CH 11

Intermediate
Accounting
11-1
Prepared by
Coby Harmon
University of California, Santa Barbara
11
Depreciation, Impairments,
and Depletion
Intermediate Accounting
14th Edition
Kieso, Weygandt, and Warfield

11-2
Learning Objectives
11-3
1.
Explain the concept of depreciation.
2.
Identify the factors involved in the depreciation process.
3.
Compare activity, straight-line, and decreasing-charge methods

of depreciation.
4.
Explain special depreciation methods.
5.
Explain the accounting issues related to asset impairment.
6.
Explain the accounting procedures for depletion of natural

resources.
7.
Explain how to report and analyze property, plant, equipment,

and natural resources.
Depreciation, Impairments, and Depletion
Depletion
Impairments
Factors involved
Recognizing
Establishing a
Presentation
Methods of
impairments
base
Analysis
depreciation
Measuring
Write-off of
Special methods
Impairments
resource cost
Special issues
Restoration of
Estimating
loss
reserves
Assets to be
Liquidating
disposed of
dividends
Continuing
controversy
11-4
Presentation
and Analysis
Depreciation
Depreciation - Method of Cost 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:
11-5
Fixed assets = Depreciation expense
Intangibles = Amortization expense
Natural resources = Depletion expense
LO 1 Explain the concept of depreciation.

Factors Involved in the Depreciation Process
Three basic questions:
(1) What depreciable base is to be used?
(2) What is the assets useful life?
(3) What method of cost allocation is best?
11-6
LO 2 Identify the factors involved in the depreciation process.

Depreciable Base
Illustration 11-1
11-7

Estimation of Service Lifes
Service life often differs from physical life.
Companies retire assets for two reasons:

1. Physical factors (casualty or expiration of
physical life).
2. Economic factors (inadequacy, supersession,

and obsolescence).
11-8

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.
Accelerated methods
(4)
Declining-balance method.
(5)
Group and composite methods.

Special methods
(6)
11-9
Hybrid or combination methods.

LO 3 Compare activity, straight-line, and decreasingcharge methods of depreciation.

Activity Method
Illustration 11-2
Stanley Coal
Mines Facts
Illustration: If Stanley uses the crane for 4,000 hours the first
year, the depreciation charge is:
Illustration 11-3
11-10
LO 3

Straight-Line Method
Illustration 11-2
Stanley Coal
Mines Facts
Illustration: Stanley computes depreciation as follows:
Illustration 11-4
11-11
LO 3

Decreasing-Charge Methods
Illustration 11-2
Stanley Coal
Mines Facts
Sum-of-the-Years-Digits. Each fraction uses the sum of the

years as a denominator (5 + 4 + 3 + 2 + 1 = 15). The numerator
is the number of years of estimated life remaining as of the
beginning of the year.
Alternate sum-of-theyears calculation
11-12
n(n+1)
2
5(5+1)
2
= 15
LO 3

Sum-of-the-Years-Digits
Illustration 11-6
11-13

Decreasing-Charge Methods
Illustration 11-2
Stanley Coal
Mines Facts
Declining-Balance Method.
Utilizes a depreciation rate (percentage) that is some multiple

of the straight-line method.
Does not deduct the salvage value in computing the

depreciation base.
11-14

Declining-Balance Method
Illustration 11-7
11-15

E11-5 (Depreciation ComputationsFour Methods): Maserati
Corporation purchased a new machine for its assembly process on
August 1, 2012. The cost of this machine was $150,000. The
company estimated that the machine would have a salvage value of
$24,000 at the end of its service life. Its life is estimated at 5 years and
its working hours are estimated at 21,000 hours. Year-end is
December 31.
Instructions: Compute the depreciation expense under the following
methods.
11-16
(a) Straight-line depreciation.
(c) Sum-of-the-years-digits.
(b) Activity method
(d) Double-declining balance.


