Unit 10 - Depreciation, Impairments, Depletion

Question 1

A company owns a machine that it purchased on January 1, year 1 for $600,000. The machine has an estimated useful life of 5 years and an estimated salvage value of $75,000. The company uses the sum-of-the-years’-digits method.

What is the depreciation expense for each year and book value of the machine at the end of year 5?

Answer 1

Year 1: ($600,000 - $75,000) x 5/15 = $175,000
Year 2: ($600,000 - $75,000) x 4/15 = $140,000
Year 3: ($600,000 - $75,000) x 3/15 = $105,000
Year 4: $(600,000 - $75,000) x 2/15 = $70,000
Year 5: ($600,000 - $75,000) x 1/15 = $35,000

Total accumulated depreciation $525,000 = ($175,000 + $140,000 + $105,000+ $70,000 + $35,000)
Book value of the machine at the end of year 5 is its salvage $75,000 = $600,000 – $525,000

Accounting Rule: the sum-of-the-years’-digits method is an accelerated depreciation method resulting in higher deprecation cost in the earlier years and lower charges in later periods. It is a passage of time depreciation method that results in a decreasing depreciation charge based on a decreasing fraction of depreciable cost (original cost less salvage value). Each fraction uses the sum of the years as a denominator (e.g. 5 + 4 + 3 + 2 + 1 = 15). The numerator is the number of years of estimated life remaining as of the beginning of the year. In this method, the numerator decreases year by year, and the denominator remains constant (e.g. 5/15, 4/15, 3/15, 2/15, and 1/15). At the end of the asset’s useful life, the balance remaining should equal the salvage value. Never depreciate beyond an asset’s salvage value.

Question 2

A company purchased a truck at the beginning of 2020 for $109,200. The truck is estimated to have a salvage value of $4,200 and a useful life of 120,000 miles. It was driven 21,000 miles in 2020 and 29,000 miles in 2021.

What is the depreciation expense for 2020 and 2021 using the variable charge method?

Answer 2

Image

Accounting Rule: The activity method (also called the variable-charge or units-of-activity/production approach) assumes that depreciation is a function of use or productivity, instead of the passage of time. It calculates depreciation based on the asset’s activity such as the number of units produced or the number of hours/miles the asset is used during the period. In other words, this method focuses on the actual use of the asset rather than the passage of time. The amount of depreciation expense is directly proportional to the amount of the asset’s usage. The activity rate is multiplied by the depreciable cost (original cost less salvage value). Another formula is: (Actual Activity in Period/Total Estimate Activity) x (Cost – Salvage Value)

Question 3

Equipment with a cost of $450,000 has an estimated salvage value of $30,000 and an estimated life
of 4 years or 10,000 hours. It is to be depreciated by the units-of-activity method.

What is the amount of depreciation for the first full year, during which the equipment was used 2,700 hours?

Answer 3

$113,400 = (2,700 / 10,000) x ($450,000 – $30,000)

Accounting Rule: (Actual Activity in Period/Total Estimate Activity) x (Cost – Salvage Value)

Question 4

The activity method of depreciation
a. is a variable charge approach.
b. assumes that depreciation is a function of the passage of time.
c. conceptually associates cost in terms of input measures.
d. all of these answers are correct.

Answer 4

a. is a variable charge approach.

Accounting Rule: under the activity method, the amount of depreciation expense is directly proportional to the amount of the asset’s usage.

Question 5

A company placed an asset into service on day 1 of year 1 with the following data related to the purchase:

Cost of machinery $225,000
Estimated salvage value $75,000
Product life hours 75,000 hours
Useful life 5 years
Hours used in Year 1 5,000 hours

What amount of annual depreciation expense should be recorded in the first year using the variable charge method, and what is the machine’s book value at the end of year 1? (round your answer)

Answer 5

$10,000 depreciation expense = (5,000 / 75,000) x ($225,000 – $75,000)
$215,000 book value = $225,000 – $10,000

Accounting Rule: (Actual Activity in Period/Total Estimate Activity) x (Cost – Salvage Value). The book value/carrying value of an asset is its original cost less accumulate depreciation.

Question 6

A company placed an asset into service on day 1 of year 1 with the following data related to the purchase:

Cost of machinery $225,000
Estimated salvage value $75,000
Product life hours 75,000 hours
Useful life 5 years
Hours used in Year 1 5,000 hours

Using the information above, what amount of annual depreciation expense should be recorded in each of the five years using the straight-line method, and what is the machine’s book value for each of the years?

Answer 6

$30,000 depreciation expense = ($225,000 – $75,000) / 5
This amount will be the same over the 5 years

$195,000 book value year 1 = $225,000 – $30,000
$165,000 book value year 2 = $225,000 – $60,000
$135,000 book value year 3 = $225,000 – $90,000
$105,000 book value year 4 = $225,000 – $120,000
$75,000 book value year 5 = $225,000 – $150,000

Accounting Rule: straight-line depreciation is the most used and simplest depreciation method for allocating the cost of a capital asset. It is calculated by simply dividing the original cost of an asset, less its salvage value, by the useful life of the asset. With the straight-line depreciation method, the value of an asset is reduced uniformly over each period until it reaches its salvage value.

Question 7

A company placed an asset into service on day 1 of year 1 with the following data related to the purchase:

Cost of machinery $225,000
Estimated salvage value $75,000
Product life hours 75,000 hours
Useful life 5 years
Hours used in Year 1 5,000 hours

Using the information above, what amount of annual depreciation expense should be recorded in the first and second years using double-declining balance method, and what is the machine’s book value for each of the years?

