Investments in Noncurrent Operating Assets--Utilization and Retirement

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Investments in Noncurrent Operating
Assets--Utilization and Retirement
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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.

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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.

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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.

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Time Line of Business Issues
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Time Line of Business Issues
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Factors Affecting the Periodic Depreciation Charge

• Asset cost
• Residual or salvage value
• Useful life
• Pattern of use

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

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Depreciation Illustration
Costs incurred are deferred until future periods.
They are recorded as an asset and the costs are
assigned to future periods.
Cost (Asset)
Depreciable
Period 2
Period 3
Period 1
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Depreciation Illustration
Cost (Asset)
Depreciable
A depreciation method is selected to assign these
costs to future periods.
Period 2
Period 3
Period 1
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Depreciation Illustration
Cost (Asset)
Depreciable
Depreciable
A depreciation method is selected to assign these
costs to future periods.
Cost
Period 2
Period 3
Period 1
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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.
Cost (Asset)
Cost
(Asset)
Period 2
Period 3
Period 1
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Depreciation Methods
Time-Factor Methods

• Straight-line This method recognizes equal
  periodic depreciation charges over the assets
  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.

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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.

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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.

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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.
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Time-Factor Methods
Straight-Line Method
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Time-Factor Methods
Straight-Line Method
35,000 28,000 21,000 14,000 7,000 0
Depreciation Expense
2002
2003
2004
2005
2006
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Time-Factor Methods
Sum-of-the-Years-Digits Method
SYD 15
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Time-Factor Methods
Sum-of-the-Years-Digits Method
t years remaining in n at the beginning of the
period
Depreciation (2002) 31,667
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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
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Time-Factor Methods
Declining-Balance Method
Depreciation F x (Cost - Accum. Depr.)
F declining balance factor (e.g., 150 or 200)
Depreciation (2002) .40 x 100,000
Depreciation (2002) 40,000

• Note
• Do not depreciate below salvage value.
• Optional Switch to straight-line when it yields
  higher depreciation.

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Time-Factor Methods
Declining-Balance Method
42,000 35,000 28,000 21,000 14,000 7,000 0
Depreciation Expense
2005
2006
2002
2003
2004
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Use Factor Methods
Service Hours Method
Depreciation 4.75 per hour
Depreciation (2002) 4.75 x 3,000
Depreciation (2002) 14,250
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Use Factor Methods
Productive-Output Method
r (per unit) 3.80 per unit
Depreciation (2002) 3.80 x 3,500
Depreciation (2002) 13,300
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Group Depreciation

• Group similar assets into depreciation accounts.
• Calculate annual depreciation charge at the
  straight-line rate times the groups 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.

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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.
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Depletion
Depletion for 2002 5.25 x 80,000 tons
Depletion for 2002 420,000
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Impairment
Before the end of an assets useful life, events
occur that impair its value. This requires an
immediate write-down of the asset.
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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.
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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.
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Impairment
3. How should an impairment loss be measured?
The impairment loss is the difference between the
book value of the asset and the assets fair
value.
The fair value can be approximated using the
present value of estimated future cash flows from
the asset.
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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.
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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.

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Asset Retirement--Determining Gain or Loss

• 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.

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Asset Retirement--Unusual Considerations
Record transaction according to general procedure.
Are assets similar in nature?
NO
YES
Are the parties in the same line of business?
Record transaction according to general procedure.
NO
YES
Record transaction according to general procedure.
Does the transaction create a gain?
NO
YES
Zero
25 or more
What percentage of the transactions 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.
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Asset Retirement--Unusual Considerations
Yes
What percentage of the transactions FMV is in
cash?
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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.
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The End