Chapter 11 Property, Plant and Equipment and intangible assets: Utilization and impairment Sommers ACCT 3311

1. Chapter 11 Property, Plantand Equipmentand intangible assets: Utilization and impairmentSommers � ACCT 3311 Chapter 1: Environment and Theoretical Structure of Financial Accounting.Chapter 1: Environment and Theoretical Structure of Financial Accounting.

2. Discussion Questions Q11�2 Depreciation is a process of cost allocation, not valuation. Explain this statement.

3. Cost Allocation � An Overview The matching principle requires that part of the acquisition cost of operational 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. Part I. The matching principle requires that part of the acquisition cost of an operational asset be expensed in periods when the future revenues are earned. A portion of an asset�s cost is moved from the balance sheet to the income statement each period. Part II. Depreciation, depletion, and amortization are cost allocation processes. We allocate the cost of the asset to expense over its useful life in some rational and systematic manner. The unused portion of the asset�s cost appears on the balance sheet. We allocate a portion of the cost to expense on the income statement each accounting period. Accumulated depreciation represents the depreciation taken on the asset since its purchase, and is deducted from the asset�s cost on the balance sheet. Part I. The matching principle requires that part of the acquisition cost of an operational asset be expensed in periods when the future revenues are earned. A portion of an asset�s cost is moved from the balance sheet to the income statement each period. Part II. Depreciation, depletion, and amortization are cost allocation processes. We allocate the cost of the asset to expense over its useful life in some rational and systematic manner. The unused portion of the asset�s cost appears on the balance sheet. We allocate a portion of the cost to expense on the income statement each accounting period. Accumulated depreciation represents the depreciation taken on the asset since its purchase, and is deducted from the asset�s cost on the balance sheet.

4. Cost Allocation � An Overview Part I. Depreciation is term used for the cost allocation process for operational assets in the property plant and equipment category. Land is not depreciated. Depletion is the cost allocation process for natural resource operational assets, and amortization refers to the allocation of intangible asset costs. Depreciation, depletion, and amortization are processes of cost allocation, not for valuation. We do not want to confuse asset valuation, an economic concept, with allocation of acquisition costs to periods benefited by the use of operational assets. Part II. Here you see an example of the property, plant and equipment section of a balance sheet showing the assets at cost less the accumulated depreciation. Accumulated depreciation is a contra-asset account and is subtracted from the assets� cost to determine book value. Net property, plant & equipment is the undepreciated cost (book value) of plant assets. Book value is not equal to market value. Part I. Depreciation is term used for the cost allocation process for operational assets in the property plant and equipment category. Land is not depreciated. Depletion is the cost allocation process for natural resource operational assets, and amortization refers to the allocation of intangible asset costs. Depreciation, depletion, and amortization are processes of cost allocation, not for valuation. We do not want to confuse asset valuation, an economic concept, with allocation of acquisition costs to periods benefited by the use of operational assets. Part II. Here you see an example of the property, plant and equipment section of a balance sheet showing the assets at cost less the accumulated depreciation. Accumulated depreciation is a contra-asset account and is subtracted from the assets� cost to determine book value. Net property, plant & equipment is the undepreciated cost (book value) of plant assets. Book value is not equal to market value.

5. Discussion Questions Q11�3 Identify and define the three characteristics of an asset that must be established to determine periodic depreciation, depletion, or amortization.

6. Measuring Cost Allocation Regardless of the method used to calculate depreciation expense, we must have three items of information: (1) the estimated useful life of the asset; (2) the allocation base which is the cost of the asset less its estimated residual value at the end of its useful life, and (3) the allocation method. Regardless of the method used to calculate depreciation expense, we must have three items of information: (1) the estimated useful life of the asset; (2) the allocation base which is the cost of the asset less its estimated residual value at the end of its useful life, and (3) the allocation method.

