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Intermediate Accounting 2 > Depreciation > Flashcards

Depreciation Flashcards

1
Q

What is the purpose of depreciation?

A

To allocate the cost of an asset to the periods of its useful life in a systematic and rational manner.

Part of the matching principle - expense an asset in the period in which it was used.

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2
Q

How does depreciation relate to revenues?

A

Depreciation matches expenses against revenues over the periods that benefit from the asset’s use.

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3
Q

What types of assets are depreciated?

A

Tangible assets with limited lives are depreciated.

For intangible assets, we use Amortization expense, but the same process applies.

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4
Q

What is the process for natural resources?

A

For natural resources, we use Depletion expense, but the same process applies.

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5
Q

What is service life?

A

The time an asset will be used by a company.

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6
Q

What is physical life?

A

How long an asset will last.

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7
Q

How is depreciation normally computed?

A

Unless otherwise stipulated, depreciation is normally computed on the basis of the nearest full month.

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8
Q

What is the depreciable base?

A

Original cost minus salvage value.

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9
Q

What factors are involved in the depreciation process?

A
  1. What is the depreciable base to be used?
  2. What is the asset’s useful life? (How long will it serve the company?) May vary from reality.
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10
Q

What is the difference between service life and physical life?

A

Service life often differs from physical life - only a cost allocation process.

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11
Q

What are the two reasons companies retire assets?

A
  1. Physical factors - Casualty, expiration of physical life.
  2. Economic factors - Inadequacy, supersession, obsolescence.
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12
Q

What must depreciation methods be?

A

Depreciation methods must be systematic and rational. You can make up your own method.

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13
Q

What is the journal entry for depreciation?

A

Debit depreciation expense
Credit accumulated depreciation contra-asset account.

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14
Q

What is the Activity Method for depreciation?

A

Depreciation is calculated based on units of use or production.

Example: If Stanley uses crane for 4,000 hours, (450,000 x 4000)/30,000 = $60,000.

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15
Q

How is depreciation calculated using the Straight Line Method?

A

Divide depreciable base by estimated useful life to get depreciation amount per year.

Example: $450,000 / 5 years = $90,000 per year.

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16
Q

What are Decreasing Charge Methods?

A

Depreciates asset more, earlier in its useful life.

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17
Q

What is the Sum-Of-The-Years’-Digits method?

A

Each fraction uses the sum of the years as the denominator. Numerator is remaining life of the asset.

Example: In 5 year depreciation, sum of years is 5+4+3+2+1 = 15.

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18
Q

How do you calculate depreciation for Year 1 using the Sum-Of-The-Years’-Digits method?

A

Year 1: 5/15 x $450,000 = $150,000 = Book Value ends up being $350 ($500 - $150).

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19
Q

What is the Sum-Of-The-Years’-Digits method?

A

Each fraction uses the sum of the years as the denominator. The numerator is the remaining life of the asset.

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20
Q

How is the sum of years calculated for a 5-year depreciation?

A

The sum of years is 5 + 4 + 3 + 2 + 1 = 15.

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21
Q

What is the formula for the alternate calculation of the denominator?

A

The formula is (n(N+1))/2.

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22
Q

What is the cost of the crane?

A

$500,000

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23
Q

What is the estimated useful life of the crane?

A

5 Years

24
Q

What is the estimated salvage value of the crane?

A

$50,000

25
Q

What is the productive life of the crane in hours?

A

30,000 Hours

26
Q

What is the Year 1 depreciation expense using the Sum-Of-The-Years’-Digits method?

A

Year 1: 5/15 × $450,000 = $150,000

Book Value ends up being $350 ($500 - $150)

27
Q

What is the Year 2 depreciation expense using the Sum-Of-The-Years’-Digits method?

A

Year 2: 4/15 x $450,000 = $120,000

Book Value ends up being $230 ($350 - $120)

28
Q

What is the Year 3 depreciation expense using the Sum-Of-The-Years’-Digits method?

A

Year 3: 3/15 x $450,000 = $90,000

Book Value ends up being $140 ($230 - $90)

29
Q

What is the Year 4 depreciation expense using the Sum-Of-The-Years’-Digits method?

A

Year 4: 2/15 × $450,000 = $60,000

Book Value ends up being $80 ($140 - $60)

30
Q

What is the Year 5 depreciation expense using the Sum-Of-The-Years’-Digits method?

A

Year 5: 1/15 × $450,000 = $30,000

Book Value ends up being $50 ($80 - $30), which is the salvage value.

31
Q

What is the Double Declining or Declining-Balance Method?

A

It utilizes a depreciation rate that is some multiple of the straight line method and does not deduct salvage value in computing the depreciation base.

32
Q

How is annual depreciation calculated under the declining-balance method?

A

Annual depreciation is based on the asset’s book value at the beginning of each year times the declining balance rate.

33
Q

What is the formula for the declining balance rate?

A

The rate = 1/Life x 2.

34
Q

What is the Year 1 depreciation expense using the declining-balance method?

A

Year 1: Beg.Asset Value $500,000 x 40% = $200,000 Expense, End Book Value $300,000.

35
Q

What is the Year 2 depreciation expense using the declining-balance method?

A

Year 2: Beg.Asset Value $300,000 x 40% = $120,000 Expense, End Book Value $180,000.

36
Q

What is the Year 3 depreciation expense using the declining-balance method?

A

Year 3: Beg.Asset Value $180,000 x 40% = $72,000 Expense, End Book Value $108,000.

37
Q

What is the Year 4 depreciation expense using the declining-balance method?

A

Year 4: Beg.Asset Value $108,000 x 40% = $43,200 Expense, End Book Value $64,800.

38
Q

What is the Year 5 depreciation expense using the declining-balance method?

A

Year 5: Beg.Asset Value $64,800 × 40% = $25,920; limit to $14,800 to get salvage of $50,000.

39
Q

How is partial year depreciation computed?

A

Depreciation is normally computed on the basis of the nearest full month.

40
Q

What is the Group Method?

A

Used when assets are similar in nature and have the same useful lives.

41
Q

What is the Composite Method?

A

Used when assets are dissimilar and have different lives.

42
Q

How is depreciation computed using the Composite Method?

A

Find average and depreciate on that basis.

43
Q

What is an example of the Composite Method?

A

Sum straight line depreciation amounts and divide by total original cost to get % to depreciate each year.

44
Q

What is the composite life in depreciation?

A

The composite life is the total depreciable cost divided by the total annual depreciation.

45
Q

How should gains or losses be recorded if a single asset is retired before/after average service life?

A

Do not book a gain or loss; it gets buried in accumulated depreciation. Debit accumulated depreciation to bury the loss.

46
Q

What are hybrid or combination methods in depreciation?

A

Companies can use any method or develop their own methods as long as they don’t depreciate more than the depreciable base or for longer than the life of the asset.

47
Q

What is the Modified Accelerated Cost Recovery System (MACRS)?

A

MACRS differs from GAAP and is required by the IRS. It has a mandated tax life, generally shorter than economic life.

48
Q

What are the key features of MACRS?

A
  1. Cost recovery on an accelerated basis using a staggered formula. 2. Assigned salvage value of zero. 3. Small businesses can fully depreciate equipment in the first year.
49
Q

How do accelerated depreciation methods help with increasing repair costs?

A

Ignoring income tax effects, accelerated depreciation methods can offset the effect of increasing repair and maintenance costs as the asset ages.

50
Q

How is impairment of property, plant, and equipment accounted for?

A

Assets are recorded at historical cost and not written up. If an asset is impaired and cannot recover future cash flows, it must be impaired or written down.

51
Q

What is the recoverability test for impairment?

A

Compare carrying value with expected net future cash flows.

52
Q

What is the fair value test for impairment?

A

Compare fair value with carrying costs.

53
Q

What is the process to record impairment loss?

A

If impairment exists, compare carrying cost and fair value. Record the difference as an impairment loss (Debit a loss account, credit Accumulated Depreciation).

54
Q

Provide an example of recording an impairment loss.

A

If carrying value is $600,000 and fair value is $500,000, record: Loss on impairment $100,000; Accumulated Depreciation $100,000.

55
Q

What happens to the carrying amount after an impairment?

A

The reduced carrying amount becomes the new cost basis. No restoration in asset held for use.

56
Q

Does IFRS allow for recovery of impaired assets?

A

Yes, IFRS permits recoveries back to the original amount.

Intermediate Accounting 2 (2 decks)

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