Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA 11-1 Property, Plant, and Equipment and Intangible Assets: Utilization and Impairment Chapter 11

11-2 Some of the cost is allocated to each period. Expense* Acquisition Cost (Balance Sheet)(Income Statement) The matching principle requires that part of the acquisition cost of property, plant, and equipment and intangible assets be expensed in periods when the future revenues are earned. Depreciation, depletion, and amortization are cost allocation processes used to help meet the matching principle requirements. Cost Allocation – An Overview *Depreciation of an asset used to produce a product is a product cost that does not become an expense until the product is sold.

11-3 Caution! Depreciation, depletion, and amortization are processes of cost allocation, not valuation! Depreciation on the Balance Sheet Cost Allocation – An Overview

11-4 Cost allocation requires three pieces of information for each 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. Allocation Base Service Life Allocation Method Measuring Cost Allocation

11-5 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

11-6 Straight-Line 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. On January 1, we purchase equipment for $50,000 cash. The equipment has an estimated service life of 5 years and estimated residual value of $5,000. What is the annual straight-line depreciation? On January 1, we purchase equipment for $50,000 cash. The equipment has an estimated service life of 5 years and estimated residual value of $5,000. What is the annual straight-line depreciation?

11-7 Accelerated Methods Note that total depreciation over the asset’s useful life is the same as the straight-line method. Accelerated methods result in more depreciation in the early years of an asset’s useful life and less depreciation in later years of an asset’s useful life. Sum-of-the-years’-digits (SYD) depreciation

11-8 Declining-Balance (DB) Methods DB depreciation  Based on the straight-line rate multiplied by an acceleration factor.  Computations initially ignore residual value. Stop depreciating when: BV = Residual Value Double-Declining-Balance (DDB) depreciation is computed as follows: Note that the book value declines each year.

11-9 Units-of-Production

11-10 The approach is based on the units-of-production method. Depletion of Natural Resources As natural resources are “used up,” or depleted, the cost of the natural resources must be allocated to the units extracted.

11-11 Amortization of Intangible Assets For an intangible asset with a finite useful life, we allocate capitalized costs over the asset’s useful life using the straight-line method, normally with a zero residual value. An intangible asset’s useful life may be limited by legal, regulatory, or contractual provisions. In other cases, the useful life may be less than the legal or contractual life. The amortization entry is: A contra-asset account is generally not used when recording the amortization of intangible assets. Amortization expense $$$ Intangible asset ……………… $$$ To record amortization expense.

11-12 Not amortized. Subject to assessment for impairment of value and may be written down. Goodwill and Trademarks Intangible Assets not Subject to Amortization

11-13 Error Correction Errors found in a subsequent accounting period are corrected by...  Entries that restate the incorrect account balances to the correct amount.  Restating the prior period’s financial statements.  Reporting the correction as a prior period adjustment to Beginning R/E. In addition, a disclosure note is needed to describe the nature of the error and the impact of its correction on net income, income before extraordinary items, and earnings per share.

11-14 Impairment of Value Long-term assets to be held and used Long-term assets held for sale Tangible and intangible with finite useful lives Intangibles with indefinite useful lives Goodwill Test for impairment of value when considered for sale. Test for impairment of value at least annually. Test for impairment of value when it is suspected that book value may not be recoverable. Test for impairment of value when it is likely that the fair value of a reporting unit is less than its book value. Accounting treatment differs.

11-15 Finite-Life Assets to be Held and Used An asset is impaired when... The undiscounted sum of its estimated future cash flows Recoverability– Step 1 Its book value <

11-16 Impairment loss = Book value Fair value – Measurement – Step 2 $0$250$125 Case 1: $50 book value. No loss recognized Case 2: $150 book value. No loss recognized Case 3: $275 book value. Loss = $275 – $125 Fair value Undiscounted future cash flows Market value, price of similar assets, or PV of future net cash inflows. Reported in the income statement as a separate component of operating expenses Finite-Life Assets to be Held and Used

11-17 Impairment loss = Book value Fair value less cost to sell – Assets held for sale include assets that management has committed to sell immediately in their present condition and for which sale is probable. Assets Held for Sale

11-18 Step 2 Loss = BV of goodwill less implied value of goodwill. Goodwill Step 1 If BV of reporting unit > FV, impairment indicated. Other Indefinite- life intangibles One-Step Process If BV of asset > FV, recognize impairment loss. One-Step Process If BV of asset > FV, recognize impairment loss. Indefinite-Life Intangibles

11-19 Type of ExpenditureDefinitionUsual Accounting Treatment Repairs and Maintenance Expenditures to maintain a given level of benefits Expense in the period incurred AdditionsThe addition of a new major component to an existing asset Capitalize and depreciate over the remaining useful life of the original asset, or over the useful life of the addition, whichever is shorter ImprovementsThe replacement of a major component Capitalize and depreciate over the useful life of the improved asset RearrangementsExpenditures to restructure an asset without addition, replacement, or improvement If expenditures are material and clearly increase future benefits, capitalize and depreciate over the future periods benefited Expenditures Subsequent to Acquisition

11-20 End of Chapter 11