Answer 7

100% / 5years = 20% straight-line rate x 2 = 40% DDB rate
$90,000 depreciation expense year 1= 40% × $225,000
$135,000 book value year 1= $225,000 – $90,000

$54,000 depreciation expense year 2= 40% × $135,000
$81,000 book value year 2= $225,000 – ($90,000 + $54,000)

Accounting Rule: the double-declining balance (DDB) method is an accelerated depreciation that records larger depreciation expenses during the earlier years of an asset’s useful life, and smaller ones in later years. First, divide 100% by the number of years in the asset’s useful life, this is the straight-line depreciation rate. Then, multiply that number by 2 and that is the double-declining depreciation rate. Multiply that rate by the asset’s book value in each year. Depreciation continues until the asset’s value declines to its salvage value.

Question 8

Depreciation is a variable expense if the depreciation method used is
a. units-of-production.
b. straight-line.
c. sum-of-the-years’-digits.
d. declining-balance.

Answer 8

a. units-of-production.

Accounting Rule: the activity method is also called the variable-charge or units-of-production approach.

Question 9

Assume an asset is used evenly over a four-year service life, which method of depreciation will always result in the largest amount of depreciation in the first year?
a. straight-line.
b. units-of-production.
c. double-declining balance.
d. sum-of-the-year’s digits.

Answer 9

c. double-declining balance.

Question 10

In the first year of an asset’s life, which of the following methods has the smallest depreciation?

a. straight-line.
b. declining balance.
c. sum-of-the-years’ digits.
d. composite or group.

Answer 10

a. straight-line.

Question 11

In the first year of an asset’s life, which of the following methods, in addition to straight line, has the smallest depreciation?
a.MACRS.
b. declining balance.
c. sum-of-the-years’ digits.
d. composite or group.

Answer 11

Ans d

Composite or group depreciation calculates annual depreciation using the straight line method.

Question 12

On July 1, 2020, a company purchased a machine with a five-year useful life for $10,000 and no salvage value. The company prepares accrual-basis financial statements on a calendar-year basis.

How many months should be included in the calculation of depreciation expense for the year of acquisition using the double-declining-balance method?

Answer 12

Six

Question 13

On July 1, 2020, a company purchased a machine with a five-year useful life for $10,000 and no salvage value. The company prepares accrual-basis financial statements on a calendar-year basis.

What is the depreciation expense for 2020 and 2021?

Answer 13

Year 2020
100% / 5years = 20% straight-line rate x 2 = 40% DDB rate
$4,000 full year = 40% × $10,000
$2,000 half year = 6/12 × $4,000

Year 2021
100% / 5years = 20% SL rate x 2 = 40% DDB rate
$ 3,200 full year (40% × $ 8,000)

Accounting Rule: in computing depreciation expense for partial periods, first determine the depreciation expense for the full year and then prorate this amount between the two periods involved.

Question 14

On July 1, 2020, a company purchased a machine with a five-year useful life for $10,000 and no salvage value. The company prepares accrual-basis financial statements on a calendar-year basis.

Using the information above, assume the company uses the sum-of-the-years’-digits method, what is the depreciation expense for 2020 and 2021?

Answer 14

Year 2020
$3,333.33 full year = 5/15 × $10,000
$1,666.67 half year = 6/12 × $3,333.33

Year 2021
$2,666.67 full year = 4/15 × $10,000
$1,666.67 half year 6/12 × $3,333.33; and $1,333.33 half year = 6/12 × $2,666.67
$3,000 = $1,666.67 + $1,333.33

Accounting Rule: in computing depreciation expense for partial periods, first determine the depreciation expense for the full year and then prorate this amount between the two periods involved.

Question 15

A company has a policy of calculating depreciation using the nearest fraction of a year policy. On May 10, the company purchased and placed in service an asset costing $50,000 with a five-year useful life.

What fraction is used to calculate the depreciation expense on December 31 and what is the depreciation expense on December 31? (round your answer to a whole number)

Answer 15

7⅔= ⅔ in May,and full months for June to December
$6,392 = (7.67/12) x ($50,000/5)

Accounting Rule: the nearest fraction of a year policy states that the depreciation expense is prorated at the time the asset is placed in service
Please make sure you are familiar with the following fractional year depreciation policy calculations.
A company purchases a machine that cost $ 45,000 on June 10, 2019 and places it in service on the same day. The machine has a useful life of 5 years and no salvage value.

Question 16

. A company purchases an asset on April 5 of the current year. The company would like to use the depreciation policy that will result in the highest depreciation expense in the last year of the asset’s useful life.

Which depreciation policy should be used?
a. nearest full month.
b. half-year convention.
c. nearest fraction of the year.
d. full year in period of disposal.

Answer 16

Ans d

Accounting Rule: please make sure you are familiar with the following fractional year depreciation policy calculations.
A company purchases a machine that cost $ 45,000 on June 10, 2019 and places it in service on the same day. The machine has a useful life of 5 years and no salvage value.

Question 17

A company purchases an asset on April 5th of the current year. The company would like to use the depreciation policy that will result in the highest depreciation expense in the first year of the asset’s useful life.

Which depreciation policy should be used?
a. nearest full month.
b. half-year convention.
c. nearest fraction of the year.
d. full year in period of disposal.

Answer 17

Ans a

Accounting Rule: using the nearest full month, the asset will be depreciated for 9 months in the first year. Using the half-year convention, the asset will be depreciated for 6 months in the first year. Using the nearest fraction of the year, the asset will be depreciated for 8⅔ months in the first year.

