Chap011 1

Chapter 11 - Property, Plant, and Equipment and Intangible Assets: Utilization and Impairment
Chapter 11
Property, Plant, and Equipment and
Intangible Assets: Utilization and Impairment
QUESTIONS FOR REVIEW OF KEY TOPICS

Question 11-1
The terms depreciation, depletion, and amortization all refer to the process of allocating the cost of property, plant, and equipment and finite-life intangible assets to periods of use. The only difference between the terms is that they refer to different types of these long-lived assets; depreciation for plant and equipment, depletion for natural resources, and amortization for intangibles.
Question 11-2
The term depreciation often is confused with a decline in value or worth of an asset. Depreciation is not measured as decline in value from one period to the next. Instead, it involves the distribution of the cost of an asset, less any anticipated residual value, over the asset's estimated useful life in a systematic and rational manner that attempts to match revenues with the use of the asset.
Question 11-3
The process of cost allocation for plant and equipment and finite-life intangible assets requires that three factors be established at the time the asset is put into use. These factors are: 1. Service (useful) life The estimated use that the company expects to receive from the asset. 2. Allocation base The value of the usefulness that is expected to be consumed. 3. Allocation method The pattern in which the usefulness is expected to be consumed.
Question 11-4
Physical life provides the upper bound for service life. Physical life will vary according to the purpose for which the asset is acquired and the environment in which it is operated. Service life may be less than physical life for several reasons. For example, the expected rate of technological changes may shorten service life. Management intent also may shorten the period of an assets usefulness below its physical life. For instance, a company may have a policy of using its delivery trucks for a three-year period before trading the trucks for new models.
11-1
Question 11-5
The total amount of depreciation to be recorded during an assets service life is called its depreciable base. This amount is the difference between the initial value of the asset at its acquisition (its cost) and its residual value. Residual or salvage value is the amount the company expects to receive for the asset at the end of its service life less any anticipated disposal costs.
11-2
Answers to Questions (continued) Question 11-6

Activity-based allocation methods estimate service life in terms of some measure of productivity. Periodic depreciation or depletion is then determined based on the actual productivity generated by the asset during the period. Time-based allocation methods estimate service life in years. Periodic depreciation or amortization is then determined based on the passage of time.
Question 11-7
The straight-line depreciation method allocates an equal amount of depreciable base to each year of an assets service life. Accelerated depreciation methods allocate higher portions of depreciable base to the early years of the assets life and lower amounts of depreciable base to later years. Total depreciation is the same by either approach.
Question 11-8
Theoretically, the use of activity-based depreciation methods would provide a better matching of revenues and expenses. Clearly, the productivity of a plant asset is more closely associated with the benefits provided by that asset than the mere passage of time. However, activity-based methods quite often are either infeasible or too costly to use. For example, buildings do not have an identifiable measure of productivity. For assets such as machinery, there may be an identifiable measure of productivity, such as machine hours or units produced, but it is more costly to determine the amount each period than it is to simply measure the passage of time. For these reasons, most companies use time-based depreciation methods.
Question 11-9
Companies might use the straight-line method because they consider that the benefits derived from the majority of plant assets are realized approximately evenly over these assets useful lives. It also is the easiest method to understand and apply. The effect on net income also could explain why so many companies prefer the straight-line method to the accelerated methods. Straight line produces a higher net income in the early years of an assets life. Net income can affect bonuses paid to management, or debt agreements with lenders. Income taxes are not a factor in determining the depreciation method because a company is not required to use the same depreciation method for both financial reporting and income tax purposes.
Question 11-10
The group approach to aggregation is applied to a collection of depreciable assets that share similar service lives and other attributes. For example, group depreciation could be used for fleets
11-3
of vehicles or collections of machinery. The composite approach to aggregation is applied to dissimilar operating assets, such as all of the depreciable assets in one manufacturing plant. Individual assets in the composite may have diverse service lives. Both approaches are similar in that they involve applying a single straight-line rate based on the average service lives of the assets in the group or composite.
11-4