7. Discussion Questions Q11�6 Briefly differentiate between activity-based and time-based allocation methods.

8. Straight-Line Time: Activity: Part I. The straight-line method is the most widely used and the most easily understood method of depreciation. It results in an equal amount of depreciation in each year of an asset�s useful life. The annual depreciation is determined by dividing the asset�s cost less its estimated residual value by the asset�s estimated useful life in years. Part II. Consider the following example. On January 1, we purchase equipment for $50,000 cash. The equipment has an estimated service life of five years and an estimated residual value of $5,000. What is the annual straight-line depreciation? Part I. The straight-line method is the most widely used and the most easily understood method of depreciation. It results in an equal amount of depreciation in each year of an asset�s useful life. The annual depreciation is determined by dividing the asset�s cost less its estimated residual value by the asset�s estimated useful life in years. Part II. Consider the following example. On January 1, we purchase equipment for $50,000 cash. The equipment has an estimated service life of five years and an estimated residual value of $5,000. What is the annual straight-line depreciation?

9. E11-1 On January 1, 2011, the Excel Delivery Company purchased a delivery van for $33,000. At the end of its five-year service life, it is estimated that the van will be worth $3,000. During the five- year period, the company expects to drive the van 100,000 miles. Calculate annual depreciation for the five-year life of the van using: Straight line

10. E11-1 On January 1, 2011, the Excel Delivery Company purchased a delivery van for $33,000. At the end of its five-year service life, it is estimated that the van will be worth $3,000. During the five- year period, the company expects to drive the van 100,000 miles. Calculate annual depreciation for the five-year life of the van using: Units of production using miles driven as a measure of output,and the following actual mileage:

11. Discussion Questions Q11�7 Briefly differentiate between the straight-line depreciation method and accelerated depreciation methods.

12. Accelerated Methods 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 Note that total depreciation over the asset�s useful life is the same as the Straight-line Method DB depreciation � Based on the straight-line rate multiplied by an acceleration factor Computations initially ignore residual value Stop depreciating when BV = Residual Value Note that the Book Value will get lower each year Part I. 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. The total amount of depreciation over the asset�s useful life is the same as the straight-line method. Part II. Sum-of-the-years�-digits depreciation is calculated by multiplying cost minus residual value times a fraction that declines each year of an asset�s useful life. The numerator of the fraction is a number equal to the remaining useful life of the asset. For an asset with a four-year life, the numerator would be four for the first year, three for the second year, two for the third year and one for the fourth year The denominator of the fraction is constant. It is the sum of the digits in the asset�s life from one to n, where n is the number of years in the asset�s life. For example, if the estimated life is four years, the sum of the digits is 1 plus 2 plus 3 plus 4, a total of 10. Part I. 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. The total amount of depreciation over the asset�s useful life is the same as the straight-line method. Part II. Sum-of-the-years�-digits depreciation is calculated by multiplying cost minus residual value times a fraction that declines each year of an asset�s useful life. The numerator of the fraction is a number equal to the remaining useful life of the asset. For an asset with a four-year life, the numerator would be four for the first year, three for the second year, two for the third year and one for the fourth year The denominator of the fraction is constant. It is the sum of the digits in the asset�s life from one to n, where n is the number of years in the asset�s life. For example, if the estimated life is four years, the sum of the digits is 1 plus 2 plus 3 plus 4, a total of 10.

13. E11-1 On January 1, 2011, the Excel Delivery Company purchased a delivery van for $33,000. At the end of its five-year service life, it is estimated that the van will be worth $3,000. During the five- year period, the company expects to drive the van 100,000 miles. Calculate annual depreciation for the five-year life of the van using: Double-declining balance

14. Use of Various Depreciation Methods In a recent survey of large publicly traded companies, 592 of the companies indicated that they used the straight-line method of depreciation. The straight-line method is used by the majority of companies because it is the easiest method to understand and to apply. In a recent survey of large publicly traded companies, 592 of the companies indicated that they used the straight-line method of depreciation. The straight-line method is used by the majority of companies because it is the easiest method to understand and to apply.

15. 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. ISA No. 16 requires that each component of an item of property, plant, and equipment must be depreciated separately if its cost is significant in relation to the total cost of the item. In the U.S., component depreciation is allowed but is not often used in practice. U.S. GAAP and IFRS determine depreciable base in the same way, by subtracting estimated residual value from cost. However, IFRS requires a review of residual values at least annually.ISA No. 16 requires that each component of an item of property, plant, and equipment must be depreciated separately if its cost is significant in relation to the total cost of the item. In the U.S., component depreciation is allowed but is not often used in practice. U.S. GAAP and IFRS determine depreciable base in the same way, by subtracting estimated residual value from cost. However, IFRS requires a review of residual values at least annually.

