Presentation on theme: "CHAPTER 11 Depreciation, Impairment, and Disposition"— Presentation transcript:
1 CHAPTER 11 Depreciation, Impairment, and Disposition
2 Copyright John Wiley & Sons Canada, Ltd. 11:Depreciation, Impairment, and DispositionAfter Studying this chapter you should be able to:Understand the importance of depreciation, impairment, and disposition from abusiness perspective.Explain the concept of depreciation and identify the factors to consider when determiningdepreciation charges.Identify how depreciation methods are selected.Calculate depreciation using the straight-line, decreasing charge, and activity methods andrecognize the effects of using each.Explain the accounting issues for depletion of mineral resources.Explain and apply the accounting procedures for partial periods and a change indepreciation rate.Copyright John Wiley & Sons Canada, Ltd.
3 Copyright John Wiley & Sons Canada, Ltd. 11:Depreciation, Impairment, and DispositionAfter studying this chapter you should be able to (continued):Explain the issues and apply the accounting standards for capital asset impairmentunder both IFRS and ASPE.Explain and apply the accounting standards for long-lived assets that are held for sale.Account for derecognition of property, plant, and equipment.Describe the types of disclosures required for property, plant, and equipment.Analyze a company’s investment in assets.Identify differences in accounting between ASPE and IFRS, and what changes are expectedin the near future.Calculate capital cost allowance in straightforward situations.Copyright John Wiley & Sons Canada, Ltd.
4 Depreciation, Impairment and Disposition Depreciation– A Method of AllocationFactors consideredMethods of allocationDepreciation – methods of calculationDepletion of mineral resourcesOther depreciation issuesImpairmentIndicators of impairmentImpairment – recognition and measurement modelsAsset groups and cash-generating unitsHeld for Sale and DerecognitionLong-lived assets to be disposed of by saleDerecognitionPresentation, Disclosure, and AnalysisPresentation and disclosureAnalysisIFRS/ASPE ComparisonComparison of IFRS and ASPELooking aheadCopyright John Wiley & Sons Canada, Ltd.
5 Depreciation – Concept Depreciation (and amortization more broadly) is a means of cost allocationIt is not a method of valuationDepreciation involves:allocating the depreciable amount of property, plant, and equipment over the periods expected to benefit from the use of the assetsThis allocation is generally recognized as Depreciation ExpenseCopyright John Wiley & Sons Canada, Ltd.
6 Factors in the Depreciation Process Questions to be answered to determine the amount of depreciation expense:What asset components are depreciated separately?What is the asset’s depreciable amount?Over what period is the asset depreciated?What pattern best reflects how the asset’s economic benefits are used up?Copyright John Wiley & Sons Canada, Ltd.
7 Components Depreciated Separately Each significant part of a PP&E asset should be identified and depreciated as a separate componentMultiple components may be grouped for calculating depreciation if they have same useful lives and depreciation methodsParts of each PP&E asset that are not individually significant can be grouped and depreciated as a single componentApplication of components for the purpose of depreciation is required by both ASPE and IFRS. However, IFRS is more detailed and strict.Copyright John Wiley & Sons Canada, Ltd.
8 Copyright John Wiley & Sons Canada, Ltd. Depreciable AmountDepreciable amount is initially calculated as:Original cost of the assetless estimated residual value (or salvage value)IFRS does not permit the use of salvage valueResidual value is the net amount expected to be received for the asset today if it were of the age and in the condition expected at the end of its useful lifeSalvage value is the asset’s estimated net realizable value at the end of the asset’s lifeResidual value should be reviewed regularly (at least annually under IFRS)Depreciation continues as long as residual value is lower than asset’s carrying amountCopyright John Wiley & Sons Canada, Ltd.
9 Copyright John Wiley & Sons Canada, Ltd. Depreciation PeriodDepreciation begins when the asset is available for useDepreciation ends when the asset is derecognized or classified as held for sale.An asset’s useful life and physical life are not the same (expressed in time or units)Useful life is sometimes referred to as the economic life—the period of time over which the asset will produce revenue for the companyFactors affecting useful life are:economic factors (e.g. obsolescence)physical factors (e.g. wear and tear)legal life (e.g. expiration of contract)Copyright John Wiley & Sons Canada, Ltd.
