Conducted by: Mr. Koy Chumnith

Property, Plant, and Equipmentand Intangible Assets: Utilization

and Impairment

11

2011, Royal University of Law and EconomicsMcGraw-Hill/Irwin

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Some of the cost is expensed each period.Some of the cost is expensed each period.

Cost Allocation – An Overview

ExpenseExpenseAcquisitionCost

AcquisitionCost

(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.

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.

Depreciation, depletion, and amortization are cost allocation processes used to help meet the

matching principle requirements.

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AssetCategory Debit

Intangible Amortization Intangible Asset

Account Credited

Accumulated Depreciation

Property, Plant, & Equipment

Depreciation

Natural Resource DepletionNatural Resource

Asset

Caution! Depreciation, depletion, and amortizationare processes of cost allocation, not valuation!

Depreciation on the

Balance Sheet

Cost Allocation – An Overview

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Cost allocation requires three piecesof information for each asset:

The estimated expected The estimated expected use from an asset. use from an asset.

The estimated expected The estimated expected use from an asset. 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.

The systematic approach used for allocation.

Allocation Base

Allocation Base

Service Life

Service Life

Allocation Method

Allocation Method

Measuring Cost Allocation

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Time-based MethodsStraight-line (SL)Accelerated Methods

Sum-of-the-years’ digits (SYD)Declining Balance (DB)

Time-based MethodsStraight-line (SL)Accelerated Methods

Sum-of-the-years’ digits (SYD)Declining Balance (DB)

Activity-based methodsUnits-of-production method (UOP).

Activity-based methodsUnits-of-production method (UOP).

Group andcomposite methods

Group andcomposite methods

TaxTaxdepreciationdepreciation

TaxTaxdepreciationdepreciation

Depreciation

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Straight-Line

The most widely The most widely used and most easily used and most easily understood method.understood method.

The most widely The most widely used and most easily used and most easily understood method.understood method.

Results in the same Results in the same amount of depreciation in amount of depreciation in each year of the asset’s each year of the asset’s

service life.service life.

Results in the same Results in the same amount of depreciation in amount of depreciation in each year of the asset’s each year of the asset’s

service life.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?

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Accumulated Accumulated UndepreciatedDepreciation Depreciation Depreciation Balance

Year (debit) (credit) Balance (book value)50,000$

1 9,000$ 9,000$ 9,000$ 41,000 2 9,000 9,000 18,000 32,000 3 9,000 9,000 27,000 23,000 4 9,000 9,000 36,000 14,000 5 9,000 9,000 45,000 5,000

45,000$ 45,000$

Residual ValueResidual ValueBV = Residual Value at the

end of the asset’s useful life.

Straight-Line

Life in Years

De

pre

cia

tio

n

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Accelerated Methods

Note that total depreciation over the asset’s usefullife 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

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2

Sum-of-the-Years’ Digits (SYD)

On January 1, we purchase equipment for $50,000 cash. The equipment has a service life of 5 years and an

estimated residual value of $5,000. Using SYD depreciation, compute depreciation for the first two years.

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Sum-of-the-Years’ Digits (SYD)

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Accumulated UndepreciatedDepreciation Depreciation Balance

Fraction (debit) Balance (book value)50,000$

5/15 15,000$ 15,000$ 35,000 4/15 12,000 27,000 23,000 3/15 9,000 36,000 14,000 2/15 6,000 42,000 8,000 1/15 3,000 45,000 5,000

45,000$

Accumulated UndepreciatedDepreciation Depreciation Balance

Fraction (debit) Balance (book value)50,000$

5/15 15,000$ 15,000$ 35,000 4/15 12,000 27,000 23,000 3/15 9,000 36,000 14,000 2/15 6,000 42,000 8,000 1/15 3,000 45,000 5,000

45,000$ Residual ValueResidual Value

Life in Years

Dep

reci

atio

n

Sum-of-the-Years’ Digits (SYD)

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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) depreciationis computed as follows:

Note that the Book Value will get lower each year.

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On January 1, we purchase equipment for $50,000 cash. The equipment has a service life of 5 years

and an estimated residual value of $5,000.What is depreciation for the first two years using

double-declining-balance?

Declining-Balance (DB) Methods

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Accumulated UndepreciatedDepreciation Depreciation Balance

Year (debit) Balance (book value)50,000$

1 20,000$ 20,000$ 30,000 2 12,000 32,000 18,000 3 7,200 39,200 10,800 4 4,320 43,520 6,480 5 1,480 45,000 5,000

45,000$

Accumulated UndepreciatedDepreciation Depreciation Balance

Year (debit) Balance (book value)50,000$

1 20,000$ 20,000$ 30,000 2 12,000 32,000 18,000 3 7,200 39,200 10,800 4 4,320 43,520 6,480 5 1,480 45,000 5,000

45,000$

Depreciation forced so that BV = Residual Value.

Life in Years

Dep

reci

atio

n

Declining-Balance (DB) Methods

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Units-of-Production

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On January 1, we purchased equipment for $50,000 cash. The equipment is expected to produce 100,000 units during

its life and has an estimated residual value of $5,000.If 22,000 units were produced this year, what is the amount

of depreciation?

Units-of-Production

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Use of Various Depreciation Methods

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U.S. GAAP vs. IFRS

• Component depreciation is allowed but not often used in practice.

• The depreciable base is determined by subtracting estimated residual value from cost. Annual reviews of residual values are not required.

• Each component of an item of property, plant, and equipment is depreciated separately if its cost is significant to the total cost of the item.

• Depreciable base is determined by subtracting estimated residual value from cost. IFRS requires a review of residual values annually.

Component Depreciation, Depreciable Base, and Residual Value

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Group and Composite Methods• Assets are grouped by common characteristics.• An average depreciation rate is used.• Annual depreciation is the average rate × the total

group acquisition cost.• Accumulated depreciation records are not maintained

for individual assets.

• Assets are grouped by common characteristics.• An average depreciation rate is used.• Annual depreciation is the average rate × the total

group acquisition cost.• Accumulated depreciation records are not maintained

for individual assets.

If assets in the group are sold, or new assets added, the composite rate remains the same.

When an asset in the group is sold or retired, debit accumulated depreciation for the difference between the asset’s cost and the proceeds.

If assets in the group are sold, or new assets added, the composite rate remains the same.

When an asset in the group is sold or retired, debit accumulated depreciation for the difference between the asset’s cost and the proceeds.

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U.S. GAAP vs. IFRS

• Property, plant, and equipment is reported in the balance sheet at cost less accumulated depreciation (book value).

• Revaluation is prohibited.

• Property, plant, and equipment may be reported at cost less accumulated depreciation, or alternatively, at fair value (revaluation).

• If revaluation is chosen, all assets within a class of property, plant, and equipment must be revalued on a regular basis.

Valuation of Property, Plant, and Equipment

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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.

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ABC Mining acquired a tract of land containing ore deposits. Total costs of acquisition and development were

$1,100,000. ABC estimated the land contained 40,000 tons of ore, and that the land will be sold for $100,000 after

the coal is mined. What is ABC’s depletion rate?

Depletion rate = 1,000,000 ÷ 40,000 Tons = $25 Per TonDepletion rate = 1,000,000 ÷ 40,000 Tons = $25 Per Ton

Depletion of Natural Resources

For the year ABC mined 13,000 tons. What is the total amount of depletion for the year?

Depletion = 13,000 tons × $25per ton = $325,000Depletion = 13,000 tons × $25per ton = $325,000

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U.S. GAAP vs. IFRS

• Biological assets, such as timber tracts, are valued at cost less accumulated depletion.

• Biological assets are valued at fair value less estimated costs to sell.

Valuation of Biological Assets

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Amortization of Intangible Assets

The amortization process uses the straight-line method, but usually assumes residual value = 0.

Amortization period is the shorter ofthe asset’s 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.

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Torch, Inc. has developed a new device. Patent registration costs consisted of $2,000 in attorney fees and

$1,000 in federal registration fees. The device has a contractual (useful) life of 5 years. The legal life is 20

years.For year 1, what is Torch’s amortization expense?

Amortization of Intangible Assets

Amortization expense ................................... 600Patent ………………........................ 600

To record amortization of patent.

