Accounting chapter 11 Part A: depreciation, depletion and amortization and B

What causes the physical life of an asset to vary

the purpose for which the asset is acquired and the environment in which it is operated

what is the measurement of impairment loss

the second setp in determining and recording an impairment loss- it is the difference between the asset's book value and its fair value.

What determines the way an impairment is recognized and measured

the way we recognize and measure an impairment loss differs depending on whether the assets are to be held and used or being held to be sold and differs depending on whether the asset has finite lives or indefinite lives.

If an impairment loss is recognized, what is used as the new cost base for future cost allocation

the written down book value becomes the new cost base

what is impairment of value

It is a significant decline or impairment of the benefits or service potential of an asset that impacts the duration of depreciation, depletion or amortizaton of property, plant, equipment and intangible assets

What is the straight line depreciation method for allocating costs:

It is a time based methods that allocates an equal amount of depreciable base to each year of the asset's service life

For assets not used in production, primarily plant and equipment and certain intangibles used in the seeling and administrative function of the company, how is periodic depreciation or amortization reported

It is an expense on the income statement

what is depletion base

It is cost less any anticipated residual value (which could be significant if cost includes land that has a value after extraction)

What is the service life or useful life of an asset

It is the amount of time that the company expects to obtain from the asset before disposing of it

what is residual or salvage value

It is the amount the company expects to receive for the asset at the end of its service life less any depreciated disposal costs.

The decreasing book value that is used in the declining balance method is also known as

carrying value or carrying amount of the asset (not depreciable base)

If a delivery truck which is depreciated as part of a group method cost $15K and was sold at $3K in a future year what are the appropriate journal entries

cash 3K Accumulated depreciation difference 12K vehicles 15K

Since assets in groups frequently change how are additions to the group recorded

Additions to the group are recorded by increasing the group asset account for the cost of the addition. Depreciation is then determined by multiplying the group rate by the total cost of assets in the group for the period

when should an asset held for use be written down

if there has been a significant impairment of value, i.e fire, new technology makes obsolete, etc.

When is the accelerated method of depreciation more appropriate

1. when the benefits derived vary from year to year such as with an asset that is more productive in the early years or 2. when the benefits of an asset are equal over its life but repair and maintenance costs increase significantly in later years.

Describe the unit of production method of depreciation

1. Estimate the number of units of output or input 2. compute the average depreciation rate per unit by dividing the depreciable base by the number of units expected. 3. Multiple the per unit rate by the number of units produced in each period.

The Jackson Mining Co paid 1 M for the right to explore for coal on land. Costs of exploring totaled 800K and intangible development costs incurred in digging and erecting the mine shaft were 500K. Jackson purchased new excavation equipment for the project at a cost of 600K. After the coal is removed, the equipment will be sold for 60K. The company estimates 1 million tons of coal will be extracted over 3 years. In 2016 300,000 tons were extracted. Jackson is required by contract to restore the land for recreational use which costs 468,360. Show how to calculate the depreciation

1. First determine the capitalized cost of the natural resource which includes acquisition, exploration, development and restoration ( 1M + 800K + 500K + 468,360= 2,768,360) 2. Since there is no residual value to the land, the depletion base equals cost (2768,360) and the depletion rate per ton is determined by depletion base divided by extamated extractable tons. In the example depletion per ton = 2,768,360 divided by 1M tons or $2.76836 per ton. For each ton of coal extracted $2.76836 in depletion is recorded.

Identify different ways that you could handle depreciation of the 600K costs of excavation equipment

1. If equipment can be moved and used elsewhere, its depreciable base should be allocated over its useful life. 2. If it cannot be moved, it should be depreciated over its useful life or the life of the natural resource, which ever is shorter. 3. Or you can use the units of production method to calculate depreciation and amortization on assets used in the excavation. You use the activity base the same as with depletion using the estimated recoverable natural resource

The process of measuring cost allocation requires what three factors be established at the time the asset is put into use:

1. Service life- the estimated use the company expects to receive from the asset 2. Allocation base- the value of the usefulness that is expected to be consumed 3. Allocation method- the pattern in which the usefulness is expected to be consumed.

Why do many comapnies use the striaght line method as opposed to time based methods

1. believe most assets are realized evenly over useful life 2. easiest to apply 3. straight line depreciation produces a higher net income than accelerated methods in the early years of assets life.