10 Choice of Depreciation Method Depreciation method determines the systematic allocation of the depreciable amount over the asset’s useful lifeDepreciation should reflect the pattern of benefits expected from the use of the assetAdditional considerations for choosing a particular depreciation method include simplicity, cost, as well as perceived economic consequencesDepreciation method affects:The balance sheetThe income statementThe ratios (e.g. return on assets, etc)Copyright John Wiley & Sons Canada, Ltd.
11 Depreciation Methods: Overview Financial AccountingDepreciation MethodsTaxDepreciationStraight-LineMethodDiminishingBalanceSpecialmethodsActivityCopyright John Wiley & Sons Canada, Ltd.
12 Copyright John Wiley & Sons Canada, Ltd. Comparison of MethodsStraight-Line MethodSimple to useBased on two broad assumptions:Constant usageOther costs same each yearDistorts rate of return analysisDiminishing Balance MethodBest match of some assets’ productivity to costMore depreciation in earlier years when asset has greatest benefitActivity MethodOnly appropriate where usage is not a function of timeDifficult to estimate total number of units over life of assetCopyright John Wiley & Sons Canada, Ltd.
13 Depreciation Methods: Example Crane Ltd. buys a crane at the beginning of the current fiscal year. Information relating to the crane follows:Cost: $500,000Estimated useful life: five years (or 30,000 hours)Residual value (end of five years of use): $50,000Actual hours used during the current year: 4, hours and assume 4,700 in next yearBased on this information, calculate the amortization for the current year using: straight-line, decreasing charge, and activity methodsCopyright John Wiley & Sons Canada, Ltd.
14 Copyright John Wiley & Sons Canada, Ltd. Straight-Line Method1. Depreciable amount = $500,000 – $50,000 = $450,0002. Annual Depreciation = $450,000 / 5 years = $90,0003. Depreciation Schedule:Book Depreciation Accumulated Book valueYear Value Expense Depreciation End of year1 $500,000 $90,000 $ 90, $410,0002 $410,000 $90,000 $180, $320,000Note that the depreciation expense is the same each yearCopyright John Wiley & Sons Canada, Ltd.
15 Diminishing Balance Method: Double-Declining-Balance Method Asset’s residual value is not deducted1. Rate of Depreciation = 2 × (1/5) = 40%2. Depreciation (current) = $500,000 × = $ 200,000Depreciation (next) = ($500,000 - $200,000) × 0.40= $120,000Last year is rounded. Book value cannot be less than residual value.Rate= (100% Useful Life) x 23. Depreciation Schedule:Book Depreciation Accumulated Book valueYear Value Expense Depreciation End of year1 $500,000 $200,000 $200, $300,0002 $300,000 $120,000 $320, $180,0003 $180,000 $ 72,000 $392, $108,0004 $108,000 $ 43,200 $435, $ 64,8005 $ 64,800 $ 14,800 $450, $ 50,000Copyright John Wiley & Sons Canada, Ltd.
16 Activity Method (unit = hour) 1. Depreciable amount = $500,000 – $50,000 = $450,0002. Depreciation per hour = $450,000 / 30,000 = $15.003. Depreciation (current) = $15.00 × 4,000 hours = $60,000Depreciation (next) = $15.00 × 4,700 hours = $70,500This same rate is used each year4. Depreciation Schedule:Book Depreciation Accumulated Book valueYear Value Expense Depreciation End of year1 $500,000 $60,000 $ 60, $440,0002 $440,000 $70,500 $130, $369,500Copyright John Wiley & Sons Canada, Ltd.
17 Depletion of Natural Resources Natural resources are depleted (amortized) over time as they are removedDepletion is calculated using an activity method (such as units-of-production)The depletion charge is initially debited to InventoryWhen the resource is sold, Inventory is credited and Cost of Goods Sold is debitedWhere an equipment’s useful life is clearly linked to the life of the resource, it is also amortized using the units-of-production methodCopyright John Wiley & Sons Canada, Ltd.