Question 18

When depreciation is computed for partial periods under a decreasing charge depreciation method, it is necessary to
a. charge a full year’s depreciation to the year of acquisition.
b. determine depreciation expense for the full year and then prorate the expense between the two periods involved.
c. use the straight-line method for the year in which the asset is sold or otherwise disposed of.
d. use a salvage value equal to the first year’s partial depreciation charge.

Answer 18

b. determine depreciation expense for the full year and then prorate the expense between the two periods involved.

Accounting Rule: in computing depreciation expense for partial periods, first determine the depreciation expense for the full year and then prorate this amount between the two periods involved.

Question 19

A company purchased machinery with an original cost of $90,000. It estimates a 20-year life with no salvage value. At the beginning of year 6, the company estimates that it will use the machine for an additional 25 years.

What is the revised total life of the machinery at the beginning of year 6?

Answer 19

30 years
5 years of depreciation taken + the additional 25 years

Accounting Rule: a change in estimate is reported in the current and prospective periods. Charges for depreciation in subsequent periods (assuming use of the straight-line method) are determined by dividing the remaining book value less any salvage value by the remining estimated life.

Question 20

A company acquired machinery on January 1, 2015 which it depreciated under the straight-line method with an estimated life of fifteen years and no salvage value. On January 1, 2020, the company estimated that the remaining life of this machinery was six years with no salvage value.

How should this change be accounted for by the company?
a. as a prior period adjustment.
b. as the cumulative effect of a change in accounting principle in 2020.
c. by setting future annual depreciation equal to one-sixth of the book value on January 1, 2020.
d. by continuing to depreciate the machinery over the original fifteen-year life.

Answer 20

Ans c

Accounting Rule: a change in estimate is reported in the current and prospective periods. Charges for depreciation in subsequent periods (assuming use of the straight-line method) are determined by dividing the remaining book value less any salvage value by the remining estimated life.

Question 21

A change in estimate should
a. result in restatement of prior period statements.
b. be handled in current and future periods.
c. be handled in future periods only.
d. be handled retroactively.

Answer 21

b. be handled in current and future periods.

Accounting Rule: a change in estimate is reported in the current and prospective periods. Charges for depreciation in subsequent periods (assuming use of the straight-line method) are determined by dividing the remaining book value less any salvage value by the remining estimated life.

Question 22

A company purchased a piece of equipment for $120,000 and estimated that the asset will have no salvage value at the end of its 15-year useful life. At the end of year 5 of ownership, when accumulated depreciation was $40,000 and the asset’s book value was $80,000, the company revised the asset’s estimated useful life to a total of 10 years.

What is depreciation expense for year 6 assuming the company uses the straight-line method?

Answer 22

$16,000 = $80,000 / 5 yrs
5 yrs = 10 yrs – 5 yrs of previous depreciation taken

Accounting Rule: a change in estimate is reported in the current and prospective periods. Charges for depreciation in subsequent periods (assuming use of the straight-line method) are determined by dividing the remaining book value less any salvage value by the remining estimated life.

Question 23

A company purchased a depreciable asset for $840,000 on January 1, 2017. The estimated salvage value is $84,000, and the estimated total useful life is 9 years. The straight-line method is used for depreciation. On January 1,2020, the company changed its estimates to a total useful life of 5 years with a salvage value of $140,000.

What is 2020 depreciation expense?
a. the equipment will depreciate 588,000 over the next five years.
b. the equipment will depreciate 448,000 over the next five years.
c. the equipment will depreciate 588,000 over the next two years.
d. the equipment will depreciate 448,000 over the next two years.

Answer 23

Ans d
$558,000 = $840,000 – $252,000 [($840,000 – $84,000) / 9] x 3
$448,000 = $558,000 – $140,000
The revised useful life of the asset is 5 years and 3 years of previous depreciation was taken leaving 2 years left.

Accounting Rule: a change in estimate is reported in the current and prospective periods. Charges for depreciation in subsequent periods (assuming use of the straight-line method) are determined by dividing the remaining book value less any salvage value by the remining estimated life.

Question 24

A company bought equipment for $240,000 on January 1, 2019. The company estimated the useful life to be 3 years with no salvage value, and the straight-line method of depreciation will be used. On January 1, 2020, Jack decides that the business will use the equipment for a total of 5 years.

What is the revised depreciation expense for 2020?

Answer 24

$40,000 = [$240,000 - ($240,000 / 3)] / 4
The revised useful life of the asset is 5 years and 1 year of previous depreciation was taken leaving 4 years left.

Accounting Rule: a change in estimate is reported in the current and prospective periods. Charges for depreciation in subsequent periods (assuming use of the straight-line method) are determined by dividing the remaining book value less any salvage value by the remining estimated life.

Question 25

A machine originally had an estimated useful life of 5 years, but after 3 complete years, it was decided that the original estimate useful life should have been 10 years. At that point the remaining cost to be depreciated should be allocated over
a. 2 years.
b. 7 years.
c. 8 years.
d. 10 years.

Answer 25

Ans 7
The revised useful life of the asset is 10 years and 3 years of previous depreciation was taken leaving 7 years left.

Accounting Rule: a change in estimate is reported in the current and prospective periods. Charges for depreciation in subsequent periods (assuming use of the straight-line method) are determined by dividing the remaining book value less any salvage value by the remining estimated life.

Question 26

A company purchased and placed into service a piece of machinery with an original cost of $100,000. It estimates a 10-year useful life with no salvage value. At the beginning of Year 8, when accumulated depreciation was $70,000 and the asset’s book value was $30,000, the company estimates that it will use the machine for a total of 12 years.

Which statement describes the proper accounting treatment beginning with Year 8?
a. the company will depreciate the $30,000 book value over the next 12 years.
b. the company will depreciate $100,000 over the next five years.
c. the company will depreciate $100,000 over the next 12 years.
d. The company will depreciate the $30,000 book value over the next five years.

