Ch. 11: PPE and Intangible Assets: Utilization and Disposition

Expenditures related to assets can increase future benefits in what 3 ways (and should thus be capitalized initially and expensed in future periods)?

1) An extension of the useful life of the asset 2) An increase in the operating efficiency of the asset resulting in either an increase in the quantity of goods/services produced of a decrease in future operating costs 3) An increase in the quality of the goods/services produced by the asset

What are the accelerated depreciation methods?

1) Declining-Balance Methods 2) Sum-of-the-years'-digits Method

For assets to be held and used, different guidelines apply to what 2 types when referring to impairments of value?

1) PPE & intangible assets with finite useful lives (subject to depreciation, depletion, or amortization) 2) Intangible assets with indefinite useful lives (not subject to amortization)

The process of cost allocation requires that what 3 factors be established at the time the asset is put into use?

1) Service Life 2) Allocation Base 3) Allocation Method

What are the 2 time-based depreciation methods?

1) Straight-Line Method 2) Accelerated Methods

What are the 3 methods used to record the cost of improvements?

1) Substitution 2) Capitalization of new cost 3) Reduction of accumulated depreciation

What are the 2 general approaches to maintain a systematic and rational cost allocation of an asset?

1) Time-based methods 2) Activity-based methods

What are 4 additional issues associated with cost allocation?

1) change in estimates 2) change in method 3) error correction 4) Impairment of value

___________________ is the difference between the cost of the asset and its estimated residual value.

Allocation base

Activity-Based Methods

Allocation of an asset's cost base using a measure of the asset's input or output

Depletion

Allocation of the cost of natural resources

How often should intangible assets with indefinite useful lives be tested for impairment?

Annually and more frequently if events or changes in circumstances indicate that it's more likely than not that the asset is impaired

When should an asset held for sale be tested for impairment?

At time of classification as held for sale and thereafter

How is the group depreciation rate determined?

By dividing the depreciation per year by the total cost

Depreciation

COST allocation for plant & equipment

The costs incurred to SUCCESSFULLY defend an intangible right should be _____________.

Capitalized

Group Depreciation Method

Collection of assets defined as depreciable assets that share similar service lives and other attributes

Units-of-Production Method

Computes a depreciation rate per measure of activity and then multiplies this rate by actual activity to determine periodic depreciation

How is the depletion base calculated?

Cost - residual value

What is the difference between depreciation and a decline in fair value of an asset?

Depreciation is a process of COST allocation, not valuation.

Replacement Depreciation Method

Depreciation is recorded when assets are replaced

Service Life (useful life)

The estimated use that the company expects to receive from the asset (can be in units of time or activity, like years or miles)

Depreciation Expense

The portion of the asset's cost that's allocated to an expense in the current year

How does residual value affect book value?

It doesn't affect the calculation, but it sets a limit that the book value can't go below

Sum-of-the-years'-digits Method

Multiplies depreciable base by a declining fraction

When does GAAP require investigation of possible impairment?

Only if events or changes in circumstances indicate that the book value of the asset or asset group may not be recoverable

Half-Year Convention

Record one-half of a full year's depreciation in the year of acquisition and another half year in the year of disposal

Residual Value (salvage value)

The amount the company expects to receive for the asset at the end of its service life - any anticipated disposal costs

What is the most common activity-based method of depreciation?

Units-of-Production method

A change in estimate should be reflected in the financial statements of which periods?

current & future

The costs incurred to UNSUCCESSFULLY defend an intangible right should be __________.

expenses

For intangible assets, _____________ life is often a limiting factor.

legal/contractual

If fair value - cost to sell is below book value, we recognize a __________ in the current period.

loss

The _________ value of future cash flows is often used as a measure of fair value.

present

The ____________ method often is used to determine depreciation and amortization on assets used in the extraction of natural resources.

units-of-production

If an impairment loss is recognized, the ___________ value becomes the new cost base for future cost allocation.

written-down book

Describe the capitalization of new cost method to recording the cost of improvements.

-Include cost of improvement (- any consideration received from disposition of old component) as a debit to related asset account, without removing the original cost and accumulated depreciation of the OG component -Acceptable only if book value of OG component has been reduced to an immaterial amount through prior depreciation

Describe the reduction of accumulated depreciation method to recording the cost of improvements.