18 Copyright John Wiley & Sons Canada, Ltd. Depletion: ExampleMining Company has right to use land to mine gold:Lease cost: $ 50,000Exploration cost: $ 100,000Development cost: $ 850,000Total capitalized cost: $1,000,000Estimated production (useful life*) = 100, ounces of gold*Note: useful life is the # of units estimated to be in the resource depositCopyright John Wiley & Sons Canada, Ltd.
19 Copyright John Wiley & Sons Canada, Ltd. Depletion: ExampleDepletion Rate = Total cost – residual valueTotal estimated unitsDepletion Rate = $1,000,000 – 0 = $10 per ounce100,000Entry to record 25,000 ounces mined:Inventory ,000Accumulated depletion ,000Copyright John Wiley & Sons Canada, Ltd.
20 Partial Year Depreciation When an asset is acquired sometime during the year, a partial depreciation charge is sometimes takenThe procedure is:determine depreciation for a full year, andallocate the amount between the two periods affected (see upcoming example)Copyright John Wiley & Sons Canada, Ltd.
21 Depreciation and Partial Periods Straight-Line MethodCalculate the amortization for the portion of the yearGenerally use the nearest full monthDeclining-Balance MethodMore complex calculations involvedUnits of Production/Use MethodNo special calculations requiredCalculate the usage rate and apply to actual usage for the periodSame rate used in subsequent yearsCopyright John Wiley & Sons Canada, Ltd.
22 Partial Year Depreciation: Example Asset purchased on July 1, Information relating to the asset is:Cost: $10,000Estimated service life: five yearsResidual value end of five years: noneDetermine depreciation expense under the double- declining-balance methodDetermine full year depreciation as follows:First full year = $10,000 x 40% = $4,000Second full year = $6,000 x 40% = $2,400Third full year = $3,600 x 40% = $1,440Copyright John Wiley & Sons Canada, Ltd.
23 Partial Year Depreciation: Example Date of purchase, July 1, 2014Allocate first full year’sdepreciation of $4,000between 2014 and 2015$2,000Allocate second full year’sdepreciation of $2,400between 2015 and 2016$1,200201420152016Copyright John Wiley & Sons Canada, Ltd.
24 Revision of Depreciation Estimates Determination of depreciation involves estimates of useful life, residual value, pattern in which asset benefits will be receivedThese estimates need to be reviewed regularly (under IFRS, at least at the end of every fiscal year end)When these estimates are revised, depreciation is recalculatedThe revised depreciation is applied prospectively to the remaining life of the asset, i.e., it is accounted for in the period of the change and to future periodsThe changes do not affect prior periodsCopyright John Wiley & Sons Canada, Ltd.
25 Revision of Depreciation Estimates: Example Depreciable asset purchased for $90,000Estimated life was 20 yearsEstimated residual value was $10,000Pattern of benefits received: equal amounts per periodIn year 9, estimates were revised as follows:Estimated life: total of 30 yearsEstimated residual value: $2,000Determine amortization for 9th year based on the straight-line method of depreciationCopyright John Wiley & Sons Canada, Ltd.
26 Revision of Depreciation Estimates: Example Book value of the asset at the date of revision of estimates:($90,000 – $10,000) / 20 years = $4,000 per year$4,000 × 8 years = $32,000 of Accumulated DepreciationBook value: $90,000 – $32,000 = $58,000Amount to be depreciated (9th to 30th year = 22 years remaining)($58,000 – $2,000) / 22 years = $2,545 each yearCopyright John Wiley & Sons Canada, Ltd.
27 Copyright John Wiley & Sons Canada, Ltd. Impairment: OverviewImpairment occurs when the carrying amount of the long-lived asset (such as PP&E) is greater than its future economic benefit to the companyThere are many external and internal indicators that provide evidence of possible impairmentManagement needs to regularly evaluate assets for these indicators of impairmentIFRS requires this at the end of each reporting periodIf there is an indicator of possible impairment, then the asset must be tested for impairmentTwo main approaches to measuring impairment losses are:Cost recovery impairment modelRational entity impairment modelCopyright John Wiley & Sons Canada, Ltd.