Straight-line Method
Current
Depreciable
Year
2012
Base
$
Years
Annual
Partial
Year
Accum.
Expense
Year
Expense
Deprec.
126,000
25,200
2013
126,000
25,200
25,200
35,700
2014
126,000
25,200
25,200
60,900
2015
126,000
25,200
25,200
86,100
2016
126,000
25,200
25,200
111,300
2017
126,000
25,200
14,700
126,000
5/12
7/12
= $
=
$
10,500
10,500
126,000
Journal entry:
2012
11-17
Depreciation expense
Accumultated depreciation
10,500
10,500

Activity Method
(Assume 800 hours used in 2012)
($126,000 / 21,000 hours = $6 per hour)

(Given)
Year
2012
Current
Hours
Rate per
Annual
Partial
Year
Accum.
Used
Hours
Expense
Year
Expense
Deprec.
800
$6
2013
2014
2015
2016
4,800
800
Journal entry:
2012
11-18
4,800
4,800
4,800
4,800
4,800
LO 3

5/12 = .416667
7/12 = .583333
Sum-of-the-Years-Digits Method
Year
Depreciable
Base
2012
Annual
Expense
Years
Current
Year
Expense
Partial
Year
x
5/12
126,000
5/15
42,000
2013
126,000
4.58/15
38,500
38,500
56,000
2014
126,000
3.58/15
30,100
30,100
86,100
2015
126,000
2.58/15
21,700
21,700
107,800
2016
126,000
1.58/15
13,300
13,300
121,100
2017
126,000
.58/15
4,900
4,900
126,000
126,000
17,500
Accum.
Deprec.
$
17,500
Journal entry:
2012
11-19
17,500
17,500
LO 3

Double-Declining Balance Method
Year
Depreciable
Base
2012
Rate
per Year
Annual
Expense
Current
Year
Expense
Partial
Year
150,000 x
40%
= $
60,000 x
5/12
= $
2013
125,000 x
40%
50,000
50,000
2014
75,000 x
40%
30,000
30,000
2015
45,000 x
40%
18,000
18,000
2016
27,000 x
40%
10,800
Plug
25,000
3,000
$
126,000
Journal entry:
2012
11-20
25,000
25,000
LO 3

Special Depreciation Methods
Choice of method depends on nature of the assets involved:
Group method used when the assets are similar in nature

and have approximately the same useful lives.
Composite approach used when the assets are dissimilar

and have different lives.
Companies are also free to develop tailor-made depreciation methods,

provided the method results in the allocation of an assets cost in a
systematic and rational manner (Hybrid or Combination Methods).
11-21
LO 4 Explain special depreciation methods.

Special Depreciation Issues
(1) How should companies compute depreciation for
partial periods?
(2) Does depreciation provide for the replacement of
assets?
(3) How should companies handle revisions in
depreciation rates?
11-22

Change in Depreciation Rate
Accounted for in the period of change and future

periods (Change in Estimate).
11-23
Not handled retrospectively.
Not considered errors or extraordinary items.
Change in Estimate Example

Arcadia HS, purchased equipment for $510,000 which was
estimated to have a useful life of 10 years with a residual value
of $10,000 at the end of that time. Depreciation has been
recorded for 7 years on a straight-line basis. In 2012 (year 8), it
is determined that the total estimated life should be 15 years
with a residual value of $5,000 at the end of that time.
Questions:
11-24
What is the journal entry to correct

the prior years depreciation?
Calculate the depreciation expense

for 2012.
No Entry
Required

Equipment cost
Salvage value
Depreciable base
Useful life (original)
Annual depreciation
After 7 years
$510,000
First, establish NBV
- 10,000
at date of change in
estimate.
500,000
10 years
$ 50,000 x 7 years = $350,000
Balance Sheet (Dec. 31, 2011)
11-25
Equipment
Accumulated depreciation
$510,000
350,000
Net book value (NBV)
$160,000