-Leave the asset account unaltered but decrease its related accumulated depreciation -Argument = many improvements extend the useful life of an asset and are = to a partial recovery of previously recorded depreciation

How are material errors occurring in a previous year treated?

-Previous years' financial statements are retrospectively restated -Account balances are corrected -IF retained earnings requires correction, the correction is reported as a prior period adjustment -A note describes the nature of the error and the impact of the correction on income

If a company underestimates future net cash flows, fair value is understated. This has what 2 effects?

1) Current year's income is unrealistically low due to the impairment loss being overstated and 2) Future income is unrealistically high because depreciation, depletion, and amortization are based on understated asset values

What are the 3 key differences between the calculation of depreciation for financial reporting and the calculation for MACRS?

1) Estimated useful lives and residual values aren't used in MACRS 2) Firms can't choose among various accelerated methods under MACRS 3) A half-year convention is used in determining the MACRS depreciation amounts

What makes the cost of goodwill different from other assets?

1) It can't be directly associated with any specific identifiable right and 2) It's not separable from the company as a whole

What 6 criteria must be met for an asset to be classified as "held for sale?"

1) Management commits to a plan to sell the asset 2) Asset is available for immediate sale in its present condition 3) An active plan to locate a buyer and sell the asset has been initiated 4) The completed sale of the asset is probable and typically expected to occur within one year 5) The asset is being offered for sale at a reasonable price relative to its current fair value 6) Management's actions indicate the plan is unlikely to change significantly or be withdrawn

Determining whether an impairment loss has occurred and for how much to record the loss is a 2 step process. Describe the steps.

1) Recoverability Test: An impairment occurs when the undiscounted sum of estimated future cash flows from an asset is less than an asset's book value 2) Measurement: If the recoverability test indicates an impairment has occurred, an impairment loss is recorded for the amount by which the asset's fair value (amount at which asset could be bought/sold currently between willing parties) is less than its book value

What are the 4 classifications of subsequent expenditures?

1) Repairs & maintenance 2) Additions 3) Improvements 4) Rearrangements

Book Value

Asset's cost - accumulated depreciation

For purposes of recognition and measurement of impairment of value, PPE and finite-life intangible assets are grouped at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets. What does this mean?

Assets shouldn't be grouped for determining impairment unless they are dependent on one annother

Accumulated Depreciation

-Contra-asset account -Represents the cumulative amount of the asset's cost that has been depreciated in all prior years including the current year -Represents the reduction in the asset's cost reported in the balance sheet

Describe the substitute method of recording the cost of improvements.

-Improvement is recorded as both a disposition of the old component and the acquisition of the new component -Practical only if OG cost and accumulated depreciation of old component can be separately identified

How is the group's average service life calculated?

By dividing the depreciable base by the depreciation per year

___________ life provides the upper bound for service life of tangible, long-lived assets.

Physical

Composite Depreciation Method

Physically dissimilar assets are aggregated to gain the convenience of group depreciation

Retirement Depreciation Method

Records depreciation when assets are disposed of and measures depreciation as the difference between the proceeds received and cost

Amortization

Cost allocation for intangibles

How is the retirement of an asset treated?

The asset account and corresponding accumulated depreciation account are removed from the books and a loss equal to the remaining book vale of the asset is recorded

Allocation Base

The cost of the asset expected to be consumed during its service life ("depreciable base," "depletion base," amortization base")

________________ depreciation methods multiply beginning-of-year book value (Not depreciable base) by an annual rate that is a multiple of the straight-line rate.

Declining-balance

How is the annual depreciation calculated for straight-line method?

Depreciable base divided by the number of years in the asset's life

When should the costs of material rearrangements be capitalized?

If they clearly increase future benefits

Activity-based methods are conceptually superior to time-based methods, but why are they not used as often?

Because they are often impractical

The allocation method used should be systematic, rational, and correspond to the pattern of asset ___________.

