Chapter 11 Flashcards
Depreciation is
Cost allocation
Depreciation
Accounting process of allocating costs of tangible assets to expense in a systematic and rational manner to those periods expected to benefit from the use of the asset.
Expiration of intangible assets such as patents or copyrights is called
Amortization
Fixed assets
Depreciation expense
Intangibles
Amortization expense
Natural resources
Deletion expense
What are the three questions in the depreciation prcoess?
- What is the depreciable base to be used for asset
- What is the assets useful life
- What method of cost apportionment is best for the asset?
Salvage value
Estimated amount that a company will receive when it sells the asset or removes it from service
The service life differs from
Physical life
What are the two reasons companies retire assets
Physical factors (casualty or expiration of physical life)
Economic factors (obsolescence)
Economic or functional factors are classified into 3 categories of
- Inadequacy
- when asset is not as useful because demand of firm have changed - Super session
- replacement of one asset with another more efficient and economical asset - Obsolescence
- catch all for situations not involving 1 and 2.
The better the maintenance the longer the the life of
Asset
In most cases the useful life of asset is based on
Past experiences with the same or similar assets
Activity method also called variable charge or units of production approach
Assumes that the depreciation is a function of use or productivity instead of the passage of time
What is the major limitation of the activity method?
It is inappropriate in situations in which depreciation is a function of time instead of activity
When economic or functional factors affect the asset what happens?
The activity method those its significance
Another problem with activity method is
Is the difficulty of estimating units of output or service hours received
Straight line method
Considers depreciation as a function of time rather than a function of usage
Why do companies use the straight line method?
Bc of its simplicity
Two major objections to straight line is
- Assets economic usefulness is the same each year
2. Maintenance and repair expense is essentially the same each period
Straight line provides a distortions in
Rate of return analysis (income/assets) develop
Decreasing charge methods
Provides a for a higher depreciation cost in the earlier years and lower charges in the later periods
Decreasing charge method is often called accelerated depreciation methods because
These methods allow for higher early year charges than in straight line method
What is the rationale for the accelerated methods?
Companies should charge more depreciation in the earlier. Years because the asset is more productive in the earlier years
Accelerate methods provide
Constant cost because the depreciation charge is lower in the later periods at the time when repair and maintenance costs are often higher
Sum of the years digits method
Results in a decreasing depreciation charge based on decreasing fraction of depreciable costs
Declining balance method
Utilizes a depreciation rate (expressed as %) that is some multiple of the straight line method
Declining method does not deduct what
Salvage value in computing deprecation base
Double declining method
Depreciates assets at twice
Two methods of depreciating multiple asset accounts
Group method
Composite method
Companies frequently use group method
When the assets are similar in nature and have approximately the same useful of lives
They use composite approach when
Assets are dissimilar and have different lives
Composite depreciation rate
Depreciation per year by total cost of assets
Composite life
The length of time it takes a company to depreciate its assets on a composite basis
Unit method (depreciation of single assets) has several advantages over group or composite methods
- Simplifies the computation mathematically
- Identifies gains and losses on disposal
- Isolates depreciation on idle equipment
- Represents the best estimate of the depreciation of each assets o
Companies can create their own methods , GAAP requires only
That the method result in the allocation of an assets cost over the assets life in a systematic and rational manner
How do companies compute depreciation expense for partial periods?
Companies must determine t he depreciation expense for the full year and then prorate this depreciation expense between the two periods evolved
Companies normally compute depreciation on
Basis of the nearest full month
Depreciation does not involve what?
A current cash flow
Depreciation does not provide what for. The replacement of. Assets?
Funds
The funds for replacement of the assets come from the
Revenues ( generated through the use of asset?
The changes in estimate should be recorded when
In the current and prospective periods
There should be no changes in the prior periods
And there is no adjusting opening balances or attempt to catch up for period periods
Why is there no adjustment. Or catching up for prior periods?
Changes in estimates are continual and inherent part of the estimation process
Impairments
Considering the write off of their long lived assets
What are events and changes in circumstances that might lead to an impairment?
- A significant decrease in the FV of asset
- A significant change in the extent or manner in which an asset is used
- A significant adverse change in legal factors or in the business climate that affects value of asset
- An accumulation of costs significantly in excess of amount originally expected to acquire or construct an asset
- A projection or forecast that demonstrates continuing losses associated with an asset
The events or changes in circumstances indicate that the company may not be able to
Record the carrying amount of the asset
Recoverability test
Is used to determined whether an impairment has occurred or not
Steps of recoverability test
- Estimate future cash flows expected from use of asset and its eventual disposition
(If sum of expected cash flow < carrying amount = impaired)
Sum expected cash flow is > or equal to carrying amount = no impairment
Recoverability test relies on a basic presumption
Balance sheet should report long lived assets at no more than carrying amounts that are recoverable
What is the impairment loss?
Carrying value of asset > FV
Fair value of asset is measured based on
Market price if an activate market for asset exists
If no market exists then UPS uses
PV of expected future cash flows to determine fair value
After recording an impairment loss , the reduced carrying amount of asset becomes what?
New cost basis
A company does not change the new cost basis except when
For depreciation or amortization in future periods for additional impairments
May not restore an impairment loss for an
Asset held for use
Assets that are held for disposal are like inventory should they should be reported at
Lower of cost or net realizable value
You can write up or down an asset held for disposal in future periods as long as
Carrying value after write up never exceeds the carrying amount of asset before impairment
Losses and gains related to impaired assets should be recorded as part of
Income from continuing operations
Because of significant impact on financial statements of depreciation methods used, the following should be disclosed
- Depreciation expense for the period
- Balances eye of major classes of depreciable assets by nature and function
- Accumulated depreciation, either by major classes of depreciable assets or in total
- A general descruption of method or methods used in computing depreciating with respect to major classes of depreciable assets
Asset turnover
How efficiently a company uses its assets to generate sales