Demonstrate how to calculate depreciation of excavation equipment using the activity based method assuming the same numbers as above for 2016.

1. depreciation per ton = (600,000-60,000)/1M tons = $.54 per ton 2. To calculate for 2016 = .54 $ 300,000 or $162K is recorded and ncluded as part of the cost of the coal inventory.

What is the two step process for determining whether an impairment loss has occurred and actually recording the loss

1. recoverability test 2. measurement of impairment

What are the different time based depreciation methods

1. straight line method 2. accelerated methods a. sum of the years digits method b. declining balance methods

What are the two methods of allocation that attempt to obtain systematic and rational allocation of the costs of an asset

1. time based methods- allocates cost base according to passage of time 2. activity based methods-allocates assets cost base using a measure of the asset's input or output

The annual fractions for an asset with a fiver year life using the sum of the years digits method is

5/15, 4/15, 3/15, 2/15 and 1/15

Why do companies often switch from accelerated to straight line depreciation methods during the useful life of the asset

Because with the accelerated method in the year where the expected residual vlaue is reached, the entire remainder of depreciation must be recorded in that one year whereas if they switch they can spread out the remaining depreciation over the remainder of the useful life.

Show the journal entry for the 300,000 tons of coal extracted in 2016 using the depletion value of the prior problem

Depletion (2.76836 x 300,000 tones) 830,508 coal mine 830,508 * Notice that the credit is to the asset, coal mine, rather than to a contra account, accumulated depletion though a contra account is acceptable.

Generally how do you determine the amount of depreciation

Distribute the cost of the asseet, less any anticipated residual value, over the estimated useful life in a systematic and rational manner that attempts to match revenues with the use of the asset, not the decline in its value.

t/f: expected obsolescence does not shorten service life below an assets physical life

False-expected obsolescence can shorten service life below physical life

On January 1, 2014, the Hogan corp purchased office furniture for 250K. It expects the service life of the furniture to be 5 years with residual value of 40K. The company's year end is 12/31 and they use straight line depreciation for all depreciable assets. During 2016, the company revised its service life to 8 years and the residual value to 22K. For 2014 and 2015 what is the depreciation How does depreciation change for 2016 and subsequent years

For 2014 and 15, depreciation is (250,000 - 40,000) /5 or $42,000 per year, $84,000 for two years For subsequent years, depreciation is determined by allocating the book value remaining at the beginning of 2016, - the revised residual value, equally over the remaining life of 6 years (8-2). The remaining book value at the beginning of 2016 is (250K- 84,000) =166K and depreciation 166/6 or 24K the journal entry is as follows: Depreciation expense (below) 24K Accumulated depreciation 24K $250,000 cost $42,000 previous annual depreciation (210K/5) x 2 years 84,000 depreciation to date (2014-15) 166,000 book value as of 1/1/16 22,000 less revised residual value 144,000/ revised depreciable base 6 divide by remaining life 8-2 years) = 24,000 new annual depreciation

What is the specific accounting treatment for assets used in the manufacture of a product

For assets used in the manufacture of a product, depreciation, depletion or amortization is considered a product cost to be included as part of the cost of inventory. Eventually when the product is sold it becomes part of the cost of the goods sold

How does managment intent limit the service life of an asset

For both tangible and intangible assets managment decisions and policies , like policy to sell trucks after 2 years, can shorten the period of an asset's usefulness and companies often disclose the range of service life for different categories of assets.

Hollins Corporation began operation in 2016. Early in january, the company purchased a franchise from Ajax for 200K. the franchise agreement is for 10 years. Hollins also purchased a patent for 50K. The remaining legal life on the patent is 13 years but with obsolescene, the company estimates its useful life at 8 years. Hollins uses straight line amortization method for intangible assets. Show the journal entries for 1 year including amounts to record amortization of the franchise and the patent

Franchise: Amortization expense (200K/10 years ) 20,000 franchise 20K for the patent: amortization expense (50K/8 years) 6,250 patent 6250

What is the goal in determining how much cost to allocate to period's of an asset's use

Generally accepted accounting principles state that the chosen method should allocate the asset's cost "as equitably as possible to the periods during which services are obtained from its use". GAAP further states that the method should produce a cost allocation in a systematic and rational manner with the objective being to allocate costs to the period in an mount that is proportional to the amount of benefits generated by the asset during the period relative to the total benefits provided by the asset during its life.

what are the rules for treatment of material errors occurring in a prior year

Like with inventory, 1. previous years' financial statements are retrospectively restated 2. account balances are corrected 3. if retained earnings requires corrections, the correction is reported as prior period adjustments and 4. a note describes the nature of the error and the impact of the correction on income

How is the sum of the years digits method of accelerated depreciation calculated

Multiply the depreciable base by a fraction that declines each year and results in depreciation that decreases by the same amount each year.

