1. Investments in Noncurrent Operating Assets--Utilization and Retirement

2. Learning Objectives
Use straight-line, accelerated, use-factor, and group depreciation methods to compute annual depreciation expense.
Discuss the issues impacting proper amortization of intangible assets.
Apply the productive-output method to the depletion of natural resources.

3. Learning Objectives
Incorporate changes in estimates into the computation of depreciation for current and future periods.
Identify whether an asset is impaired and measure the amount of the impairment loss, using U.S. GAAP and international accounting standards.
Account for the sale of depreciable assets in exchange for cash and in exchange for other depreciable assets.

4. Learning Objectives
EXPANDED MATERIAL
Compute depreciation for partial periods, using both straight-line and accelerated methods.
Understand the depreciation methods underlying the MACRS income tax depreciation system.

5. Time Line of Business Issues
ACQUIRE long-term operating assets
ESTIMATE and RECOGNIZE an asset’s use (depreciation, amortization, and depletion)
CHANGE estimates related to an asset’s life

6. Time Line of Business Issues
MONITOR asset value for possible declines
DISPOSE
of a depreciable asset

7. Factors Affecting the Periodic Depreciation Charge
Asset cost
Residual or salvage value
Useful life
Pattern of use

8. Depreciation--Financial Statement Impacts
Income
Statement
Balance Sheet
Statement of
Cash Flows
C. Assets XX
P P & E XXXX
Acc. Dep. (XX)
Total XXXX
Liab. XXX
OE XXX
Total XXXX
Revenue XXXX
COGS XXX
Gr. Profit XXX
Dep. Exp. (XX)
Net Inc. XXX
From Oper.
Net Inc. XXX
Dep. Exp. XX
Net Cash XXX

9. Depreciation--Financial Statement Impacts
Income
Statement
Balance Sheet
Statement of
Cash Flows
C. Assets XX
P P & E XXXX
Acc. Dep. (XX)
Total XXXX
Liab. XXX
OE XXX
Total XXXX
Revenue XXXX
COGS XXX
Gr. Profit XXX
Dep. Exp. (XX)
Net Inc. XXX
From Oper.
Net Inc. XXX
Dep. Exp. XX
Net Cash XXX

10. Depreciation--Financial Statement Impacts
Income
Statement
Balance Sheet
Statement of
Cash Flows
C. Assets XX
P P & E XXXX
Acc. Dep. (XX)
Total XXXX
Liab. XXX
OE XXX
Total XXXX
Revenue XXXX
COGS XXX
Gr. Profit XXX
Dep. Exp. (XX)
Net Inc. XXX
From Oper.
Net Inc. XXX
Dep. Exp. XX
Net Cash XXX
Indirect Method

11. Depreciation Vocabulary
Book Value: Historical cost of the asset less accumulated depreciation.
Depreciation: Periodic charge for cost allocation of long-term assets.
Accumulated Depreciation: Total depreciation recorded since acquisition.
Asset Cost: Purchase cost plus any capitalized expenditures.
Residual Value: Estimated resale value of the asset upon retirement.
Useful Life: Estimated life of asset in years, hours of service, or per unit of output.

12. Depreciation Illustration
Costs incurred are deferred until future periods. They are recorded as an asset and the costs are assigned to future periods.
Depreciable
Cost
(Asset)
Period 1
Period 2
Period 3

13. Depreciation Illustration
Depreciable
Cost
(Asset)
A depreciation method is selected to assign these costs to future periods.
Period 1
Period 1
Period 2
Period 3

14. Depreciation Illustration
Depreciable
Depreciable
Cost
(Asset)
A depreciation method is selected to assign these costs to future periods.
Cost
Period 2
Period 1
Period 2
Period 3

15. Depreciation Illustration
The allocation of a deferred cost, in this case depreciation expense, has no direct effect on cash. The allocation is based on the depreciable cost, useful life, and depreciation method.
Depreciable
Cost
(Asset)
Cost
(Asset)
Period 3
Period 1
Period 2
Period 3

16. Depreciation Methods Time-Factor Methods
Straight-line: This method recognizes equal periodic depreciation charges over the asset’s life.
Accelerated methods:
Sum-of-the-years’-digits--This method yields decreasing depreciation in each successive year.
Declining-balance--This method provides decreasing charges by applying a constant percentage rate to a declining asset book value.

17. Depreciation Methods Use-Factor Methods
Service hours: This depreciation method is based on the theory that purchase of an asset represents the purchase of a number of hours of direct service.
Productive output: This method is based on the theory that an asset is acquired for the service it can provide in the form of production output.

18. Group and Composite Methods
Depreciation Methods
Group and Composite Methods
This approach treats an entire group of assets as if the group were one asset.
Group: Used when the assets in the group are similar.
Composite: Used when the assets in the group are related, but dissimilar.

19. Depreciation Methods
Schuss Boom Ski Manufacturing acquired a polyurethane plastic-molding machine at the beginning of 2002 for $100,000. It has an estimated life of five years, 20,000 hours, or 25,000 units. The estimated residual value is $5,000. In 2002, the equipment was used 3,000 hours to produce 3,500 units.