Use

The goodwill impairment loss can't exceed the ___________ value of goodwill.

book

The asset is reported in the balance sheet at its __________ value, which is the asset's cost - accumulated depreciation.

book (carrying)

An asset classified as held for sale is reported at the lower of its current __________ value or its ____________ value - any cost to sell.

book; fair

PPE or an intangible asset to be disposed of by sale is classified as held for sale and measured at the lower of the assets __________ value or the assets __________ value - cost to sell.

book; fair

The costs of additions are usually ____________.

capitalized

The costs of improvements are usually _____________.

capitalized

A gain or loss is recognized for the difference between the _____________ received and the asset's __________ value.

consideration; book

In determining whether an impairment loss should be recognized for goodwill, a company compares the book value of the reporting unit with: a. the discounted sum of estimated cash flows from goodwill b. the undiscounted sum of estimated future cash flows from goodwill c. the total amount of fixed assets d. the fair value of the reporting unit

d. the fair value of the reporting unit

Expenditures for repairs and maintenance are generally __________________.

expensed when incurred

For assets held for sale, if _______ value - cost to sell is less than _______ value, an impairment loss is recognized for the difference.

fair; book

If ___________ value is < _____________ value, an impairment loss is recognized for the difference.

fair; book

Intangible assets with ___________ useful lives will be amortized, and those with ____________ useful lives will not be amortized.

finite; indefinite

Capitalized software development costs are amortized based on whichever of the following 2 methods produces a __________ amount: 1) Ratio of current revenues to current and anticipated revenues (% of revenue method), or 2) Straight-line method based on estimated useful life of asset

greater

A change in accounting method requires a clear ____________ as to why the new method is preferable.

justification

Expected _____________ can shorten service life below physical life.

obsolescence

Under MACRS, each asset is generally placed within a recovery ___________ category.

period (3, 5, 7, 10, 15, & 20 years)

Depletion of the cost of natural resources usually is determined using the ___________________ method.

units-of-production

T/F: A company must use the same depreciation method for both financial reporting and income tax purposes.

False

Modified Accelerated Cost Recovery System (MACRS)

Federal income tax code allows taxpayers to compute depreciation for their tax returns using this method

___________ is the most common intangible with an indefinite useful life, and its cost is not expensed through periodic amortization.

Goodwill

The acronym "MACRS" refers to a(n) _______________ method that may be used for __________ purposes. a. depreciation; financial reporting b. amortization; financial reporting c. depreciation; tax d. amortization; tax

c. depreciation; tax

The measurement of an impairment loss in step 2 is the difference between: a. the asset's estimated future cash flows and its fair value b. the asset's book value and its NPV c. the asset's book value and its fair value d. the asset's fair value and its lower-of-cost-or-market value

c. the asset's book value and its fair value

What problem arises when expenditures are made after acquisition, like those for repair, maintenance, and improvements of long-lived assets?

A choice must be made between capitalizing the expenditures by either increasing the asset's book value or creating a new asset, or expensing them in the period incurred

Double-Declining-Balance (DDB) Method

200% of the straight-line rate (double) is multiplied by book value

Rearrangements

Expenditures made to restructure an asset without addition, replacement, or improvement -Objective is to create a new capability for asset and not necessarily to extend its useful life -Ex: Rearranging machinery on production line to increase operational efficiency, relocating company's operating plant/office building

The retirement depreciation method assumes a _______________ cost approach in determining depreciation expense at the time the assets are disposed.

FIFO

When is a goodwill impairment loss indicated?

When the fair value of the reporting unit is < book value

The way we recognize and measure an impairment loss differs depending on?

Whether the assets are classified as: 1) Held & used or 2) Held for sale

How should an asset held for use be treated if there's been a significant impairment of value?

Written down

________________ depreciation methods report higher depreciation in earlier years.

Accelerated

Group & Composite Depreciation Methods

Aggregate assets to reduce the recordkeeping costs of determining periodic depreciation

Time-Based Methods

Allocates the cost base according to the passage of time

Straight-Line Method

Allocation of an equal amount of the depreciable base to each year of the asset's service life

T/F: No gain or loss is recorded when a group or composite asset is retired or sold. Explain.

True; dispositions are recorded under the assumption that the book value of the disposed item exactly = any proceeds received; any actual gain or loss is included in the accumulated depreciation account

Allocation Method

The pattern in which the allocation base is expected to be consumed

What do losses from the write-down of inventory and restructuring costs have in common?

The presence of these items in a corporate income statement presents a challenge to an analyst trying to determine a company's permanent earnings (that will continue into future) -Analyst must decide whether to consider asset impairment losses as temporary or part of permanent earnings

How are both the group and composite depreciation methods similar?

They involve applying a single straight-line rate based on the average service lives of the assets in the group or composite

What are 2 examples of intangible assets that are often considered to have an indefinite useful life?

Trademark, goodwill

T/F: An asset classified as held for sale is no longer depreciated or amortized.

True