PP&E: Depreciation, Disposal, and Impairment Flashcards
What are the types of depreciation?
physical - related to an asset’s deterioration and wear over a period of time
functional - arises from obsolescence or inadequacy of the asset to perform efficiently; obsolescence may result from diminished demand for the product that the depreciable asset produces or from the availability of a new depreciable asset that can perform the same function for substantially less cost
the goal of a depreciation method should be to provide for a reasonable, consistent matching of revenue and expense by systematically allocating the cost of the depreciable asset over its estimated useful life
Common terms for depreciation
salvage value - an estimate of the amount that will be realized at the end of the useful life of a depreciable asset
estimated useful life - the period of time over which an asset’s cost will be depreciated
What is component depreciation?
the separate depreciation of each part of an item of property, plant, and equipment that is significant to the total cost of the fixed asset; it is permitted but rarely used under U.S. GAAP
What is composite or group depreciation?
the process of averaging the economic lives of a number of property units and depreciating the entire class of assets over a single life, thus simplifying record keeping of assets and depreciation calculations
when a group or composite asset is sold or retired, the accumulated depreciation is treated differently from the accumulated depreciation of a single asset; if the average service life of the group of assets has not been reached when an asset is retired, the gain/loss that results is absorbed in the accumulated depreciation account; the accumulated depreciation account is debited/credited for the difference between the original cost and the cash received
composite and component depreciation can be done using any acceptable depreciation method
Straight-line depreciation
depreciation = (cost - salvage value) / estimated useful life
Sum-of-the-years’-digits depreciation
depreciation = (cost - salvage value) * (remaining life of asset /sum-of-the-years’ digits)
if an asset has a 4 year life –> sum-of-the-years’-digits = 1 + 2 + 3 + 4 = 10
first year = 4/10 * (cost - salvage value)
second year = 3/10 * (cost - salvage value)
third year = 2/10 * (cost - salvage value)
fourth year = 1/10 * (cost - salvage value)
Units-of-production (productive output) depreciation
rate per unit/hour = (cost - salvage value) / estimated units or hours
rate per unit/hour * number of units produced/hours worked = depreciation
Double-declining-balance depreciation
each year’s depreciation rate is double the straight-line rate; in the final year, the asset is depreciated to its salvage value (if there is one)
no allowance is made for salvage value because the method always leaves a remaining balance, which is treated as salvage value; however, the asset should not be depreciated below the estimated salvage value
depreciation = 2 * 1/N * (cost - accumulated depreciation)
Partial-year depreciation
when an asset is placed in service during the year, the deprecation expense is typically taken only for the portion of the year that the asset is used; however, some companies may choose to use other specific variations for assets placed in service during the year; for example, the half-year convention means one-half year’s depreciation is taken in both the year of acquisition and the year of disposal…other variations include no depreciation in the year of acquisition but a full year’s depreciation in the year of disposal and vice versa
What is depletion?
it is the allocation of the cost of wasting natural resources to the production process
Common terms for depletion
purchase cost - incudes any expenditures necessary to purchase and then prepare the land for the removal of resources or to prepare the asset for harvest
residual value - similar to salvage value; it is the monetary worth of a depleted asset after the resources have been removed
depletion base (cost - residual value) - it is the cost to purchase the property minus the estimated net residual value remaining after all resources have been removed from the property
What are two methods of depletion?
cost depletion (GAAP) - it is computed by dividing the current estimated recoverable units into unrecovered cost (less salvage) to arrive at a cost depletion rate, which is multiplied by units produced to allocate the costs to production
percentage depletion (not GAAP / tax only) - it is based on a percentage of sales; it is allowed by Congress as a tax deduction to encourage exploration in very risky businesses; it can (and usually does) exceed cost depletion; it is limited to 50% of net income from the depletion property computed before the percentage depletion allowance
How is depletion calculated?
total depletion = unit depletion rate * number of units extracted
unit depletion rate = depletion base / estimated recoverable units
depletion base = cost to purchase property + development costs to prepare the land for extraction + any estimated restoration costs - residual value of land after the resources are extracted
Impairment of PP&E
the carrying amounts of fixed assets held for use and to be disposed of need to be reviewed whenever events or changes in circumstances indicate that the carrying amount may not be recoverable
when a fixed asset is tested for impairment, the future cash flows expected to result from the use of the asset and its eventual disposition need to be estimated; if the sum of undiscounted expected (future) cash flows is less than the carrying amount, an impairment loss needs to be recognized
the impairment loss is calculated as the amount by which the carrying amount exceeds the fair value of the asset
the impairment loss is reported as a component of income from continuing operations before income taxes; the impairment loss is recognized by reducing the carrying value of the asset to its lower fair value; restoration of previously recognized impairment losses is prohibited under U.S. GAAP unless the asset is held for disposal
