Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Operational Assets: Utilization and Impairment 11 Insert Book Cover Picture 11-2 Learning Objectives Explain the concept of cost allocation as it pertains to operational assets. 11-3 Some of the cost is expensed each period. Some of the cost is expensed each period. Cost Allocation – An Overview Expense Expense Acquisition Cost Acquisition Cost (Balance Sheet) (Income Statement) The matching principle requires that part of the acquisition cost of operational assets be expensed in periods when the future revenues are earned. The matching principle requires that part of the acquisition cost of operational assets be expensed in periods when the future revenues are earned. 11-4 Cost Allocation – An Overview Some of the cost is expensed each period. Some of the cost is expensed each period. Expense Expense Acquisition Cost Acquisition Cost (Balance Sheet) (Income Statement) Depreciation, depletion, and amortization are cost allocation processes used to help meet the matching principle requirements. Depreciation, depletion, and amortization are cost allocation processes used to help meet the matching principle requirements. 11-5 Type of Operational Asset Debit Intangible Amortization Intangible Asset Account Credited Accumulated Depreciation Property, Plant, & Equipment Depreciation Natural Resource Depletion Natural Resource Asset Caution! Depreciation, depletion, and amortization are processes of cost allocation, not valuation! Cost Allocation – An Overview 11-6 Cost allocation requires three pieces of information for each asset: The estimated expected use from an asset. The estimated expected use from an asset. Total amount of cost to be allocated. Cost - Residual Value (at end of useful life) Total amount of cost to be allocated. Cost - Residual Value (at end of useful life) The systematic approach used for allocation. The systematic approach used for allocation. Allocation Base Allocation Base Service Life Service Life Allocation Method Allocation Method Measuring Cost Allocation 11-7 Learning Objectives Determine periodic depreciation using both time-based and activity-based methods. 11-8 Time-based Methods  Straight-line (SL)  Accelerated Methods  Sum-of-the-years’ digits (SYD)  Declining Balance (DB) Time-based Methods  Straight-line (SL)  Accelerated Methods  Sum-of-the-years’ digits (SYD)  Declining Balance (DB) Activity-based methods Units-of-production method (UOP). Activity-based methods Units-of-production method (UOP). Group and composite methods Group and composite methods Tax depreciation Tax depreciation Depreciation of Operational Assets 11-9 Depreciation on the Balance Sheet Net property, plant & equipment is the undepreciated cost (book value) of plant assets. 11-10 Straight-Line The most widely used and most easily understood method. The most widely used and most easily understood method. Results in the same amount of depreciation in each year of the asset’s service life. Results in the same amount of depreciation in each year of the asset’s service life. [...]... depreciation Using SYD, compute depreciation for the first two years for the first two years 1 1-1 8 Sum-of-the-Years’ Digits (SYD) 2 Use this in your computation of SYD Use this in your computation of SYD Depreciation for Years 1 & 2 Depreciation for Years 1 & 2 1 1-1 9 Sum-of-the-Years’ Digits (SYD) 1 1-2 0 Sum-of-the-Years’ Digits (SYD) Fraction Fraction 5/15 5/15 4/15 4/15 3/15 3/15 2/15 2/15 1/15 1/15 Depreciation... and an estimated residual value of $5,000 What is depreciation for What is depreciation for the first two years using the first two years using double-declining-balance? double-declining-balance? 1 1-2 5 Double-Declining-Balance (DDB) 1 1-2 6 Double-Declining-Balance (DDB) Year Year 1 1 2 2 3 3 4 4 5 5 Depreciation Depreciation (debit) (debit) Accumulated Accumulated Depreciation Depreciation Balance Balance... over the depreciation over the asset’s useful life is the asset’s useful life is the same as the Straightsame as the Straightline Method line Method 1 1-1 6 Sum-of-the-Years’ Digits (SYD) SYD depreciation is computed as follows: 2 1 1-1 7 Sum-of-the-Years’-Digits (SYD) On January 1, we purchase equipment for On January 1, we purchase equipment for $50,000 cash The equipment has a $50,000 cash The equipment... Residual Value 1 1-2 7 Depreciation Double-Declining-Balance (DDB) 20000 18000 16000 14000 12000 10000 8000 6000 4000 2000 0 1 2 3 Life in Years 4 5 1 1-2 8 Activity-Based Depreciation   Depreciation can also be Depreciation can also be based on measures of input based on measures of input or output like: or output like:     Service hours, or Service hours, or Units-of-Production Units-of-Production... 23,000 23,000 14,000 14,000 8,000 8,000 5,000 5,000 Residual Value Residual Value 1 1-2 1 Sum-of-the-Years’ Digits (SYD) Depreciation 16000 14000 12000 10000 8000 6000 4000 2000 0 1 2 3 Life in Years 4 5 1 1-2 2 Declining-Balance (DB) Methods DB depreciation DB depreciation     Based on the straight-line Based on the straight-line rate multiplied by an rate multiplied by an acceleration factor acceleration... year, what is the amount of depreciation? what is the amount of depreciation? 1 1-3 1 Units-of-Production 1 1-3 2 Use of Various Depreciation Methods Recent Survey of Large Public Companies (Sample of 684) 41 22 30 4 7 Straight Line Declining Balance Sum-of-the-years' digits Other Accelerated Units of Production Other 580 1 1-3 3 Depreciation Disclosures  Depreciation  Depreciation  Balances of major classes... hours, or Service hours, or Units-of-Production Units-of-Production Depreciation is not taken for Depreciation is not taken for idle assets idle assets This approach looks different 1 1-2 9 Units-of-Production 1 1-3 0 Units-of-Production On January 1, we purchased equipment for On January 1, we purchased equipment for $50,000 cash The equipment is expected $50,000 cash The equipment is expected to produce... depreciating Stop depreciating when: when: BV=Residual Value BV=Residual Value 1 1-2 3 Double-Declining-Balance (DDB) DDB depreciation is computed as follows: Note that the Book Value Note that the Book Value will get lower each time will get lower each time depreciation is computed! depreciation is computed! 1 1-2 4 Double-Declining-Balance (DDB) On January 1, we purchase equipment for $50,000 On January 1,...1 1-1 1 Straight-Line On January 1, we purchase equipment for On January 1, we purchase equipment for $50,000 cash The equipment has an $50,000 cash The equipment has an estimated service life of 5 years and estimated service life of 5 years and estimated residual value of $5,000 estimated residual value of $5,000 What is the annual straight-line What is the annual straight-line depreciation?... life of 5 years and estimated residual value of $5,000 estimated residual value of $5,000 What is the annual straight-line What is the annual straight-line depreciation? depreciation? 1 1-1 2 Straight-Line 1 1-1 3 Straight-Line Year 1 2 3 4 5 Depreciation (debit) Accumulated Depreciation (credit) Accumulated Depreciation Balance $ $ $ $ 9,000 9,000 9,000 9,000 9,000 45,000 $ 9,000 9,000 9,000 9,000 9,000 . Allocation 1 1-7 Learning Objectives Determine periodic depreciation using both time-based and activity-based methods. 1 1-8 Time-based Methods  Straight-line (SL)  Accelerated Methods  Sum-of-the-years’. (DB) Time-based Methods  Straight-line (SL)  Accelerated Methods  Sum-of-the-years’ digits (SYD)  Declining Balance (DB) Activity-based methods Units-of-production method (UOP). Activity-based. years. Sum-of-the-Years’-Digits (SYD) 1 1-1 8 2 Use this in your computation of SYD Depreciation for Years 1 & 2. Use this in your computation of SYD Depreciation for Years 1 & 2. Sum-of-the-Years’