The allocation of the cost of a natural resource to periods of use is called depletion. The process otherwise is identical to depreciation. The activity-based units-of-production method is the predominant method used to calculate depletion, not the time-based straight-line method.
Question 11-12
The amortization of finite-life intangible assets is based on the same concepts as depreciation and depletion. The capitalized cost of an intangible asset that has a finite useful life must be allocated to the periods the company expects the asset to contribute to its revenue generating activities. Intangibles, though, generally have no residual values, so the amortizable base is simply cost. Also, intangibles possess no physical life to provide an upper bound to service life. However, most intangibles have a legal or contractual life that limits useful life. Intangible assets that have indefinite useful lives, including goodwill, are not amortized.
Question 11-13
A company can calculate depreciation based on the actual number of days or months the asset was used during the year. A common simplifying convention is to record one-half of a full years expense in the years of acquisition and disposal. This is known as the half-year convention. The modified half-year convention records a full years expense when the asset is acquired in the first half of the year or sold in the second half. No expense is recorded when the asset is acquired in the second half of the year or sold in the first half.
Question 11-14
A change in the service life of plant and equipment and finite-life intangible assets is accounted for as a change in an estimate. The change is accounted for prospectively by simply depreciating the remaining depreciable base of the asset (book value at date of change less estimated residual value) over the revised remaining service life.
Question 11-15
A change in depreciation method is accounted for prospectively by simply depreciating the remaining depreciable base of the asset (book value at date of change less estimated residual value) over the revised remaining service life using the new depreciation method, exactly as we would
11-5
account for a change in estimate. One difference is that most changes in estimate do not require a company to justify the change. However, this change in estimate is a result of changing an accounting principle and therefore requires a clear justification as to why the new method is preferable. A disclosure note reports the effect of the change on net income and earnings per share along with clear justification for changing depreciation methods.
11-6

If a material error is discovered in an accounting period subsequent to the period in which the error is made, previous years financial statements that were incorrect as a result of the error are retrospectively restated to reflect the correction. Any account balances that are incorrect as a result of the error are corrected by journal entry. If retained earnings is one of the incorrect accounts, the correction is reported as a prior period adjustment to the beginning balance in the statement of shareholders equity. In addition, a disclosure note is needed to describe the nature of the error and the impact of its correction on net income, income before extraordinary item, and earnings per share.
Question 11-17
Impairment in the value of property, plant, and equipment and intangible assets results when there has been a significant decline in value below carrying value (book value). For property, plant, and equipment and intangible assets with finite useful lives, GAAP requires an entity to recognize an impairment loss only when the undiscounted sum of estimated future cash flows from an asset is less than the assets book value. The loss recognized is the amount by which the book value exceeds the fair value of the asset or group of assets when the fair value is readily determinable. If fair value is not determinable, it must be estimated. One method of estimating fair value is to compute the present value of estimated future cash flows from the asset or group of assets. For intangible assets with indefinite useful lives other than goodwill, if book value exceeds fair value, an impairment loss is recognized for the differences. For goodwill, an impairment loss is indicated if the fair value of the reporting unit is less than its book value. A goodwill impairment loss is measured as the excess of book value of goodwill over its implied fair value. For property, plant, and equipment and intangible assets held for sale, if book value exceeds fair value, an impairment loss is recognized for the difference.
Question 11-18
Repairs and maintenance are expenditures made to maintain a given level of benefits provided by the asset and do not increase future benefits. Expenditures for these activities should be expensed in the period incurred. Additions involve adding a new major component to an existing asset. These expenditures usually are capitalized. Improvements are expenditures for the replacement of a major component of plant and equipment. The costs of improvements usually are capitalized.
11-7
Rearrangements are expenditures to restructure plant and equipment without addition, replacement, or improvement. The objective is to create a new capability for the asset and not necessarily to extend useful life. The costs of material rearrangements should be capitalized if they clearly increase future benefits.
11-8
Answers to Questions (concluded)
Question 11-19
IFRS allows a company to value property, plant and equipment (PP&E) and intangible assets subsequent to initial valuation at (1) cost less accumulated depreciation/amortization or (2) fair value (revaluation). If a company chooses revaluation, all assets within a class of PP&E must be revalued on a regular basis. U.S. GAAP prohibits revaluation.
Question 11-20
Under U.S. GAAP, an impairment loss for property, plant, and equipment and finite-life intangible assets is measured as the difference between book value and fair value. Under IFRS, an impairment loss is measured as the difference between book value and the recoverable amount. The recoverable amount is the higher of the assets value in use (present value of estimated future cash flows) and fair value less costs to sell.
Question 11-21
Under U.S. GAAP, the measurement of an impairment loss for goodwill is a two-step process. In Step 1 we compare the fair value of the reporting unit with its book value. A loss is indicated if fair value is less than book value. In step 2, we measure the impairment loss as the excess of book value over implied fair value. Under IFRS, the measurement of an impairment loss for goodwill is a one-step process that compares the recoverable amount of the cash-generating unit to book value. If the recoverable amount is less, reduce goodwill first, then other assets. The recoverable amount is the higher of fair value less costs to sell and value in use (present value of estimated future cash flows).
Question 11-22
Under IFRS, litigation costs to successfully defend an intangible right are expensed, except in rare situations when the expenditure increases future benefits.
11-9
BRIEF exercises
Brief Exercise 11-1
Depreciation is a process of cost allocation, not valuation. Koeplin should not record depreciation expense of $18,000 for year one of the machines life. Instead, it should distribute the cost of the asset, less any anticipated residual value, over the estimated useful life in a systematic and rational manner that attempts to match revenues with the use of the asset, not the periodic decline in its value.
Brief Exercise 11-2

