Depreciation, Depreciation, Impairments, Impairments, and and Depletion Depletion Chapter 11 Intermediate Accounting 12th Edition Kieso, Weygandt, and Warfield Chapter 11-1 Prepared by Coby Harmon, University of California, Santa Barbara Learning Learning Objectives Objectives Explain the concept of depreciation Identify the factors involved in the depreciation process Compare activity, straight-line, and decreasing-charge methods of depreciation Explain special depreciation methods Explain the accounting issues related to asset impairment Explain the accounting procedures for depletion of natural resources Explain how to report and analyze property, plant, equipment, and natural resources Chapter 11-2 Depreciation, Depreciation, Impairments, Impairments, and and Depletion Depletion Depreciation Impairments Factors involved Methods of depreciation Special methods Recognizing impairments Measuring Impairments Restoration of loss Assets to be disposed of Special issues Chapter 11-3 Depletion Establishing a base Write-off of resource cost Continuing controversy Special problems Presentation and Analysis Presentation Analysis Depreciation Depreciation Method Method of of Cost Cost Allocation Allocation Depreciation is the accounting process of allocating the cost of tangible assets to expense in a systematic and rational manner to those periods expected to benefit from the use of the asset Allocating costs of long-term assets: Fixed assets = Depreciation expense Intangibles = Amortization expense Natural resources = Depletion expense Chapter 11-4 LO Explain the concept of depreciation Depreciation Depreciation Method Method of of Cost Cost Allocation Allocation Factors Involved in the Depreciation Process Three basic questions: (1) What depreciable base is to be used? (2) What is the asset’s useful life? (3) What method of cost allocation is best? Chapter 11-5 LO Identify the factors involved in the depreciation process Depreciation Depreciation Method Method of of Cost Cost Allocation Allocation Methods of Depreciation The profession requires the method employed be “systematic and rational.” Examples include: (1) Activity method (units of use or production) (2) Straight-line method (3) Sum-of-the-years’-digits (4) Declining-balance method (5) Group and composite methods (6) Hybrid or combination methods Chapter 11-6 Accelerated methods Special methods LO Compare activity, straight-line, and decreasingcharge methods of depreciation Depreciation Depreciation Method Method of of Cost Cost Allocation Allocation Exercise (Depreciation Computations—Four Methods) Robert Parish Corporation purchased a new machine for its assembly process on September 30, 2007 The cost of this machine was $117,900 The company estimated that the machine would have a salvage value of $12,900 at the end of its service life Its life is estimated at years and its working hours are estimated at 1,000 hours Year-end is December 31 Instructions: Compute the depreciation expense under the following methods (a) Straight-line depreciation (b) Activity method (c) Sum-of-the-years’-digits (d) Double-declining balance Chapter 11-7 LO Compare activity, straight-line, and decreasingcharge methods of depreciation Depreciation Depreciation Method Method of of Cost Cost Allocation Allocation Exercise (Straight-line Method) Year 2007 Depreciable Base $ 105,000 / 2008 2009 2010 2011 2012 105,000 105,000 105,000 105,000 105,000 / / / / / Years = 5 5 = = = = = Annual Expense $ 21,000 21,000 21,000 21,000 21,000 21,000 x x Partial Year 3/12 9/12 = = Current Year Expense $ 5,250 21,000 21,000 21,000 21,000 15,750 $ 105,000 Accum Deprec $ 5,250 26,250 47,250 68,250 89,250 105,000 Journal entry: 2007 Depreciation expense 5,250 Accumultated depreciation Chapter 11-8 5,250 LO Compare activity, straight-line, and decreasingcharge methods of depreciation Depreciation Depreciation Method Method of of Cost Cost Allocation Allocation Exercise (Activity Method) ($105,000 / 1,000 hours = $105 per hour) Year 2007 (Given) Hours Used 200 2008 2009 150 250 x x 105 105 = = 15,750 26,250 