Cost allocation overview: what is the logical allocation of acquiring property, plant and quipment and intangible assets

Property plant and equipment and intangible assets are purchased with the expectation that they will provide future benefits and are acquired specifically to be used as part of the revenue generating expenses so logically the costs of acquiring the assets should be allocated to expense during the reporting periods benefited by their use. That is their costs are matched with the revenues they help generate.

Describe the general difference between sum of the years-digits method and declining balance method

SYD method multiplies depreciable base by a declining fraction where declining balance depreciation multiplies beginning of year book value, not depreciable base, by an annual rate that is a multiple of the straight line rate.

t/f: declining balance methods often allocate the assets depreciable base over fewer years that the expected service life of an asset

T- especially with double declining balance where depreciation stops when book value has been reduced to expected residual value.

t/f: once the group or composite rate and the average service life are determined they normally are continued despite the addition and disposition of individual assets

T- this assumes that the service lives of new assets approximate those of individual assets they replace

what is the amount used for allocation base

The amount is the difference between the initial value of the asset at its acquisition (its cost) and its residual value (aka salvage value)

What is the denominator used in the sum of the years digits method of depreciation calculation

The demonimator of the fraction remains constant and is the sum of the digits from one to n, where n is the number of years i the asset's service life. For ex. if there are 5 years in the service life, the denominator is the sum of 1 +2+3+4+5= 15 It is also n(n +1) divided by 2 = denominator

How do you calculate the depreciable base under the straight line method

The depreciable base is simply divided by the number of years in the asset's life to determine annual depreciation.

What is the numerator used in the sum of the years digits method of calculation

The numerator decreases each year, it begins with the value of n in the first year and decreases by one each year until it equals one in the final year of the assets estimated service life.

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

The physical life of the asset

what is allocation base

The total amount of cost to be allocated over an asset's service life

GAAP reports property plant and equipment in the balance sheet at cost less accumulated depreciation(book value) How are international standards different

They allow a company to report property, plant and equipment as done in US or at is fair value(reevaluation). GAAP prohibits reevaluation.

What is the purpose of depreciation, depletion and amortization

They are cost allocation processes that attempt to satisfy the matching concept

What is the different betweent he group and composite methods of depreciation

They are the same except for the way the collection of assets is aggregated for depreciation. Both involve applying a single straight line rate based on the average service lives of the assets in the group or composite.

What is the difference between a product cost and a period cost

When a product cost is reported as an expense (costs of goods sold) depends on when the product is sold; when a period cost is reported as an expense depends on the reporting period in which it is incurred.

When do you test for impairment of property, plant and equipment and finite life intangible assets (an asset to be held and used)

When circumstances would likely cause the need to investigate impairment: 1. a significant decrease in market price 2. a significant adverse change in how the asset is being used or in its physical condition 3. a significant adverse change in legal factors or in the business climate 4. an accumulation of costs significantly higher than the amount originally expected for the acquisition or construction of an asset 5. a current period loss combined with a history of losses or a projection of continuing losses associated with the asset a realization that the asset will be disposed of significantly before the end of its estimated useful life.

What are the different ways residual value is estimated

Where it can be estimated by referring to a company's prior experience or to publicly available information concerning resale value then companies use that estimate but since it is often difficult to estimate due to the uncertainty about the future, many companies assume a residual value of zero

Depletion of natural resources typically follows which allocation method

activity based methods

what method is widely used to calculate periodic depletion

activity based units of production because usefulness of natural resources generally is directly related to the amount extracted

What is amortization

allocation of costs of intangible assets with definite useful lives.

If you want to lower tax liability for company what is the better depreciation menthod

an accellerated method will reduce taxable income more in the early years of assets life. And unlike with LIFO where conformity rules require companies using LIFO for income tas also use LIFO for financial reporting, there is no conformity rule for depreciation methods. Can use one method for tax and another for financial reporting.