$30,000 - 2,000
a. Straight-line: = $7,000 per year
4 years b. Sum-of-the-years digits: Sum-of-the-digits is ([4 (4 + 1)] 2) = 10 2011 2012 $28,000 x 4/10 $28,000 x 3/10 = $11,200 = $ 8,400
c. Double-declining balance: Straight-line rate is 25% (1 4 years) x 2 2011 2012 $30,000 x 50% ($30,000 - 15,000) x 50%
= 50% DDB rate = $15,000 = $ 7,500
d. Units-of-production: $30,000 - 2,000 = $2.80 per unit depreciation rate 10,000 hours
11-10
2011 2012
2,200 hours x $2.80 = $6,160 3,000 hours x $2.80 = $8,400
11-11
Brief Exercise 11-3

a. Straight-line: $30,000 - 2,000 = $7,000 per year 4 years 2011 2012 $7,000 x 9/12 $7,000 x 12/12 = = $5,250 $7,000
b. Sum-of-the-years digits: Sum-of-the-digits is ([4 (4 + 1)] 2) = 10 2011 2012 $28,000 x 4/10 x 9/12 $28,000 x 4/10 x 3/12 + $28,000 x 3/10 x 9/12 = = = $8,400 $2,800 6,300 $9,100
c. Double-declining balance: Straight-line rate is 25% (1 4 years) x 2 2011 2012 $30,000 x 50% x 9/12 $30,000 x 50% x 3/12 +($30,000 15,000) x 50% x 9/12 = 50% DDB rate = $11,250 = $ 3,750 = 5,625 $ 9,375
or,
11-12
2012
($30,000 11,250) x 50%
= $ 9,375
11-13
Brief Exercise 11-4
Annual depreciation will equal the group rate multiplied by the depreciable base of the group:
($425,000 40,000) x 18% = $69,300 Since depreciation records are not kept on an individual asset basis, dispositions are recorded under the assumption that the book value of the disposed item exactly equals any proceeds received and no gain or loss is recorded. Any actual gain or loss is implicitly included in the accumulated depreciation account. Journal entry (not required): Cash................................................................................ Accumulated depreciation (difference) ............................ Equipment (account balance).......................................... 35,000 7,000 42,000
Brief Exercise 11-5
$8,250,000 Depletion per ton = 3,000,000 cubic feet = $2.75 x 700,000 feet = $2.75 x 800,000 feet
= $2.75 per foot
Year 1 depletion Year 2 depletion
= $1,925,000 = $2,200,000
Brief Exercise 11-6
Expenses for the year include: Amortization of the patent = Amortization of the developed technology* = 300,000 Total $700,000
400,000
11-14
Goodwill is not amortized. amortized.
In-process research and development is not
Amortization of the patent: ($4,000,000 5) x 6/12
$400,000
*Amortization of the developed technology: ($3,000,000 5) x 6/12 = $300,000
Brief Exercise 11-7Calculation of annual depreciation after the estimate