Net book value
Salvage value (new)
Depreciable base
Useful life remaining
Annual depreciation
$160,000
5,000
155,000
8 years
$ 19,375
After 7 years
Depreciation
Expense calculation
for 2012.
Journal entry for 2012
19,375
11-26
19,375
Impairments
When the carrying amount of an asset is not recoverable, a
company records a write-off referred to as an impairment.
Events leading to an impairment:
a. Significant decrease in the fair value of an asset.
b. Significant change in the manner in which an asset is used.
c.
Adverse change in legal factors or in the business climate.
d. An accumulation of costs in excess of the amount originally

expected to acquire or construct an asset.
e. A projection or forecast that demonstrates continuing losses
associated with an asset.
11-27
LO 5 Explain the accounting issues related to asset impairment.
Impairments
Measuring Impairments
1. Review events for possible impairment.
2. If the review indicates impairment, apply the recoverability test. If
the sum of the expected future net cash flows from the long-lived
asset is less than the carrying amount of the asset, an
impairment has occurred.
3. Assuming an impairment, the impairment loss is the amount by
which the carrying amount of the asset exceeds the fair value of
the asset. The fair value is the market value or the present value
of expected future net cash flows.
11-28
Impairments
Illustration 11-16
Graphic of Accounting
for Impairments
11-29
LO 5
Impairments
E11-16 (Impairment): Presented below is information related to
equipment owned by Pujols Company at December 31, 2012. Assume
that Pujols will continue to use this asset in the future. As of December 31,
2012, the equipment has a remaining useful life of 4 years.
Instructions:
Cost
Accumulated depreciation to date
Expected future net cash flows
Fair value
9,000,000
1,000,000
7,000,000
4,400,000
(a) Prepare the journal entry (if any) to record the impairment of the asset at
December 31, 2012.
(b) Prepare the journal entry to record depreciation expense for 2013.
(c) The fair value of the equipment at December 31, 2013, is $5,100,000.
Prepare the journal entry (if any) necessary to record this increase in fair
value.
11-30
LO 5
Impairments
(a).
Cost
9,000,000
1,000,000
Carrying amount
8,000,000
Fair value
4,400,000
Loss on impairment
3,600,000
12/31/12
Loss on impairment
11-31
3,600,000
3,600,000
Impairments
(b).
Net carrying amount
4,400,000
Useful life
Depreciation per year
4 years
$
1,100,000
12/31/11
1,100,000
1,100,000
(c). Restoration of any impairment loss is not permitted.

11-32
Depletion
Natural resources, often called wasting assets, include
petroleum, minerals, and timber.
They have two main features:
1. complete removal (consumption) of the asset, and
2. replacement of the asset only by an act of nature.

Depletion is the process of allocating the cost of natural resources.
11-33
LO 6 Explain the accounting procedures for depletion of natural resources.
Depletion
Establishing a Depletion Base
Computation of the depletion base involves four factors:
(1) Acquisition cost.
(2) Exploration costs.
(3) Development costs.
(4) Restoration costs.
11-34
Depletion
Write-off of Resource Cost
Normally, companies compute depletion on a units-ofproduction method (activity approach). Depletion is a function
of the number of units extracted during the period.
Calculation:
Total cost Residual value
= Depletion cost per unit
Total estimated units available

Units extracted x Cost per unit
11-35
= Depletion
Depletion
Illustration: MaClede Co. acquired the right to use 1,000
acres of land in Alaska to mine for silver. The lease cost is
$50,000, and the related exploration costs on the property are
$100,000. Intangible development costs incurred in opening
the mine are $850,000. MaClede estimates that the mine will
provide approximately 100,000 ounces of silver.

Illustration 11-17
11-36
Depletion
If MaClede extracts 25,000 ounces in the first year, then the
depletion for the year is $250,000 (25,000 ounces x $10).
Inventory
Accumulated Depletion
250,000
250,000
MaCledes statement of financial position:

Illustration 11-18
Depletion cost related to inventory sold is part of cost of goods sold.

