Expense 79,632*

Accumulated Depreciation—

Oil Platform 79,632

*Assuming straight-line depreciation [($750,000 +

$46,319)/10]



11-40

Each year an entry must be made to recognize

the increase in the present value of the asset

retirement obligation.

Accretion Expense 3,706*

Asset Retirement Obligation 3,706

* ($46,319 x 0.08) = $3,706



11-41

• Natural resources (also called wasting

assets) are consumed as the physical units

representing these resources are removed and

sold.

• The computation of depletion expense is an

adaption of the productive-output method of

depreciation.

• Perhaps the most difficult problem is estimating

the amount of resources available for

economical removal from the land.

Depletion of Natural Resources

2. Apply the productive-output method to the

depletion of natural resources

11-42

• Land containing mineral deposits is purchased

at a cost of $5,500,000. It is expected to have a

residual value of $250,000.

• The natural resource supply is estimated at

1,000,000 tons. The unit-depletion charge and

the total depletion charge for the first year,

assuming the withdrawal of 80,000 tons, are

calculated on Slide 11-43.


11-43

Depletion

charge per ton

$5,500,000 – $250,000

1,000,000 tons=

Depletion

charge per ton= $5.25

Depletion for 2013 = $5.25 80,000 tons

= $420,000


11-44

Record the initial purchase as follows:

Mineral Deposits 5,500,000

Cash 5,500,000

Record the depletion for 2013 as follows:

Depletion Expense 420,000

Accumulated Depletion

(or Mineral Deposits) 420,000


If only 60,000 tons are sold, $105,000 is

reported as part of ending inventory.

11-45

Change in Estimated Life

• A company purchased $50,000 of equipment

and estimated a 10-year life. Using the straight-

line method with no residual value, the annual

depreciation would be $5,000.

• After four years, accumulated depreciation

would amount to $20,000, and the remaining

book value would be $30,000.

• Early in the fifth year, a reevaluation of the life

indicates only four more years of service can be

expected from the asset.

28. Incorporate changes in estimates and

methods into the computation of depreciation

for current and future periods

11-46

After four years, the

book value is $30,000

($50,000 $20,000)

Divide the book value

by the new estimated

remaining life

Change in Estimated Life

11-47

Change in Estimated Units of Production

A change in accounting for natural resources

occurs when the estimate of the recoverable

units changes as a result of further discoveries,

improved extraction processes, or changes in

sales prices that indicate changes in the

number of units that can be extracted

profitably.

11-48

• Land is purchased at a cost of $5,500,000

with estimated net residual value of

$250,000. The original estimate of natural

resources in the land was 1,000,000 tons.

• In the second year of operations, 100,000

tons of ore are withdrawn. At the end of that

year appraisers indicate a remaining tonnage

of 950,000.


11-49

Cost assignable to recoverable tons

as of the beginning of second year:

Deduct: Depletion charge for first

year 420,000

Balance of cost subject to depletion $4,830,000

$5,250,000

Original costs applicable to

depletable resources


11-50

Estimated recoverable tons as of the

beginning of second year:

Number of tons withdrawn in 2nd year 100,000

Estimated recoverable tons as of

the end of the second year 950,000

Total recoverable tons as of the

beginning of the second year 1,050,000

Depletion charge per ton for second year:

$4,830,000/1,050,000 = $4.60

Depletion charge for second year:

100,000 $4.60 = $460,000


11-51

Cost assignable to recoverable tons as

of the beginning of second year:Original costs applicable to depletable

resources $5,250,000

Add: Additional costs incurred in 2nd year 525,000

$5,775,000

Deduct: Depletion charge for first year 420,000

Balance of cost subject to depletion $5,355,000

Estimated recoverable tons as of the

beginning of second year 1,050,000

Depletion charge per ton for second year:

$5,355,000/1,050,000 = $5.10

Depletion for second year: 100,000 × $5.10 = $510,000


11-52

Change in Depreciation Method

• Another change in estimate occurs when the

actual pattern of consumption of an asset

doesn’t match the pattern of consumption

implicit in the depreciation method.

• Example: An asset is purchased for $120,000

with a 12-year expected useful life and zero

salvage value. After two years of straight line

depreciation, the asset has a remaining book

value of $10,000.

11-53

Change in Depreciation Method

• The company decides the double-declining-

balance method would yield a better estimate

of periodic depreciation.

• The straight-line depreciation rate is 10% (1/n

= 1/10 = 10%). Double that rate is 20%.

• Year 3 depreciation is $100,000 x 0.20, or

$20,000.

11-54

Accounting for Asset Impairment

FASB Statement No. 144 addresses four questions:

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.

4. Identify whether an asset is impaired, and

measure the amount of the impairment loss

using both U.S. GAAP and IASB standards

11-55

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.


