Insert Book Cover Picture Operational Assets: Utilization and Impairment 11
Learning Objectives Explain the concept of cost allocation as it pertains to operational assets. LO1
Some of the cost is expensed each period. AcquisitionCost Expense (Balance Sheet) (Income Statement) Cost Allocation – An Overview The matching principlerequires that part of the acquisition cost of operational assets be expensed in periods when the future revenues are earned.
Some of the cost is expensed each period. AcquisitionCost Expense (Balance Sheet) (Income Statement) Cost Allocation – An Overview Depreciation, depletion, and amortization are cost allocation processes used to help meet the matching principle requirements.
Cost Allocation – An Overview Caution! Depreciation, depletion, and amortization are processes of cost allocation, not valuation!
The systematic approach used for allocation. The estimated expected use from an asset. Total amount of cost to be allocated. Cost - Residual Value (at end of useful life) Measuring Cost Allocation Cost allocation requires three pieces of information for each asset: Service Life Allocation Base Allocation Method
Learning Objectives Determine periodic depreciation using both time-based and activity-based methods. LO2
Depreciation of Operational Assets Group andcomposite methods • Time-based Methods • Straight-line (SL) • Accelerated Methods • Sum-of-the-years’ digits (SYD) • Declining Balance (DB) Taxdepreciation Activity-based methods Units-of-production method (UOP).
Depreciation on the Balance Sheet Net property, plant & equipment is the undepreciated cost (book value)of plant assets.
Straight-Line The most widely used and most easily understood method. Results in the same amount of depreciation in each year of the asset’s service life.
Straight-Line 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?
Straight-Line Residual Value Note that at the end of the asset’s useful life, BV = Residual Value
Straight-Line Depreciation Life in Years
Accelerated Methods Accelerated methods result inmoredepreciation in the early years of an asset’s useful life andless 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.
2 Sum-of-the-Years’ Digits (SYD) SYD depreciation is computed as follows:
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, compute depreciation for the first two years.
2 Sum-of-the-Years’ Digits (SYD) Use this in your computation of SYD Depreciation for Years 1 & 2.
Sum-of-the-Years’ Digits (SYD) Residual Value
Sum-of-the-Years’ Digits (SYD) Depreciation Life in Years
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) DDB depreciation is computed as follows: Note that the Book Value will get lower each time depreciation is computed!
Double-Declining-Balance (DDB) 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 forthe first two years usingdouble-declining-balance?
Double-Declining-Balance (DDB) We usually have to force depreciation in the latter years to an amount that brings BV = Residual Value.
Double-Declining-Balance (DDB) Depreciation Life in Years
Activity-Based Depreciation • Depreciation can also be based on measures of input or output like: • Service hours, or • Units-of-Production • Depreciation is not taken for idle assets. This approach looks different.
Units-of-Production 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?
Depreciation Disclosures • Depreciation. • Balances of major classes of depreciable assets. • Accumulated depreciation by asset or in total. • General description ofdepreciation methods used.
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.
Group and Composite Methods • 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, debitaccumulated depreciationfor the difference between the asset’s cost and the proceeds.
Learning Objectives Calculate the periodic depletion of a natural resource. LO3
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.
Depletion of Natural Resources 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.
Depletion of Natural Resources What is ABC’s unit depletion rate? a. $40 per ton b. $50 per ton c. $25 per ton d. $20 per ton
Depletion of Natural Resources What is ABC’s unit depletion rate? a. $40 per ton b. $50 per ton c. $25 per ton d. $20 per ton Cost / Units $1,000,000 / 40,000 Tons = $25 Per Ton
Depletion of Natural Resources For the year ABC mined 13,000 tons and sold 9,000 tons. What is the total depletion and the depletion expense? a. $325,000 & $225,000 b. $325,000 & $325,000 c. $225,000 & $225,000 d. $275,000 & $225,000
Depletion of Natural Resources For the year ABC mined 13,000 tons and sold 9,000 tons. What is the total depletion and the depletion expense? a. $325,000 & $225,000 b. $325,000 & $325,000 c. $225,000 & $225,000 d. $275,000 & $225,000 Depletion = 13,000 x $25 = $325,000 Expense = 9,000 x $25 = $225,000
Learning Objectives Calculate the periodic amortization of an intangible asset. LO4
Economic Life Legal Life Amortization of Intangible Assets The amortization process uses the straight-line method, but assumes residual value = 0. Amortization period is the shorter of: or
Amortization of Intangible Assets The amortization entry is: Note that the amortization process does not use a contra-asset account.
Amortization of Intangible Assets 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 useful life of 5 years. The legal life is 20 years. At the end of year 1, what is Torch’s amortization expense?
Amortization of Intangible Assets Record the amortization entry.
Amortization of Intangible Assets Note that the patent will have a book value of $2,400 after this amortization entry is posted.
Not amortized. Subject to assessment for impairmentvalue and may bewritten down. Intangible Assets Not Subjectto Amortization Goodwill