Intermediate accounting 15e kieso warfield chapter 11

INTERMEDIATE

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ACCOUNTING
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e
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Accounting
Accounting
F I F T E E N T H

11-1

E D I T I O N

Prepared by
Coby Harmon
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Prepared by
University of California,
Barbara
CobySanta
Harmon
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of California,
Barbara
University of California, Santa Barbara
Westmont College

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weygandt
warfield
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PREVIEW OF CHAPTER 11

Intermediate Accounting
15th Edition
Kieso Weygandt Warfield
11-2


11

Depreciation, Impairment,
and Depletion

LEARNING
LEARNINGOBJECTIVES
OBJECTIVES
After studying this chapter, you should be able to:
1.

Explain the concept of depreciation.

5.

2.

Identify the factors involved in the
depreciation process.

Explain the accounting issues related to
asset impairment.

6.

Explain the accounting procedures for
depletion of natural resources.

7.

Explain how to report and analyze
property, plant, equipment, and natural
resources.

3.

4.

11-3

Compare activity, straight-line, and
decreasing-charge methods of
depreciation.
Explain special depreciation methods.

Depreciation—Method of Cost Allocation
Depreciation is the accounting process of allocating the cost
of tangible assets to expense in a systematic and rational
manner to those periods expected to benefit from the use of
the asset.
Allocating costs of long-lived assets:

11-4



Fixed assets = Depreciation expense



Intangibles = Amortization expense



Natural resources = Depletion expense

LO 1 Explain the concept of depreciation.


11

Depreciation, Impairment,
and Depletion

LEARNING
LEARNINGOBJECTIVES
OBJECTIVES
After studying this chapter, you should be able to:
1.

Explain the concept of depreciation.

5.

2.

Identify the factors involved in the
depreciation process.

Explain the accounting issues related to
asset impairment.

6.

Explain the accounting procedures for
depletion of natural resources.

7.

Explain how to report and analyze
property, plant, equipment, and natural
resources.

3.

4.

11-5

Compare activity, straight-line, and
decreasing-charge methods of
depreciation.
Explain special depreciation methods.


Depreciation—Method of Cost Allocation
Factors Involved in the Depreciation Process
Three basic questions:
(1)What depreciable base is to be used?
(2)What is the asset’s useful life?
(3)What method of cost apportionment is best?

11-6

LO 2 Identify the factors involved in the depreciation process.


Depreciation—Method of Cost Allocation
Factors Involved in the Depreciation Process
Depreciable Base for the Asset
Illustration 11-1

11-7

LO 2 Identify the factors involved in the depreciation process.


Depreciation—Method of Cost Allocation
Factors Involved in the Depreciation Process
Estimation of Service Lives


Service life often differs from physical life.



Companies retire assets for two reasons:
1. Physical factors (casualty or expiration of
physical life).
2. Economic factors (inadequacy, supersession,
and obsolescence).

11-8

LO 2 Identify the factors involved in the depreciation process.


ALPHABET
DUPE PRINCIPLE
WHAT’S
YOUR
Some companies try to imply that depreciation is
not a cost. For example, in their press releases
they will often make a bigger deal over earnings

before interest, taxes, depreciation, and
amortization (often referred to as EBITDA) than
net income under GAAP. They like it because it
“dresses up” their earnings numbers. Some on
Wall Street buy this hype because they don’t like
the allocations that are required to determine net
income. Some banks, without batting an eyelash,
even let companies base their loan covenants on
EBITDA.
For example, look at Premier Parks, which
operates the Six Flags chain of amusement
parks. Premier touts its EBITDA performance.
But that number masks a big part of how the
company operates—and how it spends its
money. Premier argues that analysts should
ignore depreciation for big-ticket items like roller
coasters because the rides have a long life.
Critics, however, say that the amusement
industry has to spend as much as 50 percent of
its EBITDA just to keep its rides and attractions
current. Those expenses are not optional—let the
11-9rides get a little rusty, and ticket

sales start to tail off. That means analysts really
should view depreciation associated with the
costs of maintaining the rides (or buying new
ones) as an everyday expense. It also means
investors in those companies should have strong
stomachs. What’s the risk of trusting a fad
accounting measure? Just look at one year’s

bankruptcy numbers. Of the 147 companies
tracked by Moody’s that defaulted on their debt,
most borrowed money based on EBITDA
performance. The bankers in those deals
probably wish they had looked at a few other
factors. On the other hand, nonfinancial
companies in the S&P 500 generated a
substantial EBITA margin of 20.9 percent in 2011.
Some analysts are concerned that such a high
number suggests that companies are reluctant to
incur costs and want to stockpile cash. The
lesson? Investors will do well to avoid focus on
any single accounting measure.
Source: Adapted from Herb Greenberg, “Alphabet Dupe:
Why EBITDA Falls Short,” Fortune (July 10, 2000), p. 240;
and V. Monga, “Operating Efficiency Runs High at U.S.
Firms,” Wall Street Journal (February 28, 2012), p. B7.


11

Depreciation, Impairment,
and Depletion

LEARNING
LEARNINGOBJECTIVES
OBJECTIVES
After studying this chapter, you should be able to:
1.

Explain the concept of depreciation.

5.