11-56

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 fair value can be approximated using

the present value of estimated future

cash flows from the asset.


11-57

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.


11-58

• Guangzhou Company purchased a building

five years ago for $600,000. It has an expected

life of 20 years and no residual value.

Guangzhou has decided that the building

should be evaluated for possible impairment.

• Guangzhou estimates that the building has a

remaining useful life of 15 years, that net cash

inflow from the building will be $25,000 per

year, and that the fair value of the building is

$230,000.


11-59

• The $450,000 book value is compared to the

$375,000 ($25,000 15 years) undiscounted

future cash flows. An impairment loss should be

recognized. The loss is $220,000 ($450,000 –

$230,000). The impairment loss would be

recorded as follows:


Building 150,000

Loss on Impairment of Building 220,000

Building ($600,000 $230,000) 370,000


11-60


In many cases, it is more appropriate to estimate

a range of possible future cash flows rather than

make a specific point estimate. It is estimated that

the following two cash flow scenarios are

possible:

Future Cash Inflow ProbabilityScenario 1 $20,000 per year for 15 years 85%

Scenario 2 $50,000 per year for 15 years 15%

11-61


Undiscounted

Future Cash Inflow Probability

Scenario 1 $20,000 x 15 years = $300,000 85%

Scenario 2 $50,000 x 15 years = $750,000 15%

Probability-Weighted

Future Cash Flows

Scenario 1 $255,000

Scenario 2 112,500

$367,500

The $367,500 is compared to the book

value of the building, indicating impairment.

11-62


Assume there is no observable market value of the

building and that the market value must be

estimated using present value techniques. If the

risk-free interest rate is 6.0%, the expected

present value is computed as follows:

Future Cash Inflow PV (at 6%) Probability

Scenario 1 $20,000 x 15 years $194,245 85%

Scenario 2 $50,000 x 15 years $485,612 15%

11-63


Probability-Weighted

Present Value

Scenario 1 $165,108

Scenario 2 72,842

$237,950


Building 150,000

Loss on Impairment of Building 212,050

Building ($600,000 $237,950) 362,050

The impairment loss entry would be—

11-64

International Accounting for

Asset Impairment: IAS 36

• IAS 36 requires that a company recognize an

impairment loss whenever the “recoverable

amount” of an asset is less than its book value.

• Recoverable amount is the higher of the

selling price of the asset or the discounted

future cash flows associated with the asset’s

use.

• IAS 36 allows for the reversal of an impairment

loss if events in subsequent years suggest the

asset is no longer impaired.

11-65

Using the Guangzhou Company example,

assume that after five years the fair market value

is $540,000. Guangzhou elects to employ the

allowable alternative under international

standards. The journal entry is needed to

recognize the asset revaluation is as follows:


Building 150,000

Revaluation Equity Reserve 90,000

Building ($600,000 $540,000) 60,000

Recognizing an Upward Asset Revaluation

11-66

Assume that immediately after revaluing the

building to $540,000, Guangzhou Company sells

it for $540,000 in cash. The disposal would be

recorded as follows:

Recording the Disposal of Revalued Asset

Cash 540,000

Building 540,000

Revaluation Equity Reserve 90,000

Retained Earnings 90,000

Note that because Guangzhou

chose to revalue the asset, the

“gain” is never reported as a gain.

11-67

• Intangible assets are to be amortized by the

straight-line method unless there is strong

justification for using another method.

• Because companies must disclose both the

original cost and the accumulated amortization

for an amortizable intangible, the credit should

be to a separate accumulated amortization

account.

Amortization and Impairment of Intangible

Assets Subject to Amortization

5. Discuss the issues impacting proper

recognition of amortization or impairment for

intangible assets

11-68

Ethereal Company purchased a customer list for

$30,000 on January 1, 2013. It is expected to

have economic value for four years. The

expected residual value is zero. On December

31, 2013, the following journal entry is made to

recognize amortization expense:

Amortization Expense ($30,000/4 years) 7,500

Accumulated Amortization—

Customer List 7,500



11-69

During 2014, before the amortization entry is

made, a test for impairment is made. The future

cash flow of the list is expected to be $15,000—

which is less than the book value of $22,500

($30,000 – $7,500). The amount of the

impairment loss is $10,500.

Impairment Loss ($22,500 – $12,000) 10,500

Accumulated Amortization—

Customer List 7,500

Customer List ($30,000 – $12,000) 18,000



11-70

Impairment of Intangibles

Not Subject to Amortization

The FASB describes the following examples of

intangibles with indefinite lives:

• Broadcast licenses often have a renewal

period of 10 years. Because renewal is

virtually automatic, such licenses are

considered to have an indefinite life.

• A trademark right is granted for a limited

time, but can be renewed almost routinely.

If economic factors suggest that the

trademark will continue to have value in the

foreseeable future, then its useful life is

indefinite.

