FAR3 M5 - PP&E Depreciation & Disposal

Question 1

Depreciation

Answer 1

Basic principle of matching revenue and expenses is applied to long-lived assets that are not held for sale in the ordinary course of business. The systematic and rational allocation used to achieve matching is accomplished by depreciation, amortization, and depletion.

Question 2

Types of Depreciation

Answer 2

Physical Depreciation - asset’s deterioration and wear over a period of time
Functional Depreciation - obsolescence or inadequacy of the asset to perform efficiently

Question 3

Salvage Value

Answer 3

An estimate of the amount that will be realized at the end of the useful life of a depreciable asset. Generally, assets have little to no salvage value. If immaterial, the amounts are ignored.

Question 4

Estimated Useful Life

Answer 4

Period of time over which an asset cost will be depreciated. Estimates are changed prospectively.

Question 5

Component Depreciation

Answer 5

A separate depreciation for each part of the item of property, plant, and equipment that is significant to the total cost of the asset. Rarely done with GAAP, but required for IFRS.

Question 6

Composite or Group Depreciation

Answer 6

The process of averaging the economic lives of a number of property units and depreciating the entire class of assets over a single life. Simplifies record keeping.

Average Life = Total Deprec Cost/Total Annual Deprec

Total Deprec Cost = Total Cost - Salvage Value
Total Annual Deprec = Asset 1 individual depr + Asset 2 individual depre

Sale of a composite asset:

Cash DB
A/D DB or CR (no gain or loss recognition)
Asset CR

Question 7

Asset Retirement of an individual asst part of composite asset

Answer 7

No gain or loss is recognized. The gain or loss that results will be absorbed in the A/D account. The A/D account is debited (credited) for the difference between the original cost and cash received.

Question 8

SL Depreciation

Answer 8

Service potential declines over time.

Annual SL Depreciation = (Cost - Salvage Value)/Est. Useful LIfe

Question 9

Sum of the Year’s Digits Depreciation

Answer 9

Accelerated depreciation method. More on the earlier years and less on later years.

Depreciation Exp = (Cost-Salvage Value) x (Remaining Life of Asset/Sum-of-the-year’s digits)

Add up the sum of the years to figure out DENOMINATOR.

For four years: 1+2+3+4 = 10

or S = [n x (n+1)]/2 n = estimated useful life
= [4 x (4+1)]/2
= 10

Question 10

Units of Production Depreciation

Answer 10

Service potential declines with use, not time. The more you use, the more depreciation.

1. Rate per unit or hour = (Cost - Salvage Value)/Estimated Units or Hours
2. Depreciation = Rate per unit/hour x # of unit produced/hrs worked (usage)

Question 11

Double Declining Balance Depreciation

Answer 11

Asset subject to repaid obsolescence. Each year’s depreciation is double the SL amount, with the exception of the final year. In the final year, the asset is depreciated to its salvage value (plug amount to get to salvage value). Salvage value is ignored because this method always leaves a remaining balance which is treated as salvage value. However, the asset should not be depreciated below the estimated salvage value. Only method to exclude salvage value. H

Depreciation Exp = 2 x 1/N x (Cost - A/D)

Question 12

Disposal

Answer 12

When the depreciation is taken individually, rather than as a composite/group, than gain or loss is recognized.

JEs:

Sale of Asset During It's Useful Life
Cash                   DB
A/D                     DB
Sold Asset Cost       CR
Gain or Loss             DB/CR

Write of of fully depreciated asset
A/D (100%) DB
Asset (100%) CR

Total & Permanent Impairment
A/D DB
Loss due to Impairment (difference) CR
Asset @ full cost CR

Question 13

Disclosure

Answer 13

• Depreciation expense for current period
• Balance of major classes of assets by nature or function
• A/D allowances by classes or total
• Methodology used in depreciation

Question 14

Depletion

Answer 14

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

Question 15

Natural Resource Purchase Cost Includes

Answer 15

• Purchase price + any expenditures to prepare the land for the removal of resources, such as drilling costs, costs for tunnels/shafts for the oil industry (intangible development costs) or prepare the asset for harvest, such as the lumber industry

Question 16

Residual Value

Answer 16

Same as salvage value, but for natural resources

Question 17

Depletion Base

Answer 17

Cost to purchase the property minus the net residual value

All Costs to obtain resources - Residual Value

Question 18

Cost Depletion (GAAP)

Answer 18

Cost Depletion = [Current est. recoverable units/unrecovered cost (less salvage value)] x unit produced

Question 19

% Depletion (NOT GAAP/Tax Only)

Answer 19

• Based on % sales

- Usually exceeds cost depletion

Question 20

Depletion Calculation

Answer 20

Depletion for the Period is calculated as:

Total Depletion = unit rate x # of units extracted

Unit Depletion Rate = Depletion Base/Est. Recov Units

Depletion Base (REAL):
- Residual value of land after the resources are
extracted
+ Extraction/development cost to prepare land
+ Anticipated estimated restoration costs
+ Land purchase price
= Depletion Base

Question 21

Recognition of Depletion

Answer 21

If all units are not sold, then depletion must be allocated between COGS and inventory. The amount of depletion in COGS will be based on the UNIT DEPLETION RATE x # of UNITS SOLD. The unsold portion will be allocated to inventory as direct materials.