11-37
LO 6
Depletion
Estimating Recoverable Reserves
Same as accounting for changes in estimates.
Revise the depletion rate on a prospective basis.
Divides the remaining cost by the new estimate of the

recoverable reserves.
11-38
Depletion
Liquidating Dividends - Dividends greater than the
amount of accumulated net income.
Illustration: Callahan Mining had a retained earnings balance
of $1,650,000, accumulated depletion on mineral properties of
$2,100,000, and share premium of $5,435,493. Callahans board
declared a dividend of $3 a share on the 1,000,000 shares
outstanding. It records the $3,000,000 cash dividend as follows.
Retained Earnings
1,650,000
Paid-in Capital in Excess of Par
1,350,000
Cash
11-39
3,000,000
Depletion
Continuing Controversy
Oil and Gas Industry:
11-40
Full cost concept
Successful efforts concept
Presentation and 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
11-41
Depreciation expense for the period.

Balances of major classes of depreciable assets.
Accumulated depreciation.
A description of the depreciation methods used.
LO 7 Explain how to report and analyze property,
plant, equipment, and natural resources.

Analysis of Property, Plant, and Equipment
Asset Turnover Ratio
Measure of a firms
ability to generate
sales from a
particular investment
in assets.
Illustration 11-20
11-42
LO 7

Profit Margin on Sales
Measure of the ability
to generate operating
income from a
particular level of
sales.
Illustration 11-21
11-43
LO 7

Rate of Return on Assets
Measures a firms
success in using
assets to generate
earnings.
Illustration 11-22
11-44
LO 7

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
Profit Margin on
Sales
Net Income
11-45
Asset Turnover
Net Sales
=
Average Total Assets
Net Sales
Average Total Assets


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
$53.5
Profit Margin on
Sales
$53.5
($838.2 + $813.5) / 2
11-46
$495.5
($838.2 + $813.5) / 2
$495.5
Asset Turnover
6.5%
10.5%
.60

APPENDIX
11A
INCOME TAX DEPRECIATION
Modified Accelerated Cost Recovery System

MACRS differs from GAAP in three respects:
1. a mandated tax life, which is generally shorter than the
economic life;
2. cost recovery on an accelerated basis; and

3. an assigned salvage value of zero.
11-47
LO 8 Describe income tax methods of depreciation.
APPENDIX
11A

Tax Lives (Recovery Periods)
Illustration 11A-1
11-48
APPENDIX
11A

Tax Depreciation Methods
Illustration 11A-2
11-49
APPENDIX
11A

Illustration: Computer and peripheral equipment purchased
by Denise Rode Company on January 1, 2011.
11-50
APPENDIX
11A

Illustration:
Illustration 11A-3
11-51
APPENDIX
11A

Illustration 11A-4
Illustration: Using the rates

from the MACRS depreciation
rate schedule for a 5-year class
of property, Rode computes
depreciation as follows
Illustration 11A-5
11-52
LO 8
APPENDIX
11A

Additional Issues
11-53
Optional straight-line method.
Tax versus book depreciation.
RELEVANT FACTS
11-54
The definition of property, plant, and equipment is essentially the

same under GAAP and IFRS.
Under both GAAP and IFRS, changes in depreciation method and

changes in useful life are treated in the current and future periods.
Prior periods are not affected. GAAP recently conformed to IFRS in
this area.
The accounting for plant asset disposals is the same under GAAP
and IFRS.
The accounting for the initial costs to acquire natural resources is

similar under GAAP and IFRS.
RELEVANT FACTS
11-55
Under both GAAP and IFRS, interest costs incurred during

construction must be capitalized. Recently, IFRS converged to
GAAP.
The accounting for exchanges of nonmonetary assets has recently

converged between IFRS and GAAP. GAAP now requires that gains
on exchanges of nonmonetary assets be recognized if the exchange
has commercial substance. This is the same framework used in
IFRS.
GAAP also views depreciation as allocation of cost over an assets

life. GAAP permits the same depreciation methods (straight-line,
diminishing-balance, units-of-production) as IFRS.
RELEVANT FACTS
11-56
IFRS requires component depreciation. Under GAAP, component

depreciation is permitted but is rarely used.
Under IFRS, companies can use either the historical cost model or
the revaluation model. GAAP does not permit revaluations of
property, plant, and equipment or mineral resources.
In testing for impairments of long-lived assets, GAAP uses a twostep model to test for impairments (details of the GAAP impairment
test is presented in the About the Numbers discussion). As long as
future undiscounted cash flows exceed the carrying amount of the
asset, no impairment is recorded. The IFRS impairment test is
stricter. However, unlike GAAP, reversals of impairment losses are
permitted.
IFRS SELF-TEST QUESTION