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Not amortized.

Subject to assessment for impairment ofvalue and may be

written down.

Goodwill and Trademarks

Intangible Assets notSubject to Amortization

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U.S. GAAP vs. IFRS

• Intangible assets are reported at cost less accumulated amortization.

• U.S.GAAP prohibits revaluation of any intangible asset.

• Intangible assets may be reported at (1) cost less accumulated amortization or (2) fair value, if fair value can be determined in an active market.

• If revaluation is chosen, all assets within the class of intangibles must be revalued on a regular basis.

• Goodwill cannot be revalued.

Valuation of Intangible Assets

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Partial-Period Depreciation

Half-Year ConventionTake ½ of a year of depreciation in the year of acquisition, and the other ½ in

the year of disposal.

Half-Year ConventionTake ½ of a year of depreciation in the year of acquisition, and the other ½ in

the year of disposal.

Pro-rating the depreciation based on the date of acquisition is time-consuming

and costly. A commonly used alternative is the . . .

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ESTIMATED service life

ESTIMATED service life

ESTIMATED residual valueESTIMATED

residual value

Changes in estimates are accounted for prospectively. The book value less any residual value at the date of

change is depreciated over the remaining useful life. A disclosure note should describe the effect of a change.

On January 1, equipment was purchased that cost $30,000, has a useful life of 10 years and no salvage value. At the beginning of the fourth year, it was decided that there were only 5 years

remaining, instead of 7 years. Calculate depreciation expense for the fourth

year using the straight-line method.

Changes in Estimates

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Asset cost 30,000$ Accumulated depreciation ($3,000 per year × 3 years) 9,000 Remaining book value 21,000 Divide by remaining life ÷ 5Revised annual depreciation 4,200$

Asset cost 30,000$ Accumulated depreciation ($3,000 per year × 3 years) 9,000 Remaining book value 21,000 Divide by remaining life ÷ 5Revised annual depreciation 4,200$

What happens if we change depreciation methods?

Changes in Estimates

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Change in Depreciation Method

We account for these changes prospectivelyprospectively,, exactly as we would any other change in estimate.

We account for these changes prospectivelyprospectively,, exactly as we would any other change in estimate.

A change in depreciation, amortization, or depletion method is considered a change in accounting estimate that is achieved by a change in accounting principle.

A change in depreciation, amortization, or depletion method is considered a change in accounting estimate that is achieved by a change in accounting principle.

On January 1, 2009, Matrix, Inc., purchased equipment for $400,000. Matrix expected a residual value $40,000, and a service life of 5

years. Matrix uses the double-declining-balance method to depreciate this type of asset. During 2011, the company switched from double-declining balance to straight-line depreciation. The

residual value remained at $40,000. Let’s determine the amount of depreciation to be recorded at the end of 2011.

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Depreciation - 2009 160,000$ ($400,000 × 40%)Depreciation - 2010 96,000 [($400,000 - $160,000) × 40%]Total Depreciation 256,000$

Cost of asset 400,000$ Undepreciated balance 144,000$ Less: residual value (40,000) New depreciable amount 104,000 Remaining service life ÷ 3 Annual depreciation 34,667$

Change in Depreciation Method

December 31, 2011:Depreciation expense ................................... 34,667

Accumulated depreciation................ 34,667To record depreciation expense.

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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 In addition, a disclosure note is needed to describe the nature of the error and the impact of its correction on net income, of the error and the impact of its correction on net income,

income before extraordinary items, and earnings per share.income before extraordinary items, and earnings per share.

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Impairment of Value

Accounting treatment differs.Accounting treatment differs.

Long-term assetsto be held and usedLong-term assets

to be held and usedLong-term assets

held for saleLong-term assets

held for sale

Tangible andintangible with finiteuseful lives

Tangible andintangible with finiteuseful lives

Intangiblewith

indefiniteuseful lives

Intangiblewith

indefiniteuseful lives

GoodwillGoodwill

Test for impairment

of value when

consideredfor 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

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Finite-life Assets to be Held and Used

An asset is impaired when . . .