16. 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. Under U.S. GAAP a company reports property, plant, and equipment in the balance sheet at cost less accumulated depreciation (book value). ISA No. 16 allows a company to report property, plant, and equipment at cost less accumulated depreciation, or, alternatively, at its fair value (revaluation). If a company chooses revaluation, all assets within a class of property, plant, and equipment must be revalued on a regular basis. U.S. GAAP prohibits revaluation. If the revaluation option is chosen, the way the company reports the difference between fair value and book value depends on which amount is higher: If fair value is higher than book value, the difference is reported as other comprehensive income (OCI) which then accumulates in a �revaluation surplus: (sometimes called revaluation reserve) account in equity. If book value is higher than fair value, the difference is reported as an expense in the income statement. An exception is when a revaluation surplus account relating to the same asset has a balance from a previous increase in fair value, that balance is eliminated before debiting revaluation expense.Under U.S. GAAP a company reports property, plant, and equipment in the balance sheet at cost less accumulated depreciation (book value). ISA No. 16 allows a company to report property, plant, and equipment at cost less accumulated depreciation, or, alternatively, at its fair value (revaluation). If a company chooses revaluation, all assets within a class of property, plant, and equipment must be revalued on a regular basis. U.S. GAAP prohibits revaluation. If the revaluation option is chosen, the way the company reports the difference between fair value and book value depends on which amount is higher: If fair value is higher than book value, the difference is reported as other comprehensive income (OCI) which then accumulates in a �revaluation surplus: (sometimes called revaluation reserve) account in equity. If book value is higher than fair value, the difference is reported as an expense in the income statement. An exception is when a revaluation surplus account relating to the same asset has a balance from a previous increase in fair value, that balance is eliminated before debiting revaluation expense.

17. Depletion and Amortization 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. The approach is based on the units-of-production method. Amortization of Intangibles with limited life The amortization process uses the straight-line method, but usually assumes no residual value. Amortization period is the shorter of the asset�s legal or contractual life. A contra-asset account is generally not used when recording the amortization of intangible assets. Part I. In general, natural resources can be thought of as anything extracted from our natural environment such as coal, oil, and iron ore. Allocation of the cost of natural resources is called depletion. Total cost, including exploration and development, is charged to depletion over the periods benefited. We use the units-of-production method to compute depletion, and report natural resources at their cost less accumulated depletion. Part II. We begin the process of calculating depletion expense by determining the depletion expense per unit of the natural resource. The numerator of the equation contains the resource cost less any estimated residual value. The denominator of the equation is our estimated total capacity of the natural resource we expected to extract. For oil we express the denominator in terms of barrels and for coal or iron ore we use tons. Once we compute the depletion rate per unit of output, we may calculate depletion for the period by multiplying the depletion rate per unit times the number of units extracted. Let�s look at an example. Part I. In general, natural resources can be thought of as anything extracted from our natural environment such as coal, oil, and iron ore. Allocation of the cost of natural resources is called depletion. Total cost, including exploration and development, is charged to depletion over the periods benefited. We use the units-of-production method to compute depletion, and report natural resources at their cost less accumulated depletion. Part II. We begin the process of calculating depletion expense by determining the depletion expense per unit of the natural resource. The numerator of the equation contains the resource cost less any estimated residual value. The denominator of the equation is our estimated total capacity of the natural resource we expected to extract. For oil we express the denominator in terms of barrels and for coal or iron ore we use tons. Once we compute the depletion rate per unit of output, we may calculate depletion for the period by multiplying the depletion rate per unit times the number of units extracted. Let�s look at an example.

