F3 - M5 - PP&E (Depreciation) Flashcards
How does PP&E incorporate the matching principle?
By systemically and rationally allocating expenses through the use of depreciation, amortization, or depletion of long-lived assets
Types of Depreciation
Physical - Assets Deterioration (Wear and Tear)
Functional - Obsolescence or inadequacy of the asset to perform efficiently
Define salvage value
Estimate of the amount, if any, that will be realized at the end of the useful life of a depreciable asset
Also known as residual value
Define estimated useful life
Period of time over which an asset’s cost will be depreciated
May be revised at any time –> change in estimate –> prospective approach
IFRS Depreciation
Method should reflect the expected pattern of fixed asset consumption (like inventory)
Requires component depreciation
What is Component Depreciation
Separate depreciation of each part of an item that is significant to the total cost of the fixed asset
IFRS requires; GAAP permits but is rarely used
More accurate, but very time consuming
What is Composite (Group) Depreciation
Averaging the economic lives of a number of units AND depreciating the entire class of assets over a singe life
More simple method
How to calculate the average composite life
Total Depreciable Cost / Total Annual Depreciation
Retiring Composite (Group) Assets
If average service life has not been reached at retirement, the gain/loss is applied to accumulated depreciation
What is the journal entry to record the disposal of a composite asset?
For a loss:
DR Cash
DR Accumulated Depreciation
CR Asset (Historical Cost)
What are the depreciation methods?
Straight Line Sum of the Years Digits Units of Production Declining Balance Partial Year
Straight Line Depreciation
Cost - Salvage value / Estimated Useful Life
Pro: Simple and easy to calculate
Con: Does not support the theory that assets are usually more useful towards the beginning
Sum of the Years Digits
Accelerated method of depreciation
Higher depreciation expense in earlier years
(Cost - Salvage Value)
X (Remaining Life of Useful Asset / Sum of Years Digit)
How to calculate sum of years digits
Each year is progressively numbered and then added – serves as the denominator in the equation
Example: 5 years = 1+2+3+4+5 = 15
For assets with a long life, use the formula: N x (N+1) / 2
N = Estimated Useful Life
Units of Production
Productive Output
Step 1: Calculate the rate per unit or hour
(Cost - Salvage) / Estimated units or hours
Step 2: Calculate Depreciation
Rate per unit or hour X # units (hours) worked
Converts depreciation to a variable cost
Declining Balance
2 / Useful Life x (Cost - Accumulated Depreciation)
Asset subject to rapid obsolescence
In final year, asset is depreciated to its salvage value
Only method to IGNORE salvage value. Method always leaves a balance which is treated as a salvage value.
Salvage Value = NBV Floor.
NBV cannot be less than Salvage Value
Partial Year
If an asset is placed in service during the year, the depreciation expense is taken only for the portion of the year that the asset is used
Is a gain/loss recognized on disposals?
If depreciation is taken on individual assets, not as a group (composite), then a gain/loss is recognized
Types of Asset Disposals
- Sale of Asset during useful life
- Write Off Fully Depreciated
- Total and Permanent Impairment
Sale of Asset - Journal Entry
DR Cash
DR Accumulated Depreciation
CR Asset (Cost)
CR/DR Difference is Gain/Loss
Write-Off Fully Depreciated Asset - Journal Entry
DR Accumulated Depreciation CR Asset (Full Cost)
Total and Permanent Impairment - Journal Entry
DR Accumulated Depreciation
DR Loss due to Impairment
CR Asset (Full Cost)
Disposal Disclosures
- Depreciation Expense for the period
- Balance of Major Classes
- Accumulated Depreciation Allowances
- Methods used by major classes
What is Depletion?
Allocation of the cost of wasting natural resources such as oil, gas, timber, and minerals to the production process
What are the purchase costs related to depletion?
Any expenditures necessary to purchase AND prepare the land for removal of resources or prepare the asset for harvest
What is residual value?
Salvage Value
Monetary worth of a depleted asset after resources have been removed
What is the depletion base?
Cost - Residual Value
Cost to Purchase Property
+ Development Costs
+ Estimated Restoration Costs
- Residual Value of Land after extraction
Methods of Depletion
- Cost Method ( GAAP)
- Percentage Completion (NOT GAAP; Tax only)
What is the Cost Depletion method?
GAAP
Unit Depletion Rate x Number of Units Extracted
What is the Unit Depletion Rate?
Amount of depletion recognized per unit extracted
(Cost - Residual Value) / Estimated Recoverable Units
What is the Percentage Depletion method?
NOT GAAP - Tax Only
Based on percentage of sales
Benefit - Tax Deduction
Usually exceeds cost depletion
Limited to 50% of net income from depleted property
How to recognized depletion?
If all units are NOT sold, depletion must be allocated between COGS and inventory
COGS = Unit Depletion Rate x Number Units Sold
Inventory = Unit Depletion Rate x Number Units Unsold
(Goes to Direct Materials)
