Chapter 11: Depreciation, Impairments, and Depletion Flashcards
Modified Accelerated Cost Recovery System
MACRS - depreciation for tax purposes
All depreciable assets placed into service in 1987 or later (subject to change)
- laws mandate tax life for various property classes
- tax life shorter than economic life: “recovery period - recovery on an accelerated basis
- zero salvage value
- use half-year convention (1/2 year depreciation in year of acquisition 1/2 year in year of disposal)
MACRS depreciation method by class
3, 5, 7, 10 year classes: double declining balance method
15, 20 year classes: 150% declining balance method
27.5 & 39 year classes: straight line
the IRS publishes tables
Optional Straight Line Method
Applies straight line method to MACRS recovery periods
Return on Assets
RoA
= Net income / average total assets
measures profitability
Profit margin on sales
how profitably a company used assets during a given period of time
= net income / net sales
Return on assets = asset turnover x profit margin on sales
Asset Turnover
How efficiently a company uses its assets
= net sales / average total assets
(average = beg + ending / 2)
varies by industry
PP&E Disclosures
- basis of valuation
- current pledges / liens/ commitments (not offset against asset reported in liabilities section)
- separate PP&E not currently employed (idle facilities) from active PP&E
- depreciation expenses
- balances of classes of depreciable assets
- accumulated depreciation (by classes or total)
- method(s) of depreciation
Full cost concept (exploration costs)
The cost of unsuccessful exploration (for a natural resource) is a cost required for successful exploration is all capitalized to the final project
(up to a ceiling of the present value of the company reserves)
Write ups of recoveries of impairment
Allowable under IFRS, NOT under GAAP
UNLESS assets are being held for disposal
Successful efforts concept
Only costs directly related to successful projects (exploration for natural resources) should be capitalized to the project
Cost of unsuccessful exploration goes to period charges
Liquidating Dividends
Dividends greater than the amount of accumulated net income: return of the original investment
Journaling Liquidating Dividends
Debit Retained Earnings
Debit Paid in Capital in Excess of Par (for any amount related to returned capital)
Credit Cash
Must include information about makeup of dividends
Journaling Depletion
Debit Inventory
Credit Asset
May use an accumulated depletion account, but it isn’t usual
Units of production method of depletion
Depreciation/ depletion per unit = (total cost - salvage value) / estimated total units available
Depreciation
The profess of allocating the costs of a tangible asset to expense in a systematic and rational manner to those periods expected to benefit from the use of the assets
NOT about valuation, but rather about cost allocation
GAAP only requires it to be systematic and rational - beyond that companies can develop their own approach
Depletion
Reduction in cost of natural resources over a period of time
(allocation of cost of natural resource to expense?)
Amortization
Expiration of intangible assets
Fixed percentage of book value method of depletion
using a rate that depreciates the asset exactly to the salvage value at the end of its life
= 1 - nth root of (salvage value / acquisition cost)
n= life in years
NOT permitted for tax purposes
Straight line depreciation
= cost less salvage value / estimated useful life
- assumes usefulness / use is same each period
- assumes maintenance and repair are the same each period
- distorts rate of return (income / assets)
- appropriate when “creeping obsolescence” is the primary reason for end of service life.
Decreasing charge depreciation methods
AKA accelerated depreciation
- higher depreciation cost in earlier periods
- aligns with matching principles if benefits from the asset decline as asset ages
- depreciation lower in later periods when repairs and maintenance are higher = more consistent costs
Methods:
- sum of the years digits
- declining balance (double declining balance)
Sum-of-the-year’s-digits method of depreication
Depreciation based on a decreasing fraction of depreciable costs
Depreciable cost x (est. remaining life in years / sum of est. life in years)
Example if 5 years life, sum is: 5+4+3+2+1=15 so 1st year 5/15
For long lived asset, where n= life in years, sum = n(n+1)/2
Declining balance method
Uses depreciation rate (percentage) that is some multiple of the straight line rate
does NOT deduct salvage value, rather in last year uses a plug to reach salvage value
book value x rate = depreciation expense
- double declining balance = 2x straight line rate
- may switch to straight line rate at the end of useful life
Straight line rate = 1/years of useful life
Composite depreciation rate
= total (straight line) depreciation per user / total cost of assets
if a new asset is added to the group must recompute the depreciation rate
Composite method of depreciation
used for group of assets when assets are dissimilar and have different lives
group depreciated at composite rate to salvage / residual value
gain or loss from asset required before service life of the group is over buried in accumulated depreciation account (okay because it evens out over time)
Debits to accumulated depreciation adjusted by gain/ loss amount
Composite life
The length of time it takes a company to depreciate assets on a composite basis
Group method of depreciation
see composite method of depreciation
when assets are similar in nature and have approximately the same useful life
use disclosures to explain
IFRS component depreciation
Required by IFRS
Depreciable Base
Original cost less salvage unit
salvage value: amount company expects to receive when it sells the asset or removes it from service (sometimes salvage value is $0)
Service life of an asset
Physical factors lead to the retirement of assets (wear and tear). sets the outside limit of service life
Economic factors that contribute:
- inadequacy for company purposes
- supersession (replacement with better option)
- obsolescence (catch all for the rest)
Methods of depreciation
- Activity method (units of use or production)
- straight line method
- decreasing charge method (accelerated)
- sum of the year’s digits
- declining balance - special depreciation methods
- group and composite
- hybrid / combination
Activity method of depreciation
AKA variable charge / units-of-production
rather than time uses input or output to calculate depreciation
= (cost - salvage value) x units for period / total life in units
Only appropriate for certain items
Matches expenses in the same period as revenues, good for when loss of utility of an asset results from use / production
Half-year convention
1/2 year of depreciation charged in year of acquisition, 1/2 year of depreciation in year of disposal
Partial period depreciation
Determine expense for the whole year and then prorate between partial periods
- unless otherwise stipulated calculate to the nearest month
Alternate:
- may not depreciate in 1st partial year and 1st year depreciation 1st full year of ownership
- use 1/2 year convention
- depreciate full year in 1st partial year and not in year of disposal
Depletion
Pattern of allocation for the cost of natural resources
Cost of depletion base:
- acquisition cost
- exploration costs
- development costs
- restoration costs (asset retirement obligation less salvage value)
then depletion calculated using units of production method
Development Costs for natural resources
Divided in two
Tangible equipment costs: usually held as separate assets with own depreciation accounts
- if un-movable from natural resource still a separate asset but may be depreciated over life of resource if shorter
Intangible development costs added to depletion base (ex: drilling costs)
Exploration costs for natural resources
May be capitalized into depletion base if substantial
often just expensed
some controversy involved
Undeveloped property account
Holding account for acquisition costs of natural resources prior to exploration
- if exploration successful costs are assigned to natural resource
- if unsuccessful then written off as a loss
Natural Resources
AKA wasting assets
- complete consumption (removal) of asset
- replacement only by an act of nature
CONSUMED over the period of use - physical characteristics depleted
Impairment loss of an asset held for disposal
-Assets held for disposal are like inventory and should be reported at lower of cost or net-realizable value
- continued reevaluation till sale - can write the asset up or down as long as never higher than pre-impairment carrying amount
- gain or loss in income from continued operations
- no further depreciation
- loss= carrying value - fair value - cost of disposal
Revising depreciation rate
Changes only made in current and following periods - no changes to previous depreciation
following depreciation changes will be based on remaining book value
Impairments
Write offs to long lived assets
- significant decrease in fair value
- significant change in asset use
- adverse legal factors/ business climate
- accumulation of costs significantly in excess or original amount expected
- projection of continuing losses associated with asset
Recoverability test
Used to determine if an impairment to an asset has occurred
- estimates clash flows expected from use & disposition of asset
- if net cash flows < carrying amount then asset is impaired
- if net cash flows are >= carrying amount then no impairment
Cash flows are not discounted for present value
Impairment loss on asset held for use
Amount by which carrying amount of asset exceeds its fair value
Fair value determined by:
- active market
- if no active market then use present value of future cash flows
Loss on impairment reported in other expenses and losses on income statement
Debit Loss on Impairment
Credit Accumulated Depreciation
Writing down impairment on an asset
Debit loss on impairment
Credit accumulated depreciation
Reported in other expenses and losses section of the income statement
Part of continuing operations
must disclose how impairment was determined
