Kế toán, kiểm toán - Chương 11: Depreciation, impairments, and depletion

C H A P T E R 11DEPRECIATION, IMPAIRMENTS, AND DEPLETIONIntermediate AccountingIFRS EditionKieso, Weygandt, and Warfield Explain the concept of depreciation.Identify the factors involved in the depreciation process.Compare activity, straight-line, and diminishing-charge methods of depreciation.Explain component depreciation.Explain the accounting issues related to asset impairment.Explain the accounting procedures for depletion of mineral resources.Explain the accounting for revaluations.Explain how to report and analyze property, plant, equipment, and mineral resources.Learning ObjectivesDepreciationFactors involvedMethods of depreciationComponent depreciationSpecial issuesImpairmentsDepletionPresentation and AnalysisRecognizing impairmentsImpairment illustrationsReversal of lossCash-generating unitsAssets to be disposed ofPresentationAnalysisEstablishing a baseWrite-off of resource costEstimating reservesLiquidating dividendsPresentationDepreciation, Impairments, and DepletionRevaluationsRecognitionIssuesAllocating costs of long-term assets:Long-lived assets = Depreciation expenseIntangibles = Amortization expenseMineral resources = Depletion expense 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.Depreciation - Method of Cost AllocationLO 1 Explain the concept of depreciation.Depreciation - Method of Cost AllocationLO 2 Identify the factors involved in the depreciation process.Three basic questions:Factors Involved in the Depreciation ProcessWhat depreciable base is to be used?What is the asset’s useful life?What method of cost apportionment is best?Depreciation - Method of Cost AllocationLO 2 Identify the factors involved in the depreciation process.Depreciable BaseFactors Involved in the Depreciation ProcessIllustration 11-1Depreciation - Method of Cost AllocationLO 2 Identify the factors involved in the depreciation process.Estimation of Service LifesFactors Involved in the Depreciation ProcessService life often differs from physical life.Companies retire assets for two reasons: Physical factors (casualty or expiration of physical life)Economic factors (inadequacy, supersession, and obsolescence).Depreciation - Method of Cost AllocationLO 3 Compare activity, straight-line, and diminishing-charge methods of depreciation.The profession requires the method employed be “systematic and rational.” Examples include:Methods of DepreciationActivity method (units of use or production).Straight-line method. Diminishing (accelerated)-charge methods:Sum-of-the-years’-digits.Declining-balance method.Depreciation - Method of Cost AllocationLO 3Activity MethodIllustration 11-2Illustration: If Stanley uses the crane for 4,000 hours the first year, the depreciation charge is:Stanley Coal Mines FactsIllustration 11-3Depreciation - Method of Cost AllocationStraight-Line MethodIllustration: Stanley computes depreciation as follows:Stanley Coal Mines FactsIllustration 11-4Illustration 11-2LO 3Depreciation - Method of Cost AllocationDiminishing-Charge MethodsStanley Coal Mines FactsSum-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.Illustration 11-2n(n+1)2=5(5+1)2=15LO 3Alternate sum-of-the-years’ calculationDepreciation - Method of Cost AllocationLO 3 Compare activity, straight-line, and diminishing-charge methods of depreciation.Sum-of-the-Years’-DigitsIllustration 11-6Depreciation - Method of Cost AllocationStanley Coal Mines FactsDeclining-Balance Method. Utilizes a depreciation rate (%) that is some multiple of the straight-line method.Does not deduct the residual value in computing the depreciation base.Diminishing-Charge MethodsIllustration 11-2LO 3Depreciation - Method of Cost AllocationLO 3 Compare activity, straight-line, and diminishing-charge methods of depreciation.Illustration 11-7Declining-Balance MethodDepreciation - Method of Cost AllocationLO 4 Explain component depreciation.IFRS requires that each part of an item of property, plant, and equipment that is significant to the total cost of the asset must be depreciated separately.Component DepreciationDepreciation - Method of Cost AllocationLO 4 Explain component depreciation.Illustration: EuroAsia Airlines purchases an airplane for €100,000,000 on January 1, 2011. The airplane has a useful life of 20 years and a residual value of €0. EuroAsia uses the straight-line method of depreciation for all its airplanes. EuroAsia identifies the following components, amounts, and useful lives.Component DepreciationIllustration 11-8Computation of depreciation expense for EuroAsia for 2011.Depreciation - Method of Cost AllocationLO 4 Explain component depreciation.Illustration 11-9Depreciation Expense 8,600,000 Accumulated Depreciation—Airplane 8,600,000Depreciation journal entry for 2011.Depreciation - Method of Cost AllocationLO 4 Explain component depreciation.Special Depreciation IssuesHow should companies compute depreciation for partial periods?Does depreciation provide for the replacement of assets?How should companies handle revisions in depreciation rates?Depreciation - Method of Cost AllocationLO 3 Compare activity, straight-line, and diminishing-charge methods of depreciation.E11-5 (Depreciation Computations—Four Methods): Maserati Corporation purchased a new machine for its assembly process on August 1, 2010. 