20. Time-Factor Methods Straight-Line Method Cost - Residual Value
Depreciation =
Cost - Residual Value
Number of Years
Depreciation =
$100,000 - $5,000 5
Depreciation =
$19,000

21. Time-Factor Methods Straight-Line Method $35,000 $28,000 $21,000
$14,000
$7,000 $0
Depreciation Expense
2002
2003
2004
2005
2006

22. Time-Factor Methods Sum-of-the-Years’-Digits Method [n (n + 1)] SYD =2
SYD =
[5 (5 + 1)] 2
SYD = 15

23. Time-Factor Methods Sum-of-the-Years’-Digits Method t Depreciation =
SYD x
(Cost - Residual Value)
Depreciation (2002) = 5 15 x
$95,000
t = years remaining in n at
the beginning of the period
Depreciation (2002) = $31,667

24. Time-Factor Methods Sum-of-the-Years’-Digits Method $35,000 $28,000
$21,000
$14,000
$7,000 $0
Depreciation Expense
2002
2003
2004
2005
2006

25. Time-Factor Methods Declining-Balance Method
Depreciation = F x (Cost - Accum. Depr.)
Depreciation (2002) = .40 x $100,000
F = declining balance factor
(e.g., 150% or 200%)
Depreciation (2002) = $40,000
Note:
Do not depreciate below salvage value.
Optional: Switch to straight-line when it yields higher depreciation.

26. Time-Factor Methods Declining-Balance Method $42,000 $35,000 $28,000
$21,000
$14,000
$7,000 $0
Depreciation Expense
2002
2003
2004
2005
2006

27. Total Estimated Service Life of Asset
Use Factor Methods
Service Hours Method
Depreciation =
Cost - Residual Value
Number of Hours
Depreciation =
$100,000 - $5,000
20,000 hours
Total Estimated Service Life of Asset
Depreciation = $4.75 per hour
Depreciation (2002) = $4.75 x 3,000
Depreciation (2002) = $14,250

28. Use Factor Methods Productive-Output Method Cost - Residual Value
r (per unit) =
Cost - Residual Value
Total Number of Units
r (per unit) =
$100,000 - $5,000
25,000 units
r (per unit) = $3.80 per unit
Depreciation (2002) = $3.80 x 3,500
Depreciation (2002) = $13,300

29. Group Depreciation Group similar assets into depreciation accounts.
Calculate annual depreciation charge at the straight-line rate times the group’s book value.
Recognize gains and losses only when all assets in the group have been retired.
Referred to as composite depreciation when the assets in the group are related but dissimilar.

30. Depletion
Land containing mineral deposits is purchased at a cost of $5,500,000. The cost to restore the land to its original state after removal of the resources is estimated to be $200,000 (then it can be sold for $450,000). In 2002, 80,000 tons of the estimated 2,000,000 tons are removed.

31. Depletion $5,500,000 - $250,000 Depletion charge per ton =
1,000,000 tons =
$450,000 - $200,000
Depletion charge per ton
= $5.25
Depletion for 2002 = $5.25 x 80,000 tons
Depletion for 2002 = $420,000

32. Impairment
Before the end of an asset’s useful life, events occur that impair its value. This requires an immediate write-down of the asset.

33. Impairment
1. When should an asset be reviewed for possible impairment?
An impairment review should be conducted whenever there has been a material change in the way an asset is used or in the business environment.
Also, if management obtains information suggesting that the market value of the asset has declined.

34. Impairment 2. When is an asset impaired?
An asset is impaired when the undiscounted sum of estimated future cash flows from an asset is less than the book value of the asset.
The sum of the undiscounted future cash flows will always be greater than the fair value of the asset.

35. Impairment 3. How should an impairment loss be measured?
The impairment loss is the difference between the book value of the asset and the asset’s fair value.
The fair value can be approximated using the present value of estimated future cash flows from the asset.

36. Impairment
4. What information should be disclosed about an impairment?
Disclosure should include a description of the impaired asset, reasons for the impairment, a description of the measurement assumptions, and the business segment or segments affected.

37. Asset Retirement-- General Procedure
Remove old asset from books: debit Accumulated Depreciation; credit the asset.
Record new asset at fair market value: debit asset
Record any cash received or paid: debit or credit Cash as appropriate.
Record any gain or loss: debit loss account or credit gain account.

38. Asset Retirement-- Determining Gain or Loss
(FMV New Asset + Cash Received) less
(Book Value Old Asset + Cash Paid)
If answer is greater than zero, record a gain.
If answer is less than zero, record a loss.

39. Asset Retirement-- Unusual ConsiderationsNO
Record transaction
according to general
procedure.
Let’s take a closer look at this last section.
Are assets
similar in nature?
YES
Are the parties
in the same line
of business? NO
Record transaction
according to general
procedure.
YES
Does the
transaction
create a gain? NO
Record transaction
according to general
procedure.
Zero
YES
25% or more
Defer
all
gains
What percentage
of the transaction’s
FMV is in cash?
Record
transaction
using general
procedure.
Less than 25%
Less than 25%
Party receiving cash
defers a portion
of all gains
Party paying cash
defers all gains.

40. Asset Retirement-- Unusual Considerations
Yes
Defer
all
gains.
Zero
25% or more
Record
transaction
using general
procedure.
What percentage
of the transaction’s
FMV is in cash?
Less than 25%
Party paying cash
defers all gains.
Party receiving cash
defers a portion
of all gains

41. Nearest month makes the most intuitive sense.
Partial Periods
Nearest whole month.
Nearest whole year.
Half-year convention.
No depreciation in year of acquisition; full year depreciation in year of retirement.
Full year depreciation in year of acquisition; no depreciation in year of retirement.
Nearest month makes the most intuitive sense.

42. The End