Answer 26

Ans d
At the start of year 8, the net book value is $30,000 [$100,000 – (($100,000 / 10) x 7)]. Since the asset has 5 more years of estimated use (years 8 through 12), the net book value of $30,000 is depreciated over the remaining 5 years.

Question 27

Composite or group depreciation is a depreciation system whereby
a. the years of useful life of the various assets in the group are added together and the total divided by the number of items.
b. the cost of individual units within an asset group is charged to expense in the year a unit is retired from service.
c. a straight-line rate is computed by dividing the total of the annual depreciation expense for all assets in the group by the total cost of the assets.
d. the original cost of all items in a given group or class of assets is retained in the asset account and the cost of replacements is charged to expense when they are acquired.

Answer 27

Ans c

Accounting Rule: two methods of depreciating multiple-asset accounts exist: the group method and the composite method. The choice of method depends on the nature of the assets involved. The group method is used when the assets are similar in nature and have approximately the same useful lives. The composite approach is used when the assets are dissimilar and have different lives. The group method more closely approximates a single-unit cost procedure because the dispersion from the average is not as great. The computation for group or composite methods is essentially the same: find total annual depreciation expense for all assets and divide by total cost of all assets.

Question 28

For the composite method, the composite
a. rate is the total cost divided by the total annual depreciation.
b. rate is the total annual depreciation divided by the total depreciable cost.
c. life is the total cost divided by the total annual depreciation.
d. life is the total depreciable cost divided by the total annual depreciation.

Answer 28

Ans d

Accounting Rule: the composite depreciation rate is the total annual depreciation divided by total cost. The composite life is the total depreciable cost divided by the total annual depreciation. Please make sure to study the calculations in the following table:

Question 29

A schedule of machinery owned by a company is presented below:
Estimated Estimated
Total Cost Salvage Value Life in Years
Machine X $600,000 $40,000 14
Machine Y 800,000 80,000 10
Machine Z 300,000 60,000 6
The company computes depreciation by the composite method.

What is the composite rate of depreciation (in percent) for these assets ? a.      8.94% b.	 10.59% c.      8.57% d.	 15.56%

Answer 29

Ans a
($600,000 – $40,000) ÷ 14 = $40,000
($800,000 – $80,000) ÷ 10 = $72,000
($300,000 – $60,000) ÷ 6 = $40,000
$1,700,000 $152,000

  $152,000
————— = 8.94%
$1,700,000

Accounting Rule: the composite depreciation rate is the total annual depreciation divided by total cost. If another machine was purchased, the new cost would be added to total cost and a new deprecation rate would have to be calculated.

Question 30

The composite life (in years) for these assets is
a. 15.6 years
b. 8.6 years
c. 8.9 years
d. 10.0 years

Answer 30

Ans d
($560,000 + $720,000 + $240,000) ÷ $152,000 = 10.0 years

Accounting Rule: the composite life is the total depreciable cost divided by the total annual depreciation.

Question 31

A company buys several different assets with varying useful lives at the beginning of the year and is trying to determine which special depreciation method to use.

Which depreciation method allows the company to use one rate to depreciate all the assets?
a. hybrid.
b. per unit.
c. group.
d. composite.

Answer 31

Ans d

Accounting Rule: the composite method uses an average rate for determining depreciation expense and is used when the assets are dissimilar and have varying useful lives.

Question 32

A company buys several similar assets with the same useful lives at the beginning of the year and is trying to determine which special depreciation method to use.

Which depreciation method allows the company to use one rate to depreciate all the assets?
a. hybrid.
b. per unit.
c. group.
d. composite.

Answer 32

A company buys several similar assets with the same useful lives at the beginning of the year and is trying to determine which special depreciation method to use.

Which depreciation method allows the company to use one rate to depreciate all the assets?
a. hybrid.
b. per unit.
c. group.
d. composite.

Question 33

A company using the composite approach to depreciation sold equipment for $12,000. The equipment was purchased five years earlier for $15,000, and the company has already recorded $5,000 in accumulated depreciation.

What is the gain from the sale?

Answer 33

None

The gain of $2,000 is not recognized ($12,000 – ($15,000 – $5,000)). It is offset against the accumulated depreciation account.
The journal entry is
Cash 12,000
Accumulated Depreciation (5,000 – 2,000) 3,000
Equipment 15,000

Accounting Rule: if an asset accounted for under the composite approach is sold, there is no gain or loss. The journal entry is a debit to cash for the amount of cash received and a credit to the fixed asset account for the historical cost of the asset. The difference between these two amounts is record against the accumulated depreciation account which gets debited.

Question 34

Which depreciation method does the real estate industry prefer?
a. straight-line.
b. declining-balance.
c. sum-of-the-years’ digits.
d. increasing-charge.

Answer 34

Ans d

Accounting Rule: real estate companies object to traditional depreciation methods because in their view, real estate often does not decline in value. In addition, because real estate is highly debt-financed, most real estate concerns report losses in earlier years of operations when the sum of depreciation and interest exceeds the revenue from the real estate project. As a result, real estate companies argue for some form of increasing-charge method of depreciation (lower depreciation at the beginning and higher depreciation at the end). With such a method, companies would report higher total assets and net income in the earlier years of the project.

Question 35

An asset costs $200,000 with an expected useful life of five years. At the end of five years, the salvage value is expected to be $20,000.

What is the depreciation base?

Answer 35

$180,000 = $200,000 - $20,000

Accounting Rule: the depreciation base is the difference between the cost and the salvage value:

Question 36

Accounting for impairment losses
a. involves a two-step process for recoverability and measurement.
b. applies only to depreciable assets.
c. applies only to assets with finite lives.
d. all of these answer choices are correct.