For purposes of recognition and measurement of impairment losses of long lived tangible assets and intangible assets with finite use, how are assets grouped

assets are grouped at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets.

What is the recoverability test

the first step in determining whether an impairment loss has occurred-an impairment loss is required only when the undiscounted sum of estimated future cash flows from an asset is less than the asset's book value.

deescribe how declining balance methods are calculated

book value at beginning of year x depreciation rate per year = depreciation. Book value at the end of that year is book value at beginning less accumulated depreciation and this is repeated for the number of years for the assets life with the prior year's end of the year book value being the starting value for the next year ex. year beg.b.v deprec rate dep. ac dep end book v 1 250K x 40% 100K 100K 150K 2. 150K x 40% 60K 160K 90K

If fair value must be estimated how is it computed

compute the discounted present value of future cash flows expected from the asset. Note, undiscounted estimates of cash flow are used in step 1 to determine whether an impairment loss is indicated but discounted estimates of cash flows are used to determine the amount of the loss. In calculating the present value either a traditional approach or an expected cash flow approach can be used. Know these methods

Allocation of the cost of natural resources is called

depletion

How is goodwill measured

difference between the purchase price of a compaany and the fair value of all of the identifiable net assets acquired (tangible and intangibles minus fair value of liabilities assumed

When 200% is used as the multiplier in the declining balance method, the method is known as

double declining balance (DDB) method because the rate used is twice the straight line rate.

For measurement purposes, how is fair value calculated

fair value is the amount at which the asset could be bought or sold in a current transaction between willing parties. Quoted market prices could be used if available. If fair value is not determinable it must be estimated.

t/f In a paper company, Plants, properties and equipment are stated at cost less accumulated depreciation. The units of production method of depreciation is used for plants and equipment while the straight line method is used for major pulp and paper mills

false- units of production is used for pulp and paper mills and straight line is used for other plants and equipment.

When is the prior period adjustment applied to retained earnings

for the year following the error, or for the earliest year being reported in the comparative financial statements when the error occurs prior to the earliest year presented + the retained earnings in years after the first year are also adjusted to what those balances would be if the error had not occurred, but a company may choose not to explicitly report those adjustments as separate line items.

the most common intangible asset with an indefinite useful life is

goodwill

For larger companies what methods of depreciation are available to reduce the recordkeeping costs of determining periodic depreciation

group and composite depreciation methods

group depreciation example asset cost resid value dep.base est life dep/year vans 150K 30K 120K 6 20K trucks 120K 16K 104K 5 20.8K wagons 60K 12K 48K 4 12K total 330K 58K 272K 52.8K what is the group depreciation rate assuming no changes in assets in the group? what is the average service life? How long will depreciation be recorded

group depreciation rate = total residual value/total asset cost or 52.8/330 = 16% average service life is total depreciable base/total depreciation per year or 272K/52.8 K = 5.15 years Depreciation will be recorded for 5.15 years so in the 6th year it is figured by 15 x full year of total depreciation or .15 % x 52,8K

When is a useful life of an intangible considered indefinite

if there is no foreseeable limit on the period of time over which the asset is expected to contribute to the cash flows of the entity. It does not necessarily mean permanent.. for instance a trademark ihas legal life of 10 years and can be renewed indefinite times so originally it will be indefinite and the cost will not be amortized. But if the co. decides to phase out the tire that is trademarked over a 3 year period, then the co. would amortize the remaining value over 3 years.

How does valuation of intangibles differ under international rules

international rules allow a company to value an intangible asset subsequent to initial valuation at 1) cost less accumulated amortizaiton ro 2) fair value if fair value can be determined by reference to an active market. If revaluation is chosed, all asset is class must be revalued regularly. GAAP does not allow revaluation here.

while physical life or obsolescence can shorten the physical life of a tangible asset, what generally limits the service life of an intangible asset

legal or contractual life (i.e a patent might be capable of producing enhanced profitability for 50 years but the legal life is only 20 years)

What might limit the useful life of an intangible asset

legal, regulatory or contractual provision, obsolescence

How is amortization expense traditionally credited

like depletion it is credited to the asset account itself rather than to accumulated amortization but a contra account is acceptable.