2.

Identify the factors involved in the
depreciation process.

Explain the accounting issues related to
asset impairment.

6.

Explain the accounting procedures for
depletion of natural resources.

7.

Explain how to report and analyze
property, plant, equipment, and natural
resources.

3.

4.

11-10

Compare activity, straight-line, and

decreasing-charge methods of
depreciation.
Explain special depreciation methods.


Depreciation—Method of Cost Allocation
Methods of Depreciation
The profession requires the method employed be “systematic
and rational.” Methods used include:
1. Activity method (units of use or production).
2. Straight-line method.
3. Sum-of-the-years’-digits.

Decreasing charge methods

4. Declining-balance method.
5. Group and composite methods.

Special methods

6. Hybrid or combination methods.
11-11

LO 3 Compare activity, straight-line, and decreasingcharge methods of depreciation.


Depreciation—Method of Cost Allocation
Activity Method
Illustration 11-2

Stanley Coal
Mines Facts

Illustration: If Stanley uses the crane for 4,000 hours the first
year, the depreciation charge is:
Illustration 11-3

11-12

LO 3


Depreciation—Method of Cost Allocation
Straight-Line Method
Illustration 11-2

Stanley Coal
Mines Facts

Illustration: Stanley computes depreciation as follows:
Illustration 11-4

11-13

LO 3


Depreciation—Method of Cost Allocation
Decreasing-Charge Methods
Illustration 11-2

Stanley Coal
Mines Facts

Sum-of-the-Years’-Digits. Each fraction uses the sum of the
years as a denominator (5 + 4 + 3 + 2 + 1 = 15). The numerator
is the number of years of estimated life remaining as of the
beginning of the year.
Alternate sum-of-theyears’ calculation
11-14

n(n+1)
2

=

5(5+1)
2

= 15
LO 3


Depreciation—Method of Cost Allocation
Sum-of-the-Years’-Digits
Illustration 11-6

11-15

LO 3 Compare activity, straight-line, and decreasingcharge methods of depreciation.

Depreciation—Method of Cost Allocation
Decreasing-Charge Methods
Illustration 11-2

Stanley Coal
Mines Facts

Declining-Balance Method.

11-16



Utilizes a depreciation rate (percentage) that is some multiple
of the straight-line method.



Does not deduct the salvage value in computing the
depreciation base.
LO 3 Compare activity, straight-line, and decreasingcharge methods of depreciation.


Depreciation—Method of Cost Allocation
Declining-Balance Method
Illustration 11-7

11-17

LO 3 Compare activity, straight-line, and decreasingcharge methods of depreciation.


Depreciation—Method of Cost Allocation
Illustration—(Four Methods): Maserati Corporation purchased a
new machine for its assembly process on August 1, 2014. The cost
of this machine was $150,000. The company estimated that the
machine would have a salvage value of $24,000 at the end of its
service life. Its life is estimated at 5 years and its working hours are
estimated at 21,000 hours. Year-end is December 31.
Instructions: Compute the depreciation expense under the
following methods.

11-18

(a) Straight-line depreciation.
digits.

(c)

Sum-of-the-years’-

(b)
Double-declining balance.

Activity method

(d)

LO 3 Compare activity, straight-line, and decreasingcharge methods of depreciation.


Depreciation—Method of Cost Allocation
Straight-line Method

11-19

Advance slide in
presentation mode to
reveal answer.

LO 3 Compare activity, straight-line, and decreasingcharge methods of depreciation.


Depreciation—Method of Cost Allocation
Activity Method

11-20

(Assume 800 hours used in 2014)

Advance slide in presentation mode to reveal answer.

LO 3


Depreciation—Method of Cost Allocation
Sum-of-the-Years’-Digits Method

11-21

Advance slide in presentation mode to reveal answer.

5/12 = .416667
7/12 = .583333

LO 3


Depreciation—Method of Cost Allocation
Double-Declining Balance Method

11-22

Advance slide in presentation mode to reveal answer.

LO 3


11

Depreciation, Impairment,
and Depletion

LEARNING
LEARNINGOBJECTIVES
OBJECTIVES
After studying this chapter, you should be able to:
1.

Explain the concept of depreciation.

5.

2.

Identify the factors involved in the
depreciation process.

Explain the accounting issues related to
asset impairment.

6.

Explain the accounting procedures for
depletion of natural resources.

7.

Explain how to report and analyze
property, plant, equipment, and natural
resources.

3.

4.

11-23

Compare activity, straight-line, and
decreasing-charge methods of
depreciation.
Explain special depreciation methods.


Depreciation—Method of Cost Allocation
Special Depreciation Methods
Two methods of depreciating multiple-asset accounts exist:


Group method used when the assets are similar in nature
and have approximately the same useful lives.



Composite approach used when the assets are dissimilar
and have different lives.

The choice of method depends on the nature of the assets involved.
The computation for group or composite methods is essentially the
same: find an average and depreciate on that basis.

11-24

LO 4 Explain special depreciation methods.


Group and Composite Methods
Illustration: Mooney Motors establishes the composite

depreciation rate for its fleet of cars, trucks, and campers as
shown below.
Illustration 11-8

11-25

LO 4 Explain special depreciation methods.