Answer 36

a. involves a two-step process for recoverability and measurement.

Accounting Rule: the first step when events or circumstances suggest an asset’s book value may not be fully recoverable is to perform a recoverability test, comparing the assets’ book value and expected future cash flows (undiscounted). If the expected future cash flows (undiscounted) are less than the book value, the asset is considered impaired. The second step is to measure the amount of impairment as the excess of the asset’s book value over its fair value.

Question 37

In testing for recoverability of property, plant, and equipment, an impairment loss is required if the
a. asset’s book value exceeds the undiscounted sum of expected future cash flows.
b. undiscounted sum of its expected future cash flows exceeds the asset’s book value.
c. present value of expected future cash flows exceeds its book value.
d. all of these answer choices are incorrect.

Answer 37

a. asset’s book value exceeds the undiscounted sum of expected future cash flows.

Accounting Rule: the recoverability test examines the undiscounted future cash flows of the asset to its book/carrying value. If the undiscounted future cash flows exceed the carrying amount, no impairment exists because the carrying amount is deemed recoverable. However, if the carrying amount of the asset exceeds the undiscounted future cash flows, an impairment exists, and the loss needs to be measured. The fair value test is used to determine the impairment loss amount. The impairment loss is the amount by which the carrying amount of the asset exceeds its fair value.

Question 38

Recent, negative events in an operating division have caused a company to believe that it is possible that it will not be able to fully recover the book value of a group of assets.

What is the second step the company should take in reviewing the assets?
a. determine if an impairment exists because the assets’ expected future cash flows (undiscounted) are greater than their book value.
b. measure the amount of impairment as the excess of the assets’ fair value over their book value.
c. determine if an impairment exists because the assets’ book value is greater than the expected future cash flows (undiscounted).
d. measure the amount of impairment as the excess of the asset’s book value over its fair value.

Answer 38

d. measure the amount of impairment as the excess of the asset’s book value over its fair value.

Accounting Rule: the first step when events or circumstances suggest an asset’s book/carrying value may not be fully recoverable is to perform a recoverability test, comparing the assets’ book/carrying value and expected future cash flows (undiscounted). If the expected future cash flows (undiscounted) are less than the book/carrying value, the asset is considered impaired. The second step is to measure the amount of impairment as the excess of the asset’s book/carrying value over its fair value.
An impairment exists when CV > UFC in other words, the asset fails the recoverability test
The impairment loss is the difference between CV and FV.
The asset’s new basis is the FV if it is lower than the CV.

Question 39

A company wants to determine if an asset is impaired.

How is the recoverability test applied?
a. carrying value less the expected future cash flow (undiscounted)
b. original cost less the fair value
c. original cost less the carrying value
d. carrying value less the fair value

Answer 39

a. carrying value less the expected future cash flow (undiscounted)

Accounting Rule: the recoverability test is used to determine if an asset has suffered an impairment. If the undiscounted future cash flows exceed the carrying amount, no impairment exists because the carrying amount is deemed recoverable. However, if the carrying amount of the asset exceeds the undiscounted future cash flows, an impairment exists, and the loss needs to be measured.
An impairment exists when CV > UFC in other words, the asset fails the recoverability test.
The impairment loss is the difference between CV and FV.
An impairment exists when CV > UFC.
The asset’s new basis is the FV if it is lower than the CV.
The journal entry to record an impairment loss is
Debit impairment loss
Credit accumulated depreciation
After recording an impairment loss, the reduced carrying amount of the asset held for use becomes its new cost basis. A company does not change the new cost basis except for depreciation in future periods or for additional impairments.

Question 40

A company owns an asset with an original cost of $300,000 and a current book value of $220,000. In reviewing the asset for impairment, the company estimates that the expected future cash flows from the use and disposal of the asset will be $160,000. The fair value of the asset, calculated as the present value of expected future cash flows, is $180,000. The company wants to identify why the asset is considered impaired, according to the recoverability test.

Which statement identifies why the asset is impaired?
a. the fair value is greater than accumulated depreciation.
b. the expected future cash flows are greater than accumulated depreciation.
c. the fair value is greater than the book value.
d. the expected future cash flows is less than the book value.

Answer 40

d. the expected future cash flows is less than the book value.
Accounting Rule: the recoverability test is used to determine if an asset has suffered an impairment. If the undiscounted future cash flows exceed the carrying amount, no impairment exists because the carrying amount is deemed recoverable. However, if the carrying amount of the asset exceeds the undiscounted future cash flows, an impairment exists, and the loss needs to be measured.
An impairment exists when CV > UFC in other words, the asset fails the recoverability test
The impairment loss is the difference between CV and FV.
The asset’s new basis is the FV if it is lower than the CV.
The journal entry to record an impairment loss is
Debit impairment loss
Credit accumulated depreciation
After recording an impairment loss, the reduced carrying amount of the asset held for use becomes its new cost basis. A company does not change the new cost basis except for depreciation in future periods or for additional impairments.

Question 41

Recognition of impairment for an asset is required if book value exceeds
a. fair value.
b. present value of expected cash flows.
c. undiscounted expected cash flows.
d. accumulated depreciation.

Answer 41

c. undiscounted expected cash flows.