change: $9,000,000 $320,000 x 2 years 640,000 8,360,000 500,000 7,860,000 18 $ 436,667 Cost Previous annual depreciation ($8 million 25 years) Depreciation to date (2009-2010) Undepreciated cost Revised residual value Revised depreciable base Estimated remaining life - 18 years (20-2) 2011 depreciation
In general, we report voluntary changes in accounting principles retrospectively. However, a change in depreciation method is considered a change in accounting estimate resulting from a change in accounting principle. In other words, a change in the depreciation method reflects a change in the (a) estimated future benefits from the asset, (b) the pattern of receiving those benefits, or (c) the companys knowledge about those benefits, and therefore the two events should be reported the same way. Accordingly, Robotics reports the change prospectively; previous financial statements are not revised. Instead, the company simply employs the double-declining balance method from now on. The undepreciated cost remaining at the time of the change would be depreciated DDB over the remaining useful life. A disclosure note should justify that the change is preferable and should describe the effect of the change on any financial statement line items and per share amounts affected for all periods reported.
Brief Exercise 11-8
11-15
Assets cost Accumulated depreciation to date* Undepreciated cost, Jan. 1, 2011 Double-declining balance depreciation for 2011
$9,000,000 (640,000) $8,360,000 x 2/23 $ 726,957
*$8,000,000 25 = $320,000 x 2 years = $640,000
Remaining life is 23 years. Twice the straight-line rate is 2/23.
11-16
Brief Exercise 11-9

If a material error is discovered in an accounting period subsequent to the period in which the error is made, previous years financial statements that were incorrect as a result of the error are retrospectively restated to reflect the correction. Any account balances that are incorrect as a result of the error are corrected by journal entry. If retained earnings is one of the incorrect accounts, the correction is reported as a prior period adjustment to the beginning balance in the statement of shareholders equity. In addition, a disclosure note is needed to describe the nature of the error and the impact of its correction on net income, income before extraordinary item, and earnings per share. In this case, depreciation of $32,000 should have been $320,000 ($8,000,000 25 years). Therefore, 2009 income before tax is overstated by $288,000 ($320,000 32,000) and accumulated depreciation is understated by the same amount. The following journal entry is needed to record the error correction (ignoring income tax): Retained earnings............................................................ 288,000 Accumulated depreciation .......................................... 288,000 Depreciation for 2011 would be $320,000.
Brief Exercise 11-10

no impairment loss.
Because the undiscounted sum of future cash flows of $28 million exceeds book value of $26.5 million, there is
Because the undiscounted sum of future cash flows of $24 million is less than book value of $26.5 million, there is an impairment loss. The impairment loss is calculated as follows: Book value $26.5 million
11-17
Fair value Impairment loss
21.0 million $ 5.5 million
11-18
Under IFRS, the impairment loss is the difference between book value and the recoverable amount. The recoverable amount is $22 million, the higher of the value-in-use of $22 million (present value of estimated future cash flows) and the $21 million fair value less costs to sell. Book value Recoverable amount Impairment loss $26.5 million 22.0 million $ 4.5 million
Recoverability: Because the book value of SCCs net assets of $42 million exceeds the fair value of $40 million, an impairment loss is indicated. Determination of implied value of goodwill: Fair value of SCC Less: Fair value of SCCs assets (excluding goodwill) Implied goodwill Measurement of impairment loss: Book value of goodwill Less: Implied value of goodwill Impairment loss
$40 million 31 million $ 9 million
11-19
Recoverability: Because the book value of SCCs net assets of $42 million is less than the fair value of $44 million, an impairment loss is not indicated.
11-20
Under IFRS, the impairment loss is the difference between book value and the recoverable amount of the cash-generating unit. The recoverable amount is $41 million, the higher of the $41 million value-in-use (present value of estimated future cash flows) and the $40 million fair value less costs to sell. Book value Recoverable amount Impairment loss $42 million 41 million $ 1 million
Annual maintenance on machinery, $5,400 - This is an example of normal repairs and maintenance. Future benefits are not increased; therefore the expenditure should be expensed in the period incurred. Remodeling of offices, $22,000 - This is an example of an improvement. The cost of the remodeling should be capitalized and depreciated, either by (1) substitution, (2) direct capitalization of the cost, or (3) a reduction of accumulated depreciation. Rearrangement of the shipping and receiving area, $35,000 - This is an example of a rearrangement. Because the rearrangement increased productivity, the cost should be capitalized and depreciated. Addition of a security system, $25,000 - This is an example of an addition. The cost of the security system should be capitalized and depreciated.
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EXERCISES
1. Straight-line:
Exercise 11-1
$33,000 - 3,000 = $6,000 per year 5 years 2. Sum-of-the-years digits:
Year 2011 2012 2013 2014 2015 Total
Depreciable Base $30,000 30,000 30,000 30,000 30,000
Depreciation X Rate per Year =
Depreciation $10,000 8,000 6,000 4,000 2,000 $30,000
Exercise 11-1 (concluded)
3. Double-declining balance:
Straight-line rate of 20% (1 5 years) x 2 = 40% DDB rate.
Year 2011 2012 2013 2014
Book Value Beginning of Year X $33,000 19,800 11,880 7,128
Depreciation Rate per Year = 40% 40% 40% 40%