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 estimatedat 5 years and its working hours are estimated at 21,000 hours. Year-end is December 31.Instructions: Compute the depreciation expense for 2010 under the following methods. (a) Straight-line depreciation. (c) Sum-of-the-years’-digits.(b) Activity method (d) Double-declining balance.Depreciation - Method of Cost AllocationLO 3 Compare activity, straight-line, and diminishing-charge methods of depreciation.Straight-line MethodDepreciation - Method of Cost AllocationLO 3Activity Method(Assume 800 hours used in 2010)Depreciation - Method of Cost AllocationSum-of-the-Years’-Digits MethodLO 35/12 = .4166677/12 = .583333Depreciation - Method of Cost AllocationDouble-Declining Balance MethodLO 3Depreciation and Replacement of PP&ELO 4 Explain component depreciation.Depreciation - Method of Cost AllocationDepreciationDoes not involve a current cash outflow.Funds for the replacement of the assets come from the revenues.Accounted for in the current and prospective periods.Not handled retrospectivelyNot considered errors or extraordinary itemsLO 4 Explain component depreciation.Depreciation - Method of Cost AllocationRevision of Depreciation RatesArcadia 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 2010 (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:What is the journal entry to correct the prior years’ depreciation?Calculate the depreciation expense for 2010.No Entry RequiredChange in Estimate ExampleLO 4 Explain component depreciation.Equipment$510,000Accumulated depreciation 350,000 Net book value (NBV)$160,000Balance Sheet (Dec. 31, 2009)Change in Estimate ExampleAfter 7 yearsEquipment cost $510,000Salvage value - 10,000Depreciable base 500,000Useful life (original) 10 yearsAnnual depreciation $ 50,000x 7 years = $350,000 First, establish NBV at date of change in estimate.LO 4 Explain component depreciation.Change in Estimate ExampleAfter 7 yearsNet book value $160,000Salvage value (new) 5,000Depreciable base 155,000Useful life remaining 8 yearsAnnual depreciation $ 19,375Depreciation Expense calculation for 2010.Depreciation expense 19,375 Accumulated depreciation 19,375Journal entry for 2010LO 4 Explain component depreciation.ImpairmentsLO 5 Explain the accounting issues related to asset impairment.A long-lived tangible asset is impaired when a company is not able to recover the asset’s carrying amount either through using it or by selling it.Recognizing ImpairmentsOn an annual basis, companies review the asset for indicators of impairments—that is, a decline in the asset’s cash-generating ability through use or sale. ImpairmentsLO 5If impairment indicators are present, then an impairment test must be conducted.Recognizing ImpairmentsIllustration 11-15ImpairmentsLO 5Example: Assume that Cruz Company performs an impairment test for its equipment. The carrying amount of Cruz’s equipment is $200,000, its fair value less costs to sell is $180,000, and its value-in-use is $205,000.Illustration 11-15$200,000$205,000$180,000$205,000No ImpairmentImpairmentsLO 5Example: Assume the same information for Cruz Company except that the value-in-use of Cruz’s equipment is $175,000 rather than $205,000.Illustration 11-15$200,000$180,000$180,000$175,000$20,000 Impairment LossImpairmentsLO 5Example: Assume the same information for Cruz Company except that the value-in-use of Cruz’s equipment is $175,000 rather than $205,000.Illustration 11-15$200,000$180,000Cruz makes the following entry to record the impairment loss.Loss on Impairment 20,000 Accumulated Depreciation—Equipment 20,000$20,000 Impairment LossImpairmentsLO 5At December 31, 2011, Hanoi Company has equipment with a cost of VND26,000,000, and accumulated depreciation of VND12,000,000. The equipment has a total useful life of four years with a residual value of VND2,000,000. The following information relates to this equipment. The equipment’s carrying amount at December 31, 2011, is VND14,000,000 (VND26,000,000 VND12,000,000).Hanoi uses straight-line depreciation. Depreciation was VND6,000,000 for 2011 and is recorded.Hanoi has determined that the recoverable amount for this asset at December 31, 2011, is VND11,000,000.The