Accounting Rule: the recoverability test is used to determine if an asset has suffered an impairment. If the undiscounted future cash flows exceed the carrying amount, no impairment exists because the carrying amount is deemed recoverable. However, if the carrying amount of the asset exceeds the undiscounted future cash flows, an impairment exists, and the loss needs to be measured.
An impairment exists when CV > UFC in other words, the asset fails the recoverability test.
The impairment loss is the difference between CV and FV.
The journal entry to record an impairment loss is
Debit impairment loss
Credit accumulated depreciation
After recording an impairment loss, the reduced carrying amount of the asset held for use becomes its new cost basis. A company does not change the new cost basis except for depreciation in future periods or for additional impairments.

Question 42

A company owns an asset with an original cost of $300,000 and a current book value of $160,000. During a review of the asset for impairment, the company estimates the expected future cash flows from the use and disposal of the asset to be $200,000. There is an active market for this asset, and the fair value of the asset, calculated as the present value of expected future cash flows, is $140,000.

Should this asset be considered impaired?
a. yes, because fair value is less than the original cost.
b. yes, because the fair value is less than the book value.
c. no, because the estimate of expected future cash flows (undiscounted) is greater than the book value.
d. no, because the estimate of expected future cash flows (undiscounted) is greater than the actual fair value.

Answer 42

c. no, because the estimate of expected future cash flows (undiscounted) is greater than the book value.

Accounting Rule: the recoverability test is used to determine if an asset has suffered an impairment. If the undiscounted future cash flows exceed the carrying amount, no impairment exists because the carrying amount is deemed recoverable. However, if the carrying amount of the asset exceeds the undiscounted future cash flows, an impairment exists, and the loss needs to be measured.
An impairment exists when CV > UFC, in other words, the asset fails the recoverability test.

Question 43

When is the restoration of an impairment loss not permitted?
a. assets held for use.
b. assets held for disposal.

Answer 43

a. assets held for use.

Accounting Rule: a company may not restore a previous impairment on an asset held for use.

Question 44

When is the restoration of an impairment loss permitted?
a. assets held for use.
b. assets held for disposal.

Answer 44

b. assets held for disposal.

Accounting Rule: assets held for disposal are like inventory; companies should report them at the lower-of-cost-or net realizable value and any losses or gains should be reported as part of income from continuing operations.

Question 45

Several years ago, a company acquired an asset held for use at a cost of $400,000. Last year, the company recognized an impairment loss of $25,000 and properly reduced the asset’s book value from $250,000 to $225,000.

Using the asset’s new base of $225,000, the company calculates depreciation for the current year to be $10,000, bringing the book value down to $215,000. However, the company has also determined that the asset’s fair value has recovered and is now estimated to be $260,000.

How should the company measure the asset on its current balance sheet?
a. the company should reverse the prior impairment and measure the asset at its current fair value of $260,000.
b. the company should reverse the prior impairment and measure the asset at its fair value prior to the initial impairment of $250,000.
c. the company should not reverse the impairment and should depreciate the asset by $10,000 to a new book value of $215,000.
d. the company should not reverse the impairment and should not depreciate the asset further, leaving the book value at $225,000.

Answer 45

c. the company should not reverse the impairment and should depreciate the asset by $10,000 to a new book value of $215,000.
Accounting Rule: after recording the impairment loss, the reduced carrying amount of the asset held for use becomes its new cost basis. The company does not change the new cost basis except for depreciation in future periods or for additional impairments. The company cannot restore the impairment loss since the asset is held for use.

Question 46

Presented below is information related to a piece of equipment owned by a company at December 31, 2019.

Cost $9,450
Accumulated depreciation to date $1,050
Expected future net cash flows $7,350
Fair value $5,040

The company intends to dispose of the equipment sometime in 2020. As of December 31, 2019, the equipment has a remaining useful life of 4 years.

What is the journal entry to record the impairment loss at December 31, 2019?

Answer 46

Debit impairment loss 3,360
Credit accumulated depreciation 3,360

Carrying/book value is $8,400 = $9,450 – $1,050
Net realizable value is $5,040
Impairment exists because CV > NRV
Impairment loss is $3,360 =$ 8,400 – $5,040

Question 47

Presented below is information related to a piece of equipment owned by a company at December 31, 2019.

Cost $9,450
Accumulated depreciation to date $1,050
Expected future net cash flows $7,350
Fair value $5,040

The company intends to dispose of the equipment sometime in 2020. As of December 31, 2019, the equipment has a remaining useful life of 4 years.

What is the equipment’s new carrying basis?

Answer 47

$5,040
The equipment is written down to its NRV . Depreciation is no longer taken because the asset is no longer in use.

Question 48

Presented below is information related to a piece of equipment owned by a company at December 31, 2019.

Cost $9,450
Accumulated depreciation to date $1,050
Expected future net cash flows $7,350
Fair value $5,040

The company intends to dispose of the equipment sometime in 2020. As of December 31, 2019, the equipment has a remaining useful life of 4 years.

Assume the equipment is still not sold and has a fair value of $5,565 at December 31,2020.

What amount of the impairment loss, if any, can be restored, and would be the journal entry?

Answer 48

Book value before impaired is $8,400
Impairment loss is $3,360
New cost basis is $5,040
New fair value is $5,565
Since the $5,565 does not exceed the $8,400, the equipment can be written up by $3,360 ($8,400 less current carrying basis of $5,040)
Debit accumulated depreciation 3,360
Credit Recovery of impairment loss 3,360

Accounting Rule: for assets held for disposal, the impairment loss is reported at the lower-of-cost-or-net realizable value just like inventory. Book Value is the historic cost of the asset less accumulated depreciation. Net realizable value is fair value less costs to sell/dispose.

Asset held for disposal impairment test:
Compare net realizable value (NRC) to carrying value (CV)
If CV > NRV, recognize a loss.
If CV < NRV, recognize a gain however, the gain cannot exceed the amount of the initial impairment loss.