15,750 26,250 36,750 63,000 2010 300 x 105 = 31,500 31,500 94,500 2011 100 1,000 x 105 = 10,500 10,500 $ 105,000 105,000 Rate per Hours x $105 = Annual Expense $ 21,000 Journal entry: 2007 Depreciation expense Accum Deprec $ 21,000 21,000 Accumultated depreciation Chapter 11-9 Partial Year Current Year Expense $ 21,000 21,000 LO Compare activity, straight-line, and decreasingcharge methods of depreciation Depreciation Depreciation Method Method of of Cost Cost Allocation Allocation Exercise (Sum-of-the-years’-digits Method) Year 2007 2008 Depreciable Base $ 105,000 105,000 2009 Accum Deprec $ 8,750 42,000 x x Years 5/15 = 4.75/15 = Annual Expense $ 35,000 33,250 105,000 x 3.75/15 = 26,250 26,250 68,250 2010 2011 105,000 105,000 x x 2.75/15 = 1.75/15 = 19,250 12,250 19,250 12,250 87,500 99,750 2012 105,000 x 5,250 5,250 $ 105,000 105,000 75/15 = x Partial Year 3/12 Current Year Expense $ 8,750 33,250 Journal entry: 2007 Depreciation expense 8,750 Accumultated depreciation Chapter 11-10 8,750 LO Compare activity, straight-line, and decreasingcharge methods of depreciation Depletion Depletion Natural resources, often called wasting assets, include petroleum, minerals, and timber They have two main features: complete removal (consumption) of the asset, and replacement of the asset only by an act of nature Depletion is the process of allocating the cost of natural resources Chapter 11-24 LO Explain the accounting procedures for depletion of natural resources Depletion Depletion Establishing a Depletion Base Computation of the depletion base involves four factors: (1) Acquisition cost of the deposit, (2) Exploration costs, (3) Development costs, and (4) Restoration costs Chapter 11-25 LO Explain the accounting procedures for depletion of natural resources Depletion Depletion Write-off of Resource Cost Normally, companies compute depletion on a units-ofproduction method (an activity approach) Thus, depletion is a function of the number of units extracted during the period Calculation: Total cost – Salvage value Total estimated units available = Depletion cost per unit Units extracted x Cost per unit = Depletion Chapter 11-26 LO Explain the accounting procedures for depletion of natural resources Depletion Depletion E11-19 (Depletion Computations—Timber) Stanislaw Timber Company owns 9,000 acres of timberland purchased in 1996 at a cost of $1,400 per acre At the time of purchase the land without the timber was valued at $400 per acre In 1997, Stanislaw built fire lanes and roads, with a life of 30 years, at a cost of $84,000 Every year Stanislaw sprays to prevent disease at a cost of $3,000 per year and spends $7,000 to maintain the fire lanes and roads During 1998, Stanislaw selectively logged and sold 700,000 board feet of timber, of the estimated 3,500,000 board feet In 1999, Stanislaw planted new seedlings to replace the trees cut at a cost of $100,000 Instructions: Determine the depreciation expense and the cost of timber sold related to depletion for 1998 Chapter 11-27 LO Explain the accounting procedures for depletion of natural resources Depletion Depletion E11-19 (Depletion Computations—Timber) Depreciation Expense: Fire lanes and roads Useful life Depreciation expense per year Chapter 11-28 $ 84,000 30 $ 2,800 LO Explain the accounting procedures for depletion of natural resources Depletion Depletion E11-19 (Depletion Computations—Timber) Depletion: Cost of timberland per acre Cost of land per acre Cost of timber only per acre Total acres Value of timber Estimated total board feet Cost per board foot Board feet of timber sold Cost of timber sold related to depletion Chapter 11-29 $ $ $ $ $ 1,400 (400) 1,000 9,000 9,000,000 3,500,000 2.57 700,000 1,800,000 LO Explain the accounting procedures for depletion of natural resources Depletion Depletion Continuing Controversy Oil and Gas Industry: Full cost concept Successful efforts concept Special Problems in Depletion Accounting Difficulty of estimating recoverable reserves Problems of discovery value Tax aspects of natural resources Accounting for liquidating dividends Chapter 