Ch. 11 - Depreciation, Impairments, Depletion

Question 1

1. Explain the Concept of Depreciation?

Hint: 1 Statement
1. 20 words - allocates cost

Answer 1

1. Depreciation allocates the cost of tangible assets to expense in a systematic and rational manner to those periods expected to benefit from the use of the asset.

Question 2

2. Identify the factors involved in the depreciation process?

Hint: 1 Statement
1. 30 words - 3 factors

Answer 2

1. Three factors involved in the depreciation process are (1) determining the depreciation base for the asset, (2) estimating service lives, and (3) selecting a method of cost apportionment (depreciation).

Question 3

3. Compare activity, straight-line, and decreasing-charge methods of depreciation

Hint: 1 Statement
1. 70 words -

Answer 3

1. (1) Activity method: Assumes that depreciation is a function of use or productivity instead of the passage of time. The life of the asset is considered in terms of either the output it provides, or an input measure such as the number of hours it works. (2) Straight-line method: Considers depreciation a function of time instead of a function of usage. The straight-line procedure is often the most conceptually appropriate when the decline in usefulness is constant from period to period. (3) Decreasing-charge methods: Provide for a higher depreciation cost in the earlier years and lower charges in later periods. The main justification for this approach is that the asset is the most productive in its early years.

Question 4

4 .Explain special depreciation methods.

Hint: 1 Statment
1. 50 words: Group/Composite & Hybrid/Combination

Answer 4

1. Two special depreciation methods are as follows. (1) Group and composite methods: The group method is frequently used when the assets are fairly similar in nature and have approximately the same useful lives. The composite method may be used when the assets are dissimilar and have dif- ferent lives. (2) Hybrid or combination methods: These methods may combine straight- line/activity approaches.

Question 5

5. Explain the accounting issues related to asset impairment

Hint: 1 Statment
1. 80 words - When can impairment be restored and when can it not?

Answer 5

1. The process to determine an impairment loss is as follows. (1) Review events and changes in circum- stances for possible impairment. (2) If events or changes suggest impairment, determine if the sum of the expected future net cash flows from the long-lived asset is less than the carrying amount of the asset. If less, measure the impairment loss. (3) The impairment loss is the amount by which the carrying amount of the asset exceeds the fair value of the asset.
   After a company records an impairment loss, the reduced carrying amount of the long-lived asset is its new cost basis. Impairment losses may not be restored for assets held for use. If the company expects to dispose of the asset, it should report the impaired asset at the lower-of-cost-or-net realizable value. It is not depreciated. It can be continu- ously revalued, as long as the write-up is never to an amount greater than the carrying amount before impairment.

Question 6

6. Explain the accounting procedures for depletion of natural resources.

Hint: 1 Statement
1. 70 words

Answer 6

To account for depletion of natural resources, companies (1) establish the depletion base and (2) write off resource cost. Four factors are part of establishing the depletion base: (a) acquisition costs, (b) exploration costs, (c) development costs, and (d) restoration costs. To write off resource cost, companies normally compute depletion on the units-of- production method. Thus, depletion is a function of the number of units withdrawn during the period. To obtain a cost per unit of product, the total cost of the natural resource less salvage value is divided by the number of units estimated to be in the resource deposit, to obtain a cost per unit of product. To compute depletion, this cost per unit is multiplied by the number of units withdrawn.

Question 7

7. Explain how to report and analyze property, plant, equipment, and natural resources.

Hint: 1 Statement
1. 40 words

Answer 7

The basis of valuation for property, plant, and equipment and for natural resources should be disclosed along with pledges, liens, and other commitments related to these assets. Companies should not offset any liability secured by property, plant, and equipment or by natural resources against these assets, but should report it in the liabilities section. When depreciating assets, credit a valuation account normally called Accumulated Depreciation. When depleting assets, use an accumulated depletion account, or credit the depletion directly to the natural resource account. Companies engaged in significant oil and gas producing activities must provide additional disclosures about these activities. Analysis may be performed to evaluate the asset turnover, profit margin on sales, and return on assets.

Question 8

8. Under what conditions is it appropriate for a business to use the composite method of depreciation for its plant assets? What are the advantages and disadvantages of this method?

Hint: 1 Statement
1. 70 words: Heterogenous

Answer 8

1. The composite method is appropriate for a company which owns a large number of heterogeneous plant assets and which would find it impractical to keep detailed records for them.
   The principal advantage is that it is not necessary to keep detailed records for each plant asset in the group. The principal disadvantage is that after a period of time the book value of the plant assets may not reflect the proper carrying value of the assets. Inasmuch as the Accumulated Depreciation account is debited or credited for the difference between the cost of the asset and the cash received from the retirement of the asset (i.e., no gain or loss on disposal is recognized), the Accumulated Depreciation account is self-correcting over time.