Which of the following statements is correct?
a. Both IFRS and GAAP permit revaluation of property, plant, and
equipment.
b. IFRS permits revaluation of property, plant, and equipment but
not GAAP.
c.
Both IFRS and GAAP do not permit revaluation of property,

plant, and equipment.
d. GAAP permits revaluation of property, plant, and equipment but

not IFRS.
11-57
IFRS SELF-TEST QUESTION

Under IFRS, value-in-use is defined as:
a. net realizable value.
b. fair value.
c.
future cash flows discounted to present value.
d. total future undiscounted cash flows.
11-58
Copyright
Copyright 2012 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.
11-59

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Intermediate

Kieso, Weygandt, and Warfield

Explain the concept of depreciation.

Identify the factors involved in the depreciation process.

Compare activity, straight-line, and decreasing-charge methods

Explain special depreciation methods.

Explain the accounting issues related to asset impairment.

Explain the accounting procedures for depletion of natural

Explain how to report and analyze property, plant, equipment,

Depreciation, Impairments, and Depletion

Depreciation - Method of Cost Allocation

Fixed assets = Depreciation expense

Intangibles = Amortization expense

Natural resources = Depletion expense

LO 1 Explain the concept of depreciation.

Depreciation - Method of Cost Allocation

(3) What method of cost allocation is best?

LO 2 Identify the factors involved in the depreciation process.

Depreciation - Method of Cost Allocation

LO 2 Identify the factors involved in the depreciation process.

Depreciation - Method of Cost Allocation

Service life often differs from physical life.

Companies retire assets for two reasons:

2. Economic factors (inadequacy, supersession,

LO 2 Identify the factors involved in the depreciation process.

Depreciation - Method of Cost Allocation

Activity method (units of use or production).

Group and composite methods.

Hybrid or combination methods.

Depreciation - Method of Cost Allocation

Depreciation - Method of Cost Allocation

Depreciation - Method of Cost Allocation

Sum-of-the-Years-Digits. Each fraction uses the sum of the

Depreciation - Method of Cost Allocation

LO 3 Compare activity, straight-line, and decreasingcharge methods of depreciation.

Depreciation - Method of Cost Allocation

Utilizes a depreciation rate (percentage) that is some multiple

Does not deduct the salvage value in computing the

LO 3 Compare activity, straight-line, and decreasingcharge methods of depreciation.

Depreciation - Method of Cost Allocation

LO 3 Compare activity, straight-line, and decreasingcharge methods of depreciation.

Depreciation - Method of Cost Allocation

(a) Straight-line depreciation.

(b) Activity method

(d) Double-declining balance.

Depreciation - Method of Cost Allocation

LO 3 Compare activity, straight-line, and decreasingcharge methods of depreciation.

Depreciation - Method of Cost Allocation

(Assume 800 hours used in 2012)

($126,000 / 21,000 hours = $6 per hour)

Depreciation - Method of Cost Allocation

Depreciation - Method of Cost Allocation

Depreciation - Method of Cost Allocation

Group method used when the assets are similar in nature

Composite approach used when the assets are dissimilar

Companies are also free to develop tailor-made depreciation methods,

LO 4 Explain special depreciation methods.

Depreciation - Method of Cost Allocation

LO 4 Explain special depreciation methods.

Depreciation - Method of Cost Allocation

Accounted for in the period of change and future

Not handled retrospectively.

Not considered errors or extraordinary items.