F3 - M5 - PP&E (Depreciation)

Question 1

How does PP&E incorporate the matching principle?

Answer 1

By systemically and rationally allocating expenses through the use of depreciation, amortization, or depletion of long-lived assets

Question 2

Types of Depreciation

Answer 2

Physical - Assets Deterioration (Wear and Tear)

Functional - Obsolescence or inadequacy of the asset to perform efficiently

Question 3

Define salvage value

Answer 3

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

Question 4

Define estimated useful life

Answer 4

Period of time over which an asset’s cost will be depreciated

May be revised at any time –> change in estimate –> prospective approach

Question 5

IFRS Depreciation

Answer 5

Method should reflect the expected pattern of fixed asset consumption (like inventory)

Requires component depreciation

Question 6

What is Component Depreciation

Answer 6

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

Question 7

What is Composite (Group) Depreciation

Answer 7

Averaging the economic lives of a number of units AND depreciating the entire class of assets over a singe life

More simple method

Question 8

How to calculate the average composite life

Answer 8

Total Depreciable Cost / Total Annual Depreciation

Question 9

Retiring Composite (Group) Assets

Answer 9

If average service life has not been reached at retirement, the gain/loss is applied to accumulated depreciation

Question 10

What is the journal entry to record the disposal of a composite asset?

Answer 10

For a loss:

DR Cash
DR Accumulated Depreciation
CR Asset (Historical Cost)

Question 11

What are the depreciation methods?

Answer 11

Straight Line
Sum of the Years Digits
Units of Production
Declining Balance
Partial Year

Question 12

Straight Line Depreciation

Answer 12

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

Question 13

Sum of the Years Digits

Answer 13

Accelerated method of depreciation
Higher depreciation expense in earlier years

(Cost - Salvage Value)
X (Remaining Life of Useful Asset / Sum of Years Digit)

Question 14

How to calculate sum of years digits

Answer 14

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

Question 15

Units of Production

Productive Output

Answer 15

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

Question 16

Declining Balance

Answer 16

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

Question 17

Partial Year

Answer 17

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

Question 18

Is a gain/loss recognized on disposals?

Answer 18

If depreciation is taken on individual assets, not as a group (composite), then a gain/loss is recognized

Question 19

Types of Asset Disposals

Answer 19

• Sale of Asset during useful life
• Write Off Fully Depreciated
• Total and Permanent Impairment

Question 20

Sale of Asset - Journal Entry

Answer 20

DR Cash
DR Accumulated Depreciation
CR Asset (Cost)

CR/DR Difference is Gain/Loss

Question 21

Write-Off Fully Depreciated Asset - Journal Entry

Answer 21

DR  Accumulated Depreciation
CR  Asset (Full Cost)

Question 22

Total and Permanent Impairment - Journal Entry

Answer 22

DR Accumulated Depreciation
DR Loss due to Impairment
CR Asset (Full Cost)

Question 23

Disposal Disclosures

Answer 23

• Depreciation Expense for the period
• Balance of Major Classes
• Accumulated Depreciation Allowances
• Methods used by major classes

Question 24

What is Depletion?

Answer 24

Allocation of the cost of wasting natural resources such as oil, gas, timber, and minerals to the production process

Question 25

What are the purchase costs related to depletion?

Answer 25

Any expenditures necessary to purchase AND prepare the land for removal of resources or prepare the asset for harvest

Question 26

What is residual value?

Answer 26

Salvage Value

Monetary worth of a depleted asset after resources have been removed

Question 27

What is the depletion base?

Answer 27

Cost - Residual Value

Cost to Purchase Property
+ Development Costs
+ Estimated Restoration Costs
- Residual Value of Land after extraction

Question 28

Methods of Depletion

Answer 28

• Cost Method ( GAAP)

- Percentage Completion (NOT GAAP; Tax only)

Question 29

What is the Cost Depletion method?

Answer 29

GAAP

Unit Depletion Rate x Number of Units Extracted

Question 30

What is the Unit Depletion Rate?

Answer 30

Amount of depletion recognized per unit extracted

(Cost - Residual Value) / Estimated Recoverable Units

Question 31

What is the Percentage Depletion method?

Answer 31

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

Question 32

How to recognized depletion?

Answer 32

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)