Accounting:
Asset is written down to NRV.
The asset is removed from PPE.
Depreciation is no longer taken.
The asset can be written up but not above original carrying value.

Assets that are impaired can only have their carrying value restored if they are held for disposal. Held for use assets are not allowed to have restoration of their carrying value.

Question 49

A mining company purchased land on February 1, 2020, at a cost of $1,190,000. Attorney fees of $50,000 and surveyor costs of $10,000 is included in the cost of land. It is estimated that a total of 60,000 tons of mineral was available for mining. After it has removed all the natural resources, the company will be required to restore the property to it previous state because of strict environmental protection laws. To help restore the land, the company purchased a CAT bulldozer for $500,000. The bulldozer will be used at this plot of land in addition to other locations.

The company estimated the fair value of the restoration obligation at $90,000. The company believes it will be able to sell the property afterwards for $100,000. The company incurred development costs of $200,000 before it was able to do any mining.

What is the depletion base the company should use?

Answer 49

$1,380,000 = $1,190,000 + $90,000 - $100,000 + $200,000
Since the bulldozer can be used elsewhere, its cost is not included in the depletion base. However, its cost would be included if the bulldozer has no use elsewhere.

Accounting Rule: the depletion base = (cost to acquire + cost to explore + cost to develop, i.e. intangible costs + cost to restore). Tangible assets used in extracting natural resources are normally set up in a separate account and depreciated separately. Tangible costs include all transportation and other heavy equipment needed to extract the resource and get it ready for market. Intangible costs are drilling costs, tunnels, shafts, and wells.

Question 50

A company incurred costs of $15.3 million for the rights to extract resources from a natural gas deposit. The company expects to extract 8 million cubic feet of natural gas during a six-year period. Natural gas extracted during years 1 and 2 were 800,000 and 1,600,000 cubic feet, respectively.

What was total depletion for year 1 and year 2 combined, assuming the company uses the units-of-production method?

Answer 50

$4.59 million
Depletion rate = $15.3 million ÷ 8 million cubic feet = $1.9125/cubic foot
Total depletion = (800,000 + 1,600,000) cubic feet × $1.9125 = $4.59 million

Accounting Rule: the depletion rate = (depletion base - salvage value) ÷ total units to be recovered. Depletion expense = depletion rate x units of usage/extracted. An activity-based method is most often used to allocate the cost of natural resources over their useful life.

Question 51

A company acquired a tract of land containing an extractable natural resource. The company is required by its purchase contract to restore the land to a condition suitable for recreational use after it has extracted the natural resource. Geological surveys estimate that the recoverable reserves will be 2,500,000 tons, and that the land will have a value of $1,000,000 after restoration. Relevant cost information follows:

Land $7,500,000
Estimated restoration costs $1,500,000

What should be the charge to depletion expense per ton of extracted material?
a. $2.60
b. $3.00
c. $3.20
d. $3.60

Answer 51

c. $3.20

$3.20 = ($7,500,000 + $1,500,000 - $1,000,000) / $2,500,000

Accounting Rule: the depletion base = (cost to acquire + cost to explore + cost to develop, i.e. intangible costs + cost to restore). Tangible assets used in extracting natural resources are normally set up in a separate account and depreciated separately. Tangible costs include all transportation and other heavy equipment needed to extract the resource and get it ready for market. Intangible costs are drilling costs, tunnels, shafts, and wells.
Depletion rate = (depletion base - salvage value) ÷ total units to be recovered.
Depletion expense = depletion rate x units of usage/extracted.
An activity-based method is most often used to allocate the cost of natural resources over their useful life.
The cost of natural resources is expensed to cost of goods sold in the period the resource is sold.

Question 52

. In January 2020, a company purchased a mineral mine for $5,100,000 with removable ore estimated by geological surveys at 2,000,000 tons. The property has an estimated value of $300,000 after the ore has been extracted. The company incurred $1,500,000 of development costs preparing the mine for production. During 2020, 600,000 tons were removed, and 480,000 tons were sold.

What is the journal entry to record the ore extracted?
What is the journal entry to record the ore sold?
What is the carrying value of the ore at the end of 2020?

Answer 52

Debit inventory (ore) 1,890,000
Credit mineral mine 1,890,000
$3.15 = [($5,100,000 + $1,500,000 -$300,000) / 2,000,000]
$1,890,000 = $3.15 x 600,000

Debit cost of goods sold 1,512,000
Credit inventory (ore) 1,512,000
$1,512,000 = $3.15 x 480,000

$378,000 = $1,890,000 - $1,512,000

Accounting Rule: the depletion base = (cost to acquire + cost to explore + cost to develop, i.e. intangible costs + cost to restore). Tangible assets used in extracting natural resources are normally set up in a separate account and depreciated separately. Tangible costs include all transportation and other heavy equipment needed to extract the resource and get it ready for market. Intangible costs are drilling costs, tunnels, shafts, and wells.
Depletion rate = (depletion base - salvage value) ÷ total units to be recovered.
Depletion expense = depletion rate x units of usage/extracted.
An activity-based method is most often used to allocate the cost of natural resources over their useful life.
Natural resources that have been harvested but not yet sold are accounted for as inventory. As the resources are sold, they are removed from inventory and expensed to cost of goods sold resulting in a new carrying value of the natural resource.

Question 53

A company spends $180,000,000 to purchase and prepare a quarry to mine granite and expects to mine 400,000 tons of granite. The salvage value of the property is $15,000,000, and the expected useful life of the property is 15 years.

What is the journal entry to record depletion if the company extracts 80,000 tons and sells 50,000 tons in the first year?