Activity based depreciation usually provides a better matching of revenues and expenses so why is it less often used

more costly to determine productivity than to simply measure passage of time

What is half year convention

most companies adopt a simplifying assumption or convention for computing partial year depreciation and use it consistently. They often record 1/2 of a full year depreciation in the year of acquisition and another half year in the year of disposal

can a company later recover an impairment loss

no

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

How is amortization of software devlopment cost different

periodic amortization percentage for software development is the greater of 1) the rati of the current revenues to current and anticipated revenues (percentage of revenue method) or 2) the straight line percentage over the useful life of the asset.

Calculations for depreciation depletion and amortization require estimates of both service life an dresidual value that can be wrong, how are changes in estimates dealt with

prospectively. When a company revises prior estimates, piro financial statements are not restated. Instead, they just incorporate the new estimate on a current and go forward basis that will affect the balance sheet and income statement in the current and future periods. A disclosure note should describe hte effect of a change in estimated net income and related per share accounts for the current period

When an asset is purchased or disposed of mid year, how is partial year depreciation determined

se e pg. 607- depending on the method, you have to multiply by the portion of the year that it actually is in use

What strategy makes it easier to correct errors

sometimes the analysis is easier if you re-create the entries actually recorded incorrectly and those that would have been recorded if the error had not occurred and compare them.

Most companies use what method of amortization for intangible assets

straight line method

Because the unit of production method estimates service life based on units produced rather than years, depreciation is not constrained by time. It is constrained by what

the asset's cost and the anticipated residual value. As such, in the last year of the asset life, depreciation will have to be modified to bring the book value of the asset down to residual value

In order to determine allocation of intangible finite assets what information is needed

the asset's useful life, its amortization base (cost less estimated residual value) and the appropriate allocation method

How are the rates determined for use in declining balance methods

they are multiples of the straight line rate which is calculated as one divided by the number of years in the assets service life. Ex. the straight line rate for an asset with a 5 year life in 1/5 or 20%. Multiples used could be $125, 150 or 200%

Because depreciation records are not kept on individual assets under group or composite depreciation, how are dispositions handled

they are recorded under the assumption that the book value of the disposed item exactly equals any proceeds received and no gain or loss is recorded. (because any gain or loss is included in the accumulated depreciation account

How do activity based depreciation methods estimate service life

they estimate it in terms of some measure of productivity, such as output (est. # of units it will produce), input (# of hours it will operate or miles it will run

How does the group depreciation method define the collection of depreciable assets

this method defines the collection as depreciable assets that share similar servce lives and other attributes, ex. fleet of vehicles

How does the composite depreciation method group assets

this method is used when assets are physically disimilar but are aggregated anyway to gain the convenience of a collective depreciation ie all assets in one plant

t/c: the units of production method computes a depreciation rate per measure of activity and then multiplies this rate by actual activity to determine periodic depreciation

true

t/f: depreciation is a process of cost allocation and not valuation

true

t/f generally accepted accounting principles require that a change in depreciation, amortization or depletion method be considered a change in accounting estimate that is achieved by a change in accounting principle

true- we account for them prospectively like any other change in estimate but this change requires a clear justification as to why the new method is better

t/f Depreciation is provided over the estimated useful lives of the assets, principally using the straight line method for financial statements and for tax purposes, accelerated methods are used

true- companies can even use different methods of depreciation for different classes of assets.

The most common activity based method is called the

units of production method

Service life of an asset can be expressed in what type of units

units of time or units of activity (years/miles)

for an intangible asset with a finite useful life what is allocated

we allocate its capitalized cost less any estimated residual value to periods in which the asset is expected to contribute to the company's revenue generating activities

When is straight line method of depreciation the better method

when the benefits are derived from the use of the assset are the same each year.

If the depreciable base of an asset is (250K- 40K) or $210. chart the depreciation, accumulated depreciation and book valueend of year (250K less accum depreciation)

year dep. base dep rate/yr dep. accu book dep value 1 210K x 5/15 = 70K 70K 180K 2. 210K x 4/15 = 56K 126K 124K 3 210K x 3/15 = 42K 168K 82K 4. 210K x 2/15 = 28K 196K 54K 5. 210K x 1/15 = 14K 210K 40K

Usually what is the expected reisdual value of an intangible asset

zero but might not be if at the end of its useful life to the reporting entity the asset will benefit another entity. Ex. another co. has agreed to buy a patent at the end of it life to the originating co. then purchase prise is residual value.