remaining useful life after December 31, 2011, is two years.Impairments IllustrationsCase 1Case 1: Hanoi records the impairment on its equipment at December 31, 2011, as follows.ImpairmentsLO 5Illustration 11-15VND14,000,000VND11,000,000VND3,000,000 Impairment LossLoss on Impairment 3,000,000 Accumulated Depreciation—Equipment 3,000,000ImpairmentsLO 5Depreciation Expense 5,500,000 Accumulated Depreciation—Equipment 5,500,000Equipment VND 26,000,000Less: Accumulated Depreciation-Equipment 15,000,000Carrying value (Dec. 31, 2011) VND 11,000,000Hanoi Company determines that the equipment’s total useful life has not changed (remaining useful life is still two years). However, the estimated residual value of the equipment is now zero. Hanoi continues to use straight-line depreciation and makes the following journal entry to record depreciation for 2012.ImpairmentsLO 5At the end of 2010, Verma Company tests a machine for impairment. The machine has a carrying amount of $200,000. It has an estimated remaining useful life of five years. Because there is little market-related information on which to base a recoverable amount based on fair value, Verma determines the machine’s recoverable amount should be based on value-in-use. Verma uses a discount rate of 8 percent. Verma’s analysis indicates that its future cash flows will be $40,000 each year for five years, and it will receive a residual value of $10,000 at the end of the five years. It is assumed that all cash flows occur at the end of the year.Impairments IllustrationsCase 2Illustration 11-16Case 2: Computation of the impairment loss on the machine at the end of 2010.ImpairmentsLO 5Illustration 11-15$200,000$166,514Unknown$166,514$33,486 Impairment LossCase 2: Computation of the impairment loss on the machine at the end of 2010.ImpairmentsLO 5Illustration 11-15$200,000$166,514Unknown$166,514$33,486 Impairment LossLoss on Impairment 33,486 Accumulated Depreciation—Machine 33,486ImpairmentsLO 5Illustration: Tan Company purchases equipment on January 1, 2010, for $300,000, useful life of three years, and no residual value. Reversal of Impairment LossAt December 31, 2010, Tan records an impairment loss of $20,000. Loss on Impairment 20,000 Accumulated Depreciation—Equipment 20,000ImpairmentsLO 5Depreciation expense and related carrying amount after the impairment.Reversal of Impairment LossAt the end of 2011, Tan determines that the recoverable amount of the equipment is $96,000. Tan reverses the impairment loss.Accumulated Depreciation—Equipment 6,000 Recovery of Impairment Loss 6,000ImpairmentsWhen it is not possible to assess a single asset for impairment because the single asset generates cash flows only in combination with other assets, companies identify the smallest group of assets that can be identified that generate cash flows independently of the cash flows from other assets. Cash-Generating UnitsLO 5 Explain the accounting issues related to asset impairment.ImpairmentsReport the impaired asset at the lower-of-cost-or-net realizable value (fair value less costs to sell).No depreciation or amortization is taken on assets held for disposal during the period they are held.Can write up or down an asset held for disposal in future periods, as long as the carrying amount after the write up never exceeds the carrying amount of the asset before the impairment.Impairment of Assets to Be Disposed OfLO 5 Explain the accounting issues related to asset impairment.ImpairmentsLO 5Illustration 11-18Graphic of Accounting for ImpairmentsNatural resources can be divided into two categories:Biological assets (timberlands)Fair value approach (chapter 9) Mineral resources (oil, gas, and mineral mining).Complete removal (consumption) of the asset. Replacement of the asset only by an act of nature.DepletionLO 6 Explain the accounting procedures for depletion of mineral resources.Depletion - process of allocating the cost of mineral resources.Establishing a Depletion BaseDepletionLO 6 Explain the accounting procedures for depletion of mineral resources.Computation of the depletion base involves: Pre-exploratory costs.Exploratory and evaluation costs.Development costs.Write-off of Resource CostDepletionLO 6 Explain the accounting procedures for depletion of mineral resources.Normally, companies compute depletion on a units-of-production method (activity approach). Depletion is a function of the number of units extracted during the period.Calculation:Total cost – Residual valueTotal estimated units available= Depletion cost per unitUnits extracted x Cost per unit= DepletionIllustration: MaClede Co. acquired the right to use 1,000 acres of land in South Africa 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. DepletionLO 6 Explain the accounting procedures for depletion of mineral resources.Illustration 11-18If MaClede extracts 25,000 ounces in the first year, then the depletion for the year is $250,000 (25,000 ounces x $10). DepletionLO 6Inventory 250,000 Accumulated Depletion 250,000MaClede’s statement of financial position:Depletion cost related to inventory sold is part of cost of goods sold.Estimating Recoverable ReservesDepletionLO 6 Explain the accounting procedures for depletion of mineral resources.