11-71

• Impalpable Company has a broadcast license

that has no foreseeable end to its useful life.

The license cost $60,000, and it was estimated

that the license generated cash flows of $7,000

per year.

• Recent events have convinced management

that the cash flow will be reduced. The

weighted probability shows that the estimated

fair value is $52,000.



11-72

Because the estimated fair value is less than the book value ($52,000 < $60,000), the intangible asset is impaired. The loss is recognized with the following journal entry:

Impairment Loss ($60,000 $52,000) 8,000

Broadcast License 8,000



11-73

Procedures in Testing Goodwill for Impairment

• The procedure in testing goodwill for impairment

is a four step test.

• Buyer Company acquired Target Company on

January 1, 2013. As part of the acquisition,

$1,000 in goodwill was recognized; this goodwill

was assigned to Buyer’s Manufacturing unit. For

2013, earnings for the Manufacturing unit were

$350.

• Separately traded companies with operations

similar to the manufacturing reporting unit have

market values approximately equal to six times

earning.

11-74

Procedures in Testing Goodwill

for Impairment

As of December 31, 2013, book and fair values

of assets and liabilities of the Manufacturing

reporting units are as follow:

Book Values Fair Values

Identifiable assets $3,500 $4,000

Goodwill 1,000 ?

Liabilities 2,000 2,000

11-75


for Impairment

1. Compute the fair value of each reporting unit

to which goodwill has been assigned.

Using the earnings multiple, the fair

value of the Manufacturing reporting

unit is estimated to be $2,100 ($350

x 6).

11-76


for Impairment

2. If the fair value of the reporting unit exceeds

the net book value of the assets and

liabilities of the reporting unit, the goodwill is

assumed to not be impaired and no

impairment is recognized.

The net book value of the assets and

liabilities of the Manufacturing reporting

unit is $2,500 [($3,500 +$1,000) – $2,000].

Since $2,100 (step 1) is less than $2,500,

further computations are needed.

11-77

3. If the fair value of the reporting unit is less

than the net book value of the assets and

liabilities of the reporting unit, then a new fair

value of goodwill is computed. Goodwill

value is always a residual value.

Implied fair value of goodwill is calculated

as follows:


for Impairment

Estimated fair value of Manufacturing $2,100

Fair value of identifiable assets – fair

value of liabilities ($4,000 – $2,000) 2,000

Implied fair value of goodwill $ 100

11-78

4. If the implied amount of goodwill computed in

(3) is less than the amount initially recorded, a

goodwill impairment loss is recognized for the

difference.


for Impairment

The implied fair value of goodwill is less than

the recorded amount of goodwill

($100 < $1,000). The journal entry necessary

to recognize goodwill impairment loss is as

follows:

Goodwill Impairment Loss 900

Goodwill 900

11-79

Asset Retirement by Sale

On July 1, 2013, Landon Supply Co. sells

machinery for $43,600 that is recorded on the

books at a cost of $83,600 with accumulated

depreciation as of January 1, 2013, of $50,600.

Assume a 10 percent straight-line rate.

Depreciation Expense—Machinery 4,180


Machinery 4,180

To record depreciation for six

months in 2013.$83,600 x .10 x

6/12

6. Account for the sale of depreciable assets

in exchange for cash and in exchange for

other depreciable assets

11-80

Asset Retirement by Sale

Cash 43,600

Accumulated Depreciation—Machinery 54,780

Machinery 83,600

Gain on Sale of Machinery 14,780

To record sale of machinery at

a gain.

[$43,600 – ($83,600 – $54,780)]

The entry to record the sale is as follows:

11-81

Asset Classified as Held for Sale

• Management commits to a plan to sell a long-

term operating asset.

• The asset is available for immediate sale.

• An active effort to locate a buyer is underway.

• It is probable that the sale will be completed

within one year.

Special accounting is required if the following

conditions are satisfied:

11-82

If the criteria are satisfied, two uncommon

accounting actions are required. During the

interval between being classified as held for sale

and actually being sold:

1. No depreciation is to be recognized, and

2. The asset is to be reported at the lower of its

book value or its fair value (less the estimated

cost to sell).


11-83

• On July 1, 2013, Haas Company has a

building that cost $100,000 and

accumulated depreciation of $35,000. Haas

commits to plans to sell the building by

March 1, 2014.

• On July 1, 2013, the building has an

estimated fair value of $40,000 and it is

estimated that the selling costs will be

$3,000.


11-84

Building—Held for Sale 37,000

Loss on Held-for-Sale Classification 28,000

Accumulated Depreciation—Building 35,000

Building 100,000

The following entry would be made on July 1:

If the net realizable value had been greater than

the book value of $65,000 ($100,000 $35,000),

no journal entry would have been made.