11-22
Depreciation $ 13,200 7,920 4,752 2,851
Book Value End of Year $19,800 11,880 7,128 4,277
2015 Total
4,277
1,277 * $30,000
3,000
* Amount necessary to reduce book value to residual value
4. Units-of-production: $33,000 - 3,000 = $.30 per mile depreciation rate 100,000 miles
Year 2011 2012 2013 2014 2015 Totals
Actual Miles Driven X 22,000 24,000 15,000 20,000 21,000 102,000
Depreciation Rate per Mile = $.30 .30 .30 .30 *
Depreciation $6,600 7,200 4,500 6,000 5,700 * $30,000
Book Value End of Year $26,400 19,200 14,700 8,700 3,000
* Amount necessary to reduce book value to residual value
11-23
Exercise 11-2
1. Straight-line: $115,000 - 5,000 = $11,000 per year 10 years 2. Sum-of-the-years digits: Sum-of-the-digits is ([10 (10 + 1)] 2) = 55 2011 2012 $110,000 x 10/55 $110,000 x 9/55 = $20,000 = $18,000
3. Double-declining balance: Straight-line rate is 10% (1 10 years) x 2 2011 2012 $115,000 x 20% ($115,000 - 23,000) x 20% = 20% DDB rate = $23,000 = $18,400
4. One hundred fifty percent declining balance: Straight-line rate is 10% (1 10 years) x 1.5 2011 2012 $115,000 x 15% ($115,000 - 17,250) x 15% = 15% rate = $17,250 = $14,663
5. Units-of-production: $115,000 - 5,000

11-24
= $.50 per unit depreciation rate 220,000 units 2011 2012 30,000 units x $.50 = $15,000 25,000 units x $.50 = $12,500
11-25
Exercise 11-3
1. Straight-line: $115,000 - 5,000 = $11,000 per year 10 years 2011 2012 $11,000 x 3/12 $11,000 x 12/12 = = $ 2,750 $11,000
2. Sum-of-the-years digits: Sum-of-the-digits is {[10 (10 + 1)]/2} = 55 2011 2012 $110,000 x 10/55 x 3/12 $110,000 x 10/55 x 9/12 + $110,000 x 9/55 x 3/12 = $ 5,000 = $15,000 = 4,500 $19,500
3. Double-declining balance: Straight-line rate is 10% (1 10 years) x 2 2011 2012 $115,000 x 20% x 3/12 $115,000 x 20% x 9/12 + ($115,000 - 23,000) x 20% x 3/12 = 20% DDB rate = = = $5,750 $17,250 4,600 $21,850 $21,850
or, 2012
($115,000 - 5,750) x 20%
4. One hundred fifty percent declining balance: Straight-line rate is 10% (1 10 years) x 1.5
11-26
= 15% rate
2011 2012
$115,000 x 15% x 3/12 $115,000 x 15% x 9/12 + ($115,000 - 17,250) x 15% x 3/12
= = =
$ 4,313 $12,937 3,666 $16,603 $16,603
Or, 2012
($115,000 - 4,313) x 15%
11-27
Exercise 11-3 (concluded) 5. Units-of-production: $115,000 - 5,000 = $.50 per unit depreciation rate 220,000 units 2011 2012 10,000 units x $.50 = 25,000 units x $.50 = $ 5,000 $12,500
Building depreciation:
Exercise 11-4
$5,000,000 - 200,000 = $160,000 per year 30 years Building addition depreciation: Remaining useful life from June 30, 2011 is 27.5 years. $1,650,000 = $60,000 per year 27.5 years 2011 $60,000 x 6/12 = $30,000 2012 $60,000 x 12/12 =
$60,000
11-28
Exercise 11-5
Asset A: Straight-line rate is 20% (1 5 years) x 2 = 40% DDB rate $24,000 = $60,000 = Book value at the beginning of year 2 .40 Cost - (Cost x 40%) = $60,000 .60Cost = $60,000 Cost = $100,000 Asset B: Sum-of-the-years digits is 36 {[8 (8 + 1)]2} ($40,000 - residual) x 7/36 = $7,000 $280,000 7residual -------------------------- = $7,000 36 $280,000 - 7residual = $252,000 7residual = Residual = Asset C: $65,000 - 5,000 = $6,000 Life Life = 10 years Asset D: $230,000 - $10,000 $28,000 $4,000
= $220,000 depreciable base