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.Liquidating Dividends - Dividends greater than the amount of accumulated net income.DepletionLO 6 Explain the accounting procedures for depletion of mineral resources.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. Callahan’s 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 1,650,000Share Premium—Ordinary 1,350,000 Cash 3,000,000Presentation on the Financial StatementsDepletionLO 6 Explain the accounting procedures for depletion of mineral resources.Disclosures related to E&E expenditures should include:Accounting policies for exploration and evaluation expenditures, including the recognition of E&E assets.Amounts of assets, liabilities, income and expense, and operating cash flow arising from the exploration for and evaluation of mineral resources.Companies may value long-lived tangible asset after acquisition at cost or fair value.Network Rail (GBR) elected to use fair values to account for its railroad network. Increased long-lived tangible assets by £4,289 million. Change in the fair value accounted for by adjusting the asset account and establishing an unrealized gain. Unrealized gain is often referred to as revaluation surplus.RevaluationsLO 7 Explain the accounting for revaluations.Recognizing RevaluationsRevaluation—LandRevaluationsIllustration: Siemens Group (DEU) purchased land for €1,000,000 on January 5, 2010. The company elects to use revaluation accounting for the land in subsequent periods. At December 31, 2010, the land’s fair value is €1,200,000. The entry to record the land at fair value is as follows.LO 7 Explain the accounting for revaluations.Land 200,000 Unrealized Gain on Revaluation - Land 200,000Unrealized Gain on Revaluation—Land increases other comprehensive income in the statement of comprehensive income.Revaluation—Depreciable AssetsIllustration: Lenovo Group (CHN) purchases equipment for ¥500,000 on January 2, 2010. The equipment has a useful life of five years, is depreciated using the straight-line method of depreciation, and its residual value is zero. Lenovo chooses to revalue its equipment to fair value over the life of the equipment. Lenovo records depreciation expense of ¥100,000 (¥500,000 5) at December 31, 2010, as follows.LO 7 Explain the accounting for revaluations.RevaluationsDepreciation Expense 100,000 Accumulated Depreciation—Equipment 100,000Revaluation—Depreciable AssetsAfter this entry, Lenovo’s equipment has a carrying amount of ¥400,000 (¥500,000 - ¥100,000). Lenovo receives an independent appraisal for the fair value of equipment at December 31, 2010, which is ¥460,000.LO 7 Explain the accounting for revaluations.RevaluationsAccumulated Depreciation—Equipment 100,000 Equipment 40,000 Unrealized Gain on Revaluation—Equipment 60,000Revaluation—Depreciable AssetsLO 7 Explain the accounting for revaluations.RevaluationsIllustration 11-22Financial StatementPresentation—RevaluationsLenovo reports depreciation expense of ¥100,000. The Accumulated Other Comprehensive Income account related to revaluations cannot have a negative balance.Company can select to value only one class of assets, say buildings, and not revalue other assets such as land or equipment. Most companies do not use revaluation accounting. Substantial and continuing costs associated with appraisals.Gains associated with revaluations above historical cost are not reported in net income but rather go directly to equity.Losses associated with revaluation below historical cost decrease net income. In addition, the higher depreciation charges related to the revalued assets also reduce net income.RevaluationsLO 7 Explain the accounting for revaluations.Revaluations IssuesPresentation of Property, Plant, Equipment, and Mineral ResourcesPresentation and AnalysisBasis of valuation (usually cost)Pledges, liens, and other commitmentsDepreciating assets, use Accumulated Depreciation.Depleting assets may include use of Accumulated Depletion account, or the direct reduction of asset.DisclosuresLO 8 Explain how to report and analyze property, plant, equipment, and mineral resources.Measure of a firm’s ability to generate sales from a particular investment in assets. Presentation and AnalysisIllustration 11-24LO 8Analysis of Property, Plant, and EquipmentAsset Turnover RatioMeasure of the ability to generate operating income from a particular level of sales.Presentation and AnalysisIllustration 11-25LO 8Analysis of Property, Plant, and EquipmentProfit Margin on SalesMeasures a firm’s success in using assets to generate earnings.Presentation and AnalysisIllustration 11-26LO 8Analysis of Property, Plant, and EquipmentRate of Return on AssetsAnalyst obtains further insight into the behavior of ROA by disaggregating it into components of profit margin on sales and asset turnover as follows:Net Income Average Total Assets Rate of Return on Assets = Net Income Net Sales Profit Margin on Sales = Net SalesAsset Turnover x x Average Total Assets Presentation and AnalysisLO 8 Explain how to report and analyze property, plant, equipment, and mineral resources.€644(€9,533 €8,325) / 2Rate of Return on Assets = €644€10,799Profit Margin on Sales = €10,799Asset Turnover x x Presentation and Analysis7.2% 5.96% = x 1.21 (€9,533 €8,325) / 2Analyst obtains further insight into the behavior of ROA by disaggregating it into components of profit margin on sales and asset turnover as follows:LO 8 Explain how to report and analyze property, plant, equipment, and mineral resources.Under both iGAAP and U.S. GAAP, interest costs incurred during construction must be capitalized.The accounting for exchanges of non-monetary assets has recently converged between IFRS and U.S. GAAP. U.S. GAAP now requires that gains on exchanges of non-monetary assets be recognized if the exchange has commercial substance. This is the same framework used in IFRS.U.S. GAAP also views depreciation as allocation of cost over an asset’s life. U.S. GAAP permits the same depreciation methods (straight-line, diminishing-balance, units-of-production) as IFRS.IFRS requires component depreciation. Under U.S. GAAP, component depreciation is permitted but is rarely used.Under IFRS, companies can use either the historical cost model or the revaluation model. U.S. GAAP does not permit revaluations of property, plant, and equipment or mineral resources.In testing for impairments of long-lived assets, U.S. GAAP uses a two-step model to test for impairments. The IFRS impairment test is stricter. However, unlike U.S. GAAP, reversals of impairment losses are permitted.LO 9 Explain revaluation accounting procedures.The general rules for revaluation accounting are as follows.When a company revalues its long-lived tangible assets above historical cost, it reports an unrealized gain that increases other comprehensive income. Thus, the unrealized gain bypasses net income, increases other comprehensive income, and increases accumulated other comprehensive income.If a company experiences a loss on impairment (decrease of value below historical cost), the loss reduces income and retained earnings. Thus, gains on revaluation increase equity but not net income, whereas losses decrease income and retained earnings (and therefore equity).LO 9 Explain revaluation accounting procedures.If a revaluation increase reverses a decrease that was previously reported as an impairment loss, a company credits the revaluation increase to income using the account Recovery of Impairment Loss up to the amount of the prior loss. Any additional valuation increase above historical cost increases other comprehensive income and is credited to Unrealized Gain on Revaluation.If a revaluation decrease reverses an increase that was reported as an unrealized gain, a company first reduces other comprehensive income by eliminating the unrealized gain. Any additional valuation decrease reduces net income and is reported as a loss on impairment.Revaluation of LandLO 9Revaluation—2010: Valuation IncreaseIllustration: Unilever Group (GBR and NLD) purchased land on January 1, 2010, that cost €400,000. Unilever decides to report the land at fair value in subsequent periods. At December 31, 2010, an appraisal of the land indicates that its fair value is €520,000. Unilever makes the following entry to record the increase in fair value.Land 120,000 Unrealized Gain on Revaluation—Land 120,000Illustration 11A-1Revaluation of LandLO 9Revaluation—2011: Decrease below CostIllustration: What happens if the land’s fair value at December 31, 2011, is €380,000, a decrease of €140,000 (€520,000 - €380,000)?Unrealized Gain on Revaluation—Land 120,000Loss on Impairment 20,000 Land 140,000Illustration 11A-2Revaluation of LandLO 9Revaluation—2012: Recovery of LossIllustration: At December 31, 2012, Unilever’s land value increases to €415,000, an increase of €35,000 (€415,000 - €380,000).Land 35,000 Unrealized Gain on Revaluation—Land 15,000 Recovery of Impairment Loss 20,000Illustration 11A-3Copyright © 2011 John Wiley & Sons, Inc. All rights reserved. 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