28 Cost Recovery Impairment Model Under this model, an asset is impaired only if carrying amount cannot be recovered from using and eventually disposing of the asset (recoverability test)i.e. impaired if carrying amount > undiscounted future net cash flowsImpairment loss is then measured as asset’scarrying amountless fair valueFair value of the asset is best measured by quoted market prices in active marketsIt is by its nature a present value or discounted measureImpairment losses cannot be reversedApplied by ASPECopyright John Wiley & Sons Canada, Ltd.
29 Rational Entity Impairment Model Impairment loss is measured by comparing the asset’s carrying amount and recoverable amountRecoverable amount is measured as higher ofValue in use, and(present value of future net cash flows)Fair value less cost to sellIf carrying amount < recoverable amount, then there is no impairment lossIf carrying amount > recoverable amount, then impairment loss is difference between two valuesImpairment losses may be reversedApplied under IFRSCopyright John Wiley & Sons Canada, Ltd.
30 Asset Groups and Cash-Generating Units (CGU) Many assets do not generate cash flows independently, so impairment analysis cannot be done at the level of the individual assetThese assets are identified with an asset group or cash-generating unit (CGU)i.e. “smallest identifiable group of assets that generates cash inflows that are largely independent of the cash flows from other assets or groups of assets” (IAS 36.6)Both cost recovery and the rational entity impairment models are then applied to the groups of assets, instead of the individual assetAny impairment losses are then allocated to individual assets on a pro-rata basisNo individual asset should be reduced below its fair value (under cost recovery model) or recoverable amount (under rational entity model) – if these amounts are knownCopyright John Wiley & Sons Canada, Ltd.
31 Copyright John Wiley & Sons Canada, Ltd. Held for SaleLong-lived asset is classified as held for sale if the company intends on disposing the asset by sale and meets strict criteria (described in Ch. 4)Held for sale assets areReported separately on the balance sheetNot depreciatedMeasured at the lower ofCarrying amount, andFair value less costs to sellSubsequent increases in net realizable value may be recognized as gains, but only to the extent they offset previously recognized lossesCopyright John Wiley & Sons Canada, Ltd.
32 Copyright John Wiley & Sons Canada, Ltd. DerecognitionPlant assets may be:retired voluntarily, or disposed of by sale, exchange, involuntary conversion, donationDepreciation is recorded up to the date of disposal before determining gain or lossGains or losses from disposal are normally shown with “Other” revenues and expenses in the income statementCopyright John Wiley & Sons Canada, Ltd.
33 Presentation and Disclosure There are many significant disclosures required for property, plant, and equipmentTypes of disclosures include the following:cost and the accumulated depreciationdepreciation method and rate or periodassumptions surrounding fair-value-related measurementscarry amounts of assets held for saleoutstanding contingenciesSpecific standards under IFRS generally have more extensive disclosure requirements compared to ASPECopyright John Wiley & Sons Canada, Ltd.
34 Analysis of Property, Plant, and Equipment 1. Activity analysis(efficiency in using assets to generate revenues)Average Total AssetsNet RevenueTotal Asset Turnover =Net IncomeProfit Margin =Net Revenue2. Profitability analysis(net income earned from each sales dollar):Copyright John Wiley & Sons Canada, Ltd.
35 Analysis of Property, Plant, and Equipment Net RevenueAverage Total Assets×Return on Assets(effect long-lived assets have on profitability):Net Income= Net Revenue= Net IncomeProfit Margin= Asset TurnoverCopyright John Wiley & Sons Canada, Ltd.
36 Copyright John Wiley & Sons Canada, Ltd. IFRS and ASPEASPE and IFRS are consistent in many areas of accounting for depreciation and dispositionMost significant difference between the two standards relates to measurement of impairment lossesThere are no major changes expected in this areaCopyright John Wiley & Sons Canada, Ltd.