11-30 LO Explain the accounting procedures for depletion of natural resources Presentation Presentation and and Analysis Analysis Presentation of Property, Plant, Equipment, and Natural Resources Depreciating assets, use Accumulated Depreciation Depleting assets may include use of Accumulated Depletion account, or the direct reduction of asset Basis of valuation (cost) Pledges, liens, and other commitments Disclosures Depreciation expense for the period Balances of major classes of depreciable assets Accumulated depreciation A description of the depreciation methods used Chapter 11-31 LO Explain how to report and analyze property, plant, equipment, and natural resources Presentation Presentation and and Analysis Analysis Rate of Return on Assets measures a firm’s success in using assets to generate earnings ROA = 6.56% = Chapter 11-32 Net Income Average Total Assets $56,200 ($1,030,400 + 682,400) / LO Explain how to report and analyze property, plant, equipment, and natural resources Presentation Presentation and and Analysis Analysis The analyst obtains further insight into the behavior of ROA by disaggregating it into components of profit margin on sales and asset turnover as follows: Rate of Return on Assets Net Income Average Total Assets Chapter 11-33 = = Profit Margin on Sales Net Income Sales x x Asset Turnover Sales Average Total Assets LO Explain how to report and analyze property, plant, equipment, and natural resources Presentation Presentation and and Analysis Analysis The analyst obtains further insight into the behavior of ROA by disaggregating it into components of profit margin on sales and asset turnover as follows: Rate of Return on Assets $56,200 = = ($1,030,400 + 682,400) / 6.56% Chapter 11-34 Profit Margin on Sales $56,200 x x 18.73% $300,000 ($1,030,400 + 682,400) / $300,000 = Asset Turnover x 3503 LO Explain how to report and analyze property, plant, equipment, and natural resources Presentation Presentation and and Analysis Analysis The profit margin on sales is a measure of the ability of a firm to generate operating income from a particular level of sales Rate of Return on Assets Net Income = = Average Total Assets 6.56% Chapter 11-35 Profit Margin on Sales Net Income x x Sales = 18.73% Asset Turnover Sales Average Total Assets x 3503 LO Explain how to report and analyze property, plant, equipment, and natural resources Presentation Presentation and and Analysis Analysis The profit margin on sales is a measure of the ability of a firm to generate operating income from a particular level of sales Rate of Return on Assets Net Income Average Total Assets = = Profit Margin on Sales Net Income Sales x x Asset Turnover Sales Average Total Assets Differences in the profit margin on sales (from year to year) can be studied by analyzing individual revenues and expenses Chapter 11-36 LO Explain how to report and analyze property, plant, equipment, and natural resources Presentation Presentation and and Analysis Analysis The assets turnover is a measure of a firm’s ability to generate sales from a particular investment in assets Rate of Return on Assets Net Income = = Average Total Assets 6.56% Chapter 11-37 Profit Margin on Sales Net Income x x Sales = 18.73% Asset Turnover Sales Average Total Assets x 3503 LO Explain how to report and analyze property, plant, equipment, and natural resources Copyright Copyright Copyright © 2006 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein Chapter 11-38 ... cash flows Chapter 11- 19 LO Explain the accounting issues related to asset impairment Impairments Impairments Illustration 11- 16 Accounting for Impairments Chapter 11- 20 LO Explain the accounting. .. $ 11, 790 42,444 25,466 15,280 9,168 852 $ 105,000 Accum Deprec $ 11, 790 54,234 79,700 94,980 104,148 105,000 Journal entry: 2007 Depreciation expense 11, 790 Accumultated depreciation Chapter 11- 11... Depletion Accounting Difficulty of estimating recoverable reserves Problems of discovery value Tax aspects of natural resources Accounting for liquidating dividends Chapter 11- 30 LO Explain the accounting