Answer 53

Debit inventory (granite) 33,000,000
Credit quarry 33,000,000
$33,000,000 = (($180,000,000 - $15,000,000)/400,000) x 80,000

Debit cost of goods sold 20,625,000
Credit inventory (granite) 20,625,000
$20,625,000 = (($180,000,000 - $15,000,000)/400,000) x 50,000

Accounting Rule: the depletion base = (cost to acquire + cost to explore + cost to develop, i.e. intangible costs + cost to restore). Tangible assets used in extracting natural resources are normally set up in a separate account and depreciated separately. Tangible costs include all transportation and other heavy equipment needed to extract the resource and get it ready for market. Intangible costs are drilling costs, tunnels, shafts, and wells.
Depletion rate = (depletion base - salvage value) ÷ total units to be recovered.
Depletion expense = depletion rate x units of usage/extracted.
An activity-based method is most often used to allocate the cost of natural resources over their useful life.
Natural resources that have been harvested but not yet sold are accounted for as inventory. As the resources are sold, they are removed from inventory and expensed to cost of goods sold resulting in a new carrying value of the natural resource.

Question 54

A company invests $50,000,000 into a coal mine estimated to have 20 million tons of coal. The company estimates that it can sell the coal mine for $3,000,000 after it spends $1,000,000 to restore the property after extraction. In year 1, the company extracted and sold 4,000,000 tons of coal.

How much depletion expense is incurred in year 1?

Answer 54

$9,600,000
($50,000,000 + $1,000,000 - $3,000,000) x (4,000,000 / 20,000,000). The salvage value and restoration costs are included in the calculation of depletion.

Question 55

A company believes a property contains natural resources and pays $80,000 for the property. The company spends $50,000 on a bulldozer to be used in multiple projects, $10,000 to dig the land to find the natural resources, and $3,000 on intangible development costs.

What is the depletion base for the natural resources?

Answer 55

$93,000
Cost of land, exploration, and intangible development cost are all part of the depletion base $80,000+$10,000+$3,000

Question 56

A company invests $15,000,000 into a coal mine estimated to have 20 million tons of coal. The coal mine is estimated to be in operation for the next five years. In year 1, the company extracted and sold 1 million tons of coal.

How much is depletion in year 1?

Answer 56

$750,000 = ($15,000,000 / 20,000,000) x 1,000,000

Question 57

A company invested $15,000,000 in a coal mine estimated to have 1,500,000 tons of coal. In the first year, the company extracted 100,000 tons of coal. At the end of the first year, it became clear that the coal mine was likely to have only another 700,000 tons of coal remaining.

What is the depletion rate starting in the second year?

Answer 57

$20.00 = ($15,000,000 - $1,000,000) / 700,000

Question 58

Using the information above, what type of accounting change does the change to the recoverable reserve estimate represent?
a. principle change.
b. estimate change.
c. both a principle and estimate change.
d. neither a principle nor estimate change.

Answer 58

b. estimate change.

Accounting Rule: a change in the estimate of recoverable reserves represents a change in estimate.

Question 59

Using the information above, how is the change in the recoverable reserve estimate accounted for?
a. retrospectively, currently, and prospectively.
b. retrospectively only.
c. prospectively only.
d. currently and prospectively.

Answer 59

c. prospectively only.

Accounting Rule: when there is a change in estimate, account for it in the period of change and determine the impact of the change on future periods. The procedure is to revise the depletion rate on a prospective basis.

Question 60

A company invested $15,000,000 in a coal mine estimated to have 1,500,000 tons of coal. In the first year, the company extracted 100,000 tons of coal. At the end of the first year, it became evident that the coal mine was likely to have an additional 600,000 tons of coal available (in addition to the original estimate of 1,500,000 tons of coal).

What is the depletion rate starting in the second year?

Answer 60

$7.00 = ($15,000,000 - $1,000,000) / (1,400,000 + 600,000)

Question 61

A company purchased a mine for $70 million which is estimated to have 250,000 tons of ore and a salvage value of $10 million. The company extracted and sold 50,000 tons in the first year.

What is the journal entry to record depletion expense for the first year?

Assume in the second year, 150,000 tons of ore are extracted, and 125,000 tons are sold.

What is the journal entry to record depletion expense for the second year?

How is the 25,000 tons not sold accounted for?

What is the journal entry to record the ore when sold?

Answer 61

Debit depletion expense 12,000,000
Credit accumulated depletion 12,000,000
$12,000,000 = (($70,000,000 - $10,000,000)/250,000) x 50,000

Accounting Rule: sometimes an accumulated depletion account is used to record depletion expense which is a contra-asset account to the depletion asset account.

Debit depletion expense 30,000,000
Credit accumulated depletion 30,000,000
$12,000,000 = (($70,000,000 - $10,000,000)/250,000) x 125,000

The 25,000 tons of ore that was extracted and not sold is reported in the current asset section of the balance sheet in an Inventory account.

Debit inventory (ore) 6,000,000
Credit accumulated depletion 6,000,000
$6,000,000 = $240 x 25,000

Debit cost of goods sold 6,000,000
Credit inventory (ore) 6,000,000

Depletion Recap Journal Entries:
Natural resource is extracted and sold.
Debit depletion expense account
Credit Natural resource account or accumulated depletion account

The next set of journal entries are for a natural resource extracted and sold later
Natural resource is extracted. The natural resource is housed in an inventory account until it is sold.
Debit inventory account
Credit natural resource account

Natural resource is subsequently sold.
Debit cost of goods sold
Credit inventory account

Question 62

A company purchased a mine for $70 million which is estimated to have 250,000 tons of ore and a salvage value of $10 million. The company extracted and sold 50,000 tons in the first year.