11-29
$220,000 10 years =
$22,000 per year
Method used is straight-line. Asset E: Straight-line rate is 12.5% (1 8 years) x 1.5 = 18.75% rate Year 1 $200,000 x 18.75% = $37,500 Year 2 ($200,000 - 37,500) x 18.75% =
$30,469
Requirement 1
Exercise 11-61. Straight-line:

$260,000 - 20,000 = $40,000 per year 6 years 2011 2012 $40,000 x 8/12 $40,000 x 12/12 = $26,667 = $40,000
2. Sum-of-the-years digits: Sum-of-the-years digits is ([6 (6 + 1)] 2) = 21 2011 2012 $240,000 x 6/21 x 8/12 = $45,714 $240,000 x 6/21 x 4/12 = $22,857 + $240,000 x 5/21 x 8/12 = 38,095 $60,952
3. Double-declining balance:
11-30
1/6 (the straight-line rate) x 2 2011 2012 $260,000 x 1/3 x 8/12 $260,000 x 1/3 x 4/12 + ($260,000 86,667) x 1/3 x 8/12 =
= 1/3 DDB rate = $57,778 = $28,889 38,518 $67,407 = $67,407
or, 2012
($260,000 57,778) x 1/3
Exercise 11-7Requirement 1
U.S. GAAP 2011: 2012: $120,000 8 = $15,000 x 6/12 = $7,500 $120,000 8 = $15,000
Requirement 2 IFRS: 2011: Machine: $100,000 8 = $12,500 x 6/12 = $6,250 Drill: $ 20,000 4 = $5,000 x 6/12 Total
2,500 $8,750
11-31
2012:
Machine: $100,000 8 = $12,500 Drill: $ 20,000 4 = 5,000 Total $17,500
Depreciation for 2011: $240,000 6 = $40,000 x 9/12 = $30,000 Requirement 2 Before After Revaluation Revaluation Equipment $240 x 220/210 = $251 Accumulated depreciation 30 x 220/210 = 31 Book value $ 210 x 220/210 = $ 220
($ in thousands)
Equipment ($251,000 240,000) Accumulated depreciation ($31,000 30,000) Revaluation surplusOCI ($220,000 -- 210,000)
11,000 1,000 10,000
Requirement 3 Depreciation for 2012: $220,000 5.25 years = $41,905 Requirement 4

($ in thousands)
Before
11-32
After
Revaluation Revaluation Equipment $240 x 195/210 = $223 Accumulated depreciation 30 x 195/210 = 28 Book value $ 210 x 195/210 = $195 Revaluation expense* ($195,000 210,000) Accumulated depreciation ($28,000 30,000) Equipment ($223,000 240,000) 15,000 2,000 17,000
*If a revaluation surplus account relating to the same asset had existed, that account would have been debited up to the amount of its balance before debiting revaluation expense.
11-33
Depreciation per Year (straight line) $2,000 1,800 1,875 $5,675
Asset Stoves Refrigerators Dishwashers Totals
Cost $15,000 10,000 8,000 $33,000
Residual Value $3,000 1,000 500 $4,500
Depreciable Base $12,000 9,000 7,500 $28,500
Estimated Life(yrs.) 6 5 4
$5,675 Group depreciation rate = $33,000 Group life = $28,500 = 5.02 years (rounded) $5,675 Requirement 2 To record the purchase of new refrigerators. Refrigerators................................................................... Cash............................................................................ 2,700 2,700 = 17.2% (rounded)
To record the sale of old refrigