Ch 11 Flashcards by leo Gottlieb

Depletion

Describes reduction in cost of natural resources over
Period of time

(timber, gravel, oil, coal)

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Depreciation, is the accounting process of…

allocating cost of tangible assets to expense in systematic manner to periods expected to benefit from use of asset

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Amortization

Expiration of intangible assets

such as patents and copyrights

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3 basic questions used in the depreciation process?

1 what Depreciable base is used for the asset?

2 what’s the asset’s useful life?

3 what method of cost appointment is best for this asset?

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Salvage value

Estimated amount company will receive when it sells

Asset or removes it from service

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Depreciation base

Total amount of depreciation that has occurred over asset’s useful life

Ex. Asset that cost $10,000 with a salvage value of $1,000
Has a depreciation base of $9,000

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2 reasons companies retire assets?

1 physical factors (such as casualty or expiration of
Physical life)

2 economic factors (obsolescence)

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3 economic or functional factors that cause retirement of asset?

1 inadequacy

2 supersession

3 obsolescence

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Economic/fct. Factor: inadequacy?

Asset ceases to be useful to company because demands

Have changed

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Economic/fct. Factor: supersession

Replacement of one asset with another more efficient

And economical asset

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Economic/fct. Factor: obsolescence

Different situations not involving inadequacy or

Supersession

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Activity method of depreciation AKA variable charge, units of production approach

Assumes depreciation is function of use of productivity,

Not passage of time

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Depreciation: Activity Method equation

Depreciation charge =

((cost - salvage value) x (hours this yr.))/total estimated hours

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Depreciation: straight line method

Considers depreciation as function of time

Not a function of usage

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Depreciation: straight line method equation

Depreciation charge = (cost - salvage value)/estimated service life

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The expense recognition principle does not justify a constant charge to income. If the benefits from the asset decline as the asset ages, then a…

Decreasing charge to income better matches cost

To benefits

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Decreasing-charge methods AKA Accelerated depreciation methods

Provide for high depreciation cost in earlier years

And lower charges in later periods

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Sum of years digits method depreciation?

Results in a decreasing depreciation charge based on

Decreasing fraction of Depreciable cost

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Depreciable cost

Original cost - salvage value

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Declining balance method depreciation

Utilizes depreciation rate (expressed as percentage)
That is sum multiple of straight line method

Does not deduct salvage value in computing
Depreciation base

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Double declining balance method

Depreciates assets at twice (200%) the straight line rate

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Companies often switch from the declining balance

method to the straight line method to ensure that they…

Depreciate asset only to its salvage value

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Special depreciation method: group method

Used when assets are similar in nature and have

Similar useful lives

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Special depreciation method: composite method

Used when assets are dissimilar and have different

Lives

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Composite depreciation rate equation?

Composite depreciation rate = | Depreciation per year/ total cost of assets

Composite life

Length of time it takes to depreciate assets on | composite basis

Companies are free to develop their own special or tailor-made depreciation methods. GAAP requires only that the method result in the...

Allocation of asset's cost over asset's life in | Systematic and rational manner

Hybrid depreciation method used in steel industry: | Product Variable Method

Combination straight line/activity approach

Half year convention

Charge one half year's depreciation both in year of | Acquisition and in year of disposal

How should companies compute depreciation for partial periods unless otherwise stipulated?

Compute depreciation on basis of nearest full month

Does depreciation provide for the replacement of assets? | What generates for replacement of assets specifically?

Depreciation in no way provides funds for replacement of assets The funds for replacement of assets come from revenues Generated from use of asset

How should companies handle revisions of depreciation rates?

Report change of rate of depreciation in current and prospective reports Divided remaining book value - salvage value by remaining estimated life

Lower of cost or market for inventories does not apply to...

Property, plant and equipment

Under GAAP, companies don't report fair value of | Long lived assets because a...

Does not plan to sell such assets

If assumption of being able to recover the cost of an investment is not valid, then the company should...

Report reduction in value

Impairments

Write offs of long lived assets

Recoverability test

Used to determine whether impairment has occurred

Recoverability test estimates the future net cash flows expected from the...

Use of that asset and it's eventual disposition

If the sum of net cash flows is less than carrying amount of asset then... Greater than...

Asset is impaired (less) Asset not impaired

IFRS Fair value test, difference btw GAAP recoverability test

Used to measure impairment loss, more strict than GAAP Doesn't include first stage of recoverability test comparing Undiscounted cash flows to carrying amount

Impairment loss

Amount by which carrying amount of asset exceeds its | Fair value

If no active market exists for an asset, to measure fair value...

The present value of expected future net cash flows | Used to calculate fair value

Impairment write-ups IFRS VS. GAAP?

IFRS permits write ups for subsequent recoveries of Impairment up to original amount GAAP prohibits write ups, except for assets to be Disposed of

Assets held for disposal should be reported at...

Lower of cost or net realizable value

An asset held for disposal in future periods can be written up or down as long as...

Carrying value after write up never exceeds carrying | Amount of asset before impairment

How should companies report losses or gains for assets held for future disposal?

Part of income from operations

Natural resources AKA wasting assets

Petroleum, minerals and timber

2 main features of natural resources?

1 complete removal (consumption) of asset 2 replacement of asset only by an act of nature

Depletion

Process of allocating cost of natural resources

Four factors involved in computation of depletion base?

1 acquisition cost of deposit 2 exploration cost 3 development costs 4 restoration costs

Acquisition cost

Price company pays to obtain property right to | Search and find undiscovered natural resources

Exploration costs

Costs needed to find resource

2 types of development costs

Tangible equipment costs Intangible development costs

Tangible equipment costs

Include all transportation and heavy equipment needed To extract resource and get it ready for market Normally not included in depletion base

Intangible development costs

Drilling costs, tunnels, shafts and wells needed for Production of natural resource Considered part of depletion base

Restoration costs

Costs of restoring land after extraction of natural resource Costs part of depletion base

How do companies usually compute cost of depletion

Using the units of production method (an activity approach)

Computation of depletion rate equation?

Depletion cost per unit = | (total cost - salvage value)/total estimated units available

Liquidating dividends

Dividends greater than amount of accumulated | Net income

Full cost concept

Cost of drilling a dry hole is cost needed to find | commercially profitable wells

Successful efforts concept

Capitalize costs only of successful projects

Reserve recognition accounting (RRA)

As soon as company discovers oil, it reports value On balance sheet and income statement No longer used after 1981

IFRS and GAAP permit oil exploration companies today to use either...

Full cost or successful efforts approaches

Companies should disclose the following info for property, plant and equipment, 4 things?

1 depreciation expense for period 2 balances of major classes of Depreciable assets By nature and function 3 acc. Depr. 4 general description of depreciation method used

Asset turnover, what does it measure? Equation?

How efficiently company uses assets to generate sales Asset turnover = net sales/avg. total assets

Profit margin on sales, what does it measure?, equation?

Measure for analyzing the use property, plant and equipment for profitability Profit margin on sales = net income/net sales

Return on assets (ROA), what does it measure? 2 equations?

Measures profitability Return on assets = profit margin on sales x asset turnover Return on assets = net income/avg. total assets