The undiscounted sum of its estimated future cash flows

Measurement – Step 1Measurement – Step 1

Itsbookvalue

<

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Impairmentloss =

Bookvalue

Fairvalue–

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 ValueUndiscounted future

cash flows

Market value, price of similar assets,or PV of future net cash inflows.

Reported as partof income from

continuing operations.

Finite-life Assets to be Held and Used

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Impairmentloss =

Bookvalue

Fair value lesscost to sell–

Assets held for saleinclude assets that management

has committed to sell immediately intheir present condition andfor which sale is probable.

Assets Held for Sale

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U.S. GAAP vs. IFRS

• Assets are tested for impairment when events or changes in indicators suggest that book value may not be recoverable.

• An impairment loss is required when an asset’s book value exceeds the undiscounted sum of the estimated future cash flows.

• Assets must be assessed for circumstances of impairment at the end of each reporting period.

• An impairment loss is required when an asset’s book value exceeds the higher of the asset’s value-in-use (present value of estimated future cash flow) and fair value less costs to sell.

Impairment of Value: Property, Plant, and Equipment and Finite-life Intangible Assets

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U.S. GAAP vs. IFRS

• The impairment loss is the difference between book value and fair value.

• Reversals of impairment losses are prohibited.

• The impairment loss is the difference between book value and the recoverable amount, the higher of the asset’s value-in-use and fair value less costs to sell.

• An impairment loss is reversed if the circumstances that caused the impairment is resolved.

Impairment of Value: Property, Plant, and Equipment and Finite-life Intangible Assets

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Finite-life Assets to be Held and Used

Step 1 $140 million < $200 million

Impairment loss is indicated.

Because Acme Auto Parts has seen its sales steadily decrease due to the decline in new car sales, Acme’s management believes that equipment that originally cost $350 million, with a $200 million book value may not be recoverable. Management estimates that future undiscounted cash flows associated with the equipment’s

remaining useful life will be only $140 million, and that the equipment could be sold now for $120 million. Has Acme suffered

an impairment loss and if so, how should it be recorded?

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Finite-life Assets to be Held and Used

Step 2 Impairment loss = $200 million – $120 million = $80 million

Impairment loss ................................... 80,000,000Accumulated depreciation ................... 150,000,000

Equipment ……………………. 230,000,000To record impairment loss.

Because Acme Auto Parts has seen its sales steadily decrease due to the decline in new car sales, Acme’s management believes that equipment that originally cost $350 million, with a $200 million book value may not be recoverable. Management estimates that future undiscounted cash flows associated with the equipment’s

remaining useful life will be only $140 million, and that the equipment could be sold now for $120 million. Has Acme suffered

an impairment loss and if so, how should it be recorded?

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Step 2 Loss = BV of goodwill less implied value

of goodwill.

Step 2 Loss = BV of goodwill less implied value

of goodwill.

GoodwillGoodwill

Step 1 If BV of reporting unit > FV, impairment

indicated.

Step 1 If BV of reporting unit > FV, impairment

indicated.

Other IndefiniteLife Intangibles Other IndefiniteLife 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

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U.S. GAAP vs. IFRS

• Indefinite-life intangible assets other than goodwill are tested for impairment at least annually.

• The impairment loss is the difference between book value and fair value.

• Indefinite-life intangible assets other than goodwill are tested for impairment at least annually.

• The impairment loss is the difference between book value and the recoverable amount, the higher of the asset’s value-in-use (present value of estimated future cash flows) and fair value less costs to sell.

Impairment of Value: Indefinite-life Intangible Assets Other than Goodwill

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U.S. GAAP vs. IFRS

• Reversals of impairment losses are prohibited.

• If certain criteria are met, indefinite-life intangible assets are combined for the required annual impairment test.

• An impairment loss is reversed if the circumstances that caused the impairment is resolved.

• Indefinite-life intangible assets may not be combined with other indefinite-life intangible assets for the required annual impairment test.

Impairment of Value: Indefinite-life Intangible Assets Other than Goodwill

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U.S. GAAP vs. IFRS

• Goodwill is tested for impairment at least annually.

• Reversals of impairment losses are prohibited.

• The level of testing (reporting unit) is a segment or a component of an operating segment for which discrete financial information is available.

• Goodwill is tested for impairment at least annually.

• Reversals of impairment losses are prohibited.

• The level of testing (cash-generating unit) is the smallest identifiable group of assets that generates cash flows that are largely independent of the cash flows from other assets.

Impairment of Value: Goodwill

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U.S. GAAP vs. IFRS

• Measurement of an impairment loss is a two-step process. In step one the fair value of the reporting unit is compared to its book value. A loss is indicated if the fair value is less than the book value. In step two, the impairment loss is calculated as the excess of book value of goodwill over the implied fair value of goodwill.

• Measurement of an impairment loss is a one-step process. The recoverable amount of the cash-generating unit is compared to its book value. If the recoverable amount is less, goodwill is reduced before other assets are reduced.

Impairment of Value: Goodwill

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Impairment of Goodwill

Step 1 $500 million > $400 million

Impairment loss is indicated.

Simmons Company recorded $150 million of goodwill when it acquired Blake Company. Blake continues to operate as a separate company and is considered to be a reporting unit. At the end of the current year Simmons noted the following related to Blake: (1) book value of net assets, including $150 million of goodwill is $500 million;

(2) fair value of Blake is $400 million; and (3) fair value of Blake’s identifiable net assets, excluding goodwill is $350 million. Is goodwill

impaired and if so, by what amount?

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Impairment of Goodwill

Step 2

Determination of implied goodwillFair value of Blake 400,000,000$ Fair value of Blake's net assets excluding goodwill 350,000,000 Implied value of goodwill 50,000,000$

Measure of impairment lossBook value of goodwill 150,000,000$ Implied value of goodwill 50,000,000 Impairment loss 100,000,000$

Step 2

Determination of implied goodwillFair value of Blake 400,000,000$ Fair value of Blake's net assets excluding goodwill 350,000,000 Implied value of goodwill 50,000,000$

Measure of impairment lossBook value of goodwill 150,000,000$ Implied value of goodwill 50,000,000 Impairment loss 100,000,000$

Simmons Company recorded $150 million of goodwill when it acquired Blake Company. Blake continues to operate as a separate company and is considered to be a reporting unit. At the end of the current year Simmons noted the following related to Blake: (1) book value of net assets, including $150 million of goodwill is $500 million;

(2) fair value of Blake is $400 million; and (3) fair value of Blake’s identifiable net assets, excluding goodwill is $350 million. Is goodwill

impaired and if so, by what amount?

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Type of Expenditure Definition Usual Accounting TreatmentRepairs and Maintenance

Expenditures to maintaina given level of benefits

Expense in the period incurred

Additions The 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

Improvements The replacement ofa major component

Capitalize and depreciate over the useful life of the improved asset

Rearrangements Expenditures to restructure an asset without addition,

replacement, or improvement

If expenditures are material and clearly increase future benefits, capitalize and depreciate overthe future periods benefited

Expenditures Subsequentto Acquisition

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U.S. GAAP vs. IFRS

• Litigation costs to successfully defend intangible rights are capitalized and amortized over the remaining useful life of the asset.

• Litigation costs are expensed, except in rare situations when an expenditure increases future benefits.

Costs of Defending Intangible Rights

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Ignores residual

value

Provides for rapid write-off

Rates based on asset

“class lives”

Most corporations use the Modified Accelerated Cost Recovery System

(MACRS) for tax purposes.

Most corporations use the Modified Accelerated Cost Recovery System

(MACRS) for tax purposes.

Appendix 11A – Comparison with MACRS (Tax Depreciation)

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Retirement MethodAcquisitions:

• Record initial acquisitions of assets at cost in the asset account.• Record subsequent acquisitions of assets at cost in the asset account

Dispositions: • Credit the asset account for cost.• Debit depreciation expense for cost less the proceeds received.

Replacement MethodAcquisitions:

• Record initial acquisitions of assets at cost in the asset account.• Record subsequent acquisitions with a debit to depreciation expense.

Dispositions:• Credit depreciation expense for the proceeds received.

Used for groups of similar, low-valuedUsed for groups of similar, low-valuedassets with short service lives.assets with short service lives.

Appendix 11B – Retirement and Replacement Methods of Depreciation

End of Chapter 11