11-85

Building—Held for Sale 18,000

Gain on Recovery Value—Held for

Sale 18,000

($58,000 – $3,000) – $37,000

On December 31, 2013, the estimated selling

price was $58,000 (with $3,000 estimated selling

costs), the following journal entry would be

necessary:


11-86

• When an operating asset is acquired in

exchange for another nonmonetary asset, the

new asset acquired is generally recorded at

its fair market value or the fair value of the

nonmonetary asset given in exchange,

whichever is more clearly determinable.

• However, if the exchange has no real

commercial substance, the asset received is

sometimes recorded at the BOOK value of

the asset given.

Asset Retirement by Exchange for Other

Nonmonetary Assets

11-87

Delivery equipment that cost $83,600 and has

accumulated depreciation of $54,780 is

exchanged for delivery equipment that has a

fair market value of $43,600.

Delivery Equipment 43,600


Machinery 54,780

Machinery 83,600

Gain on Exchange of Machinery 14,780


Nonmonetary Assets

11-88

Assume the delivery equipment’s fair market

value is not determinable, but the machinery

has a market value of $25,000. The entry to

record the exchange would be as follows:



Machinery 54,780

Loss on Exchange of Machinery 3,820

Machinery 83,600


Nonmonetary Assets

11-89

Assume the delivery equipment’s fair market

value is not determinable, but the machinery has

a market value of $25,000. In addition to the

delivery equipment, cash of $3,000 was received.

The entry would be as follows:

Cash 3,000


Accumulated Depreciation—Mach. 54,780


Machinery 83,600Fair market value

of machine


Nonmonetary Assets

11-90

Nonmonetary Exchange without

Commercial Substance

Example 1—No Cash Involved

Republic Manufacturing Company owns a molding

machine that it decided to exchange for a machine

owned by Logan Square Company. The following

cost and market data relate to the two machines:

11-91

The entry on Republic’s books to record the

exchange will be:Machinery (new) 14,000

Accumulated Depreciation—Machinery (old) 32,000

Machinery 46,000

The entry on Logan’s books to record the



Loss on Exchange of Machinery 300

Machinery (old) 54,000



11-92

Example 2—Small Amount of Cash Involved

Assume the same facts as Example 1, except that it

is agreed that Republic’s machine has a market

value of $16,000 and Logan’s machine is worth

$17,000. Republic pays Logan $1,000 cash.



17,000

11-93





Cash 1,000



The book value of Logan’s machine is less than

the fair value, indicating a $700 gain ($17,000 –

$16,300). A portion of the gain should be

recognized as having been earned.

11-94



The amount to be recognized is computed using

the following formula:Recognized

gain

Cash received

Cash received + Fair value of

acquired asset

Total

indicated

gain

= x

For Logan:

$1,000

$1,000 + $16,000

Recognized

gain = x $700 = $41

11-95



The entry on Logan’s books to record the

exchange is as follows:Cash 1,000

Machinery (new) 15,341



Gain on Exchange of Machinery 41

11-96

Example 3—Large Amount of Cash Involved

Assume the same facts as in Example 2, except

that it is agreed that Republic’s machine has a

fair value of $12,750 and Logan’s machine has

a fair value of $17,000. Republic pays Logan

$4,250 cash.



11-97






Cash 4,250



The entry on Logan’s books:Cash 4,250

Machinery (new) 12,750



Gain on Exchange of Machinery 700

11-98

1. Nearest whole month

2. Nearest whole year

3. Half-year convention

4. No depreciation in year of acquisition; full year depreciation in year of retirement.

5. Full year depreciation in year of acquisition; no depreciation in year of retirement.

Makes the

most intuitive

sense

Depreciation for Partial Periods

7. Compute depreciation for partial periods,

using both straight-line and accelerated

methods

11-99

From this point, each year’s depreciation will be

$6,333 less than the previous year’s

depreciation.


11-100

Sum-of-the-Years’-Digits Method


11-101



If the asset was purchased three-fourths of the

way through the fiscal year and the firm uses the

double-declining-balance depreciation, the

annual expense for depreciation is shown on the

following slide.

11-102



11-103

Income Tax Depreciation

• The term cost recovery was used in the tax

regulations to emphasize that ACRS is not a

standard depreciation method because the

system is not based strictly on asset life or

pattern of use.

• Salvage values are ignored.

• Depreciate over three to five years.

8. Understand the depreciation methods

underlying the MACRS income tax

depreciation system

11-10411-104

11-105

The MACRS method for personal property

also incorporates a half-year convention,

meaning that one-half of a year’s

depreciation is recognized on all assets

purchased or sold during the year.


11-106


Office equipment is purchased for $100,000 on

October 1, 2013. It has an estimated residual value

of $5,000.

chapter 11 investments in noncurrent operating assets ... · assets 6. the sale of depreciable...

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