18. 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.  IAS No. 38 allows a company to value an intangible asset subsequent to initial valuation at (1) cost less accumulated amortization or (2) fair value, if fair value can be determined by reference to an active market. If revaluation is chosen, all assets within the class of intangibles must be revalued on a regular basis. Goodwill, however, cannot be revalued. U.S.GAAP prohibits revaluation of any intangible asset. The revaluation option is possible only if fair value can be determined by reference to an active market, making the option relatively uncommon. However, the option possibly could be used for intangibles such as franchises and certain license agreements. If the revaluation option is chosen, the accounting treatment is similar to the way we applied the revaluation option for property, plant, and equipment earlier. The way the company reports the difference between fair value and book value depends on which amount is higher. If fair value is higher than book value, the difference is reported as other comprehensive income (OCI) and then accumulated in a revaluation surplus account in equity. If book value is higher than fair value, the difference is expensed.IAS No. 38 allows a company to value an intangible asset subsequent to initial valuation at (1) cost less accumulated amortization or (2) fair value, if fair value can be determined by reference to an active market. If revaluation is chosen, all assets within the class of intangibles must be revalued on a regular basis. Goodwill, however, cannot be revalued. U.S.GAAP prohibits revaluation of any intangible asset. The revaluation option is possible only if fair value can be determined by reference to an active market, making the option relatively uncommon. However, the option possibly could be used for intangibles such as franchises and certain license agreements. If the revaluation option is chosen, the accounting treatment is similar to the way we applied the revaluation option for property, plant, and equipment earlier. The way the company reports the difference between fair value and book value depends on which amount is higher. If fair value is higher than book value, the difference is reported as other comprehensive income (OCI) and then accumulated in a revaluation surplus account in equity. If book value is higher than fair value, the difference is expensed.

19. E11-12 At the beginning of 2011, Terra Lumber Company purchased a timber tract from Boise Cantor for $3,200,000. After the timber is cleared, the land will have a residual value of $600,000. Roads to enable logging operations were constructed and completed on March 30, 2011. The cost of the roads, which have no residual value and no alternative use after the tract is cleared, was $240,000. During 2011, Terra logged 500,000 of the estimated five million board feet of timber. Calculate the 2011 depletion of the timber tract and depreciation of the logging roads assuming the units-of-production method is used for both assets. Timber tract: Logging roads:

20. E10-4 (Remember this one?) Jackpot Mining Company operates a copper mine in central Montana. The company paid $1,000,000 in 2011 for the mining site and spent an additional $600,000 to prepare the mine for extraction of the copper. After the copper is extracted in approximately four years, the company is required to restore the land to its original condition, including repaving of roads and replacing a greenbelt. The company has provided the following three cash flow possibilities for the restoration costs: To aid extraction, Jackpot purchased some new equipment on July 1, 2011, for $120,000. After the copper is removed from this mine, the equipment will be sold. The credit-adjusted, risk-free rate of interest is 10%. Determine the cost of the copper mine. Then prepare the journal entries to record the acquisition costs of the mine and the purchase of equipment.

21. E10-4 (Remember this one?) ARO: PV(FV=445,000, pmt=0, n=4, i=10%) = $303,939 Cost of copper mine: Mining site $1,000,000 Development costs 600,000 Restoration costs 303,939 $1,903,939 Copper mine 1,903,939 Cash ($1,000,000 + 600,000) 1,600,000 Asset retirement liability 303,939 Equipment 120,000 Cash 120,000

22. E11-13 Jackpot Mining Company operates a copper mine in central Montana. The company paid $1,000,000 in 2011 for the mining site and spent an additional $600,000 to prepare the mine for extraction of the copper. After the copper is extracted in approximately four years, the company is required to restore the land to its original condition, including repaving of roads and replacing a greenbelt. The company has provided the following three cash flow possibilities for the restoration costs: To aid extraction, Jackpot purchased some new equipment on July 1, 2011, for $120,000. After the copper is removed from this mine, the equipment will be sold for an estimated residual amount of $20,000. There will be no residual value for the copper mine. The company expects to extract 10 million pounds of copper from the mine. Actual production was 1.6 million pounds in 2011 and 3 million pounds in 2012. Compute depletion and depreciation on the mine and mining equipment for 2011 and 2012. The units-of-production method is used to calculate depreciation.

23. E11-13 Depletion of Mine: Depreciation of Equipment:

24. E11-10 On January 2, 2011, the Jackson Company purchased equipment to be used in its manufacturing process. The equipment has an estimated life of eight years and an estimated residual value of $30,625. The expenditures made to acquire the asset were as follows: Purchase price $154,000 Freight charges 2,000 Installation charges 4,000 Jackson�s policy is to use the double-declining-balance (DDB) method of depreciation in the early years of the equipment�s life and then switch to straight line halfway through the equipment�s life. Calculate depreciation for each year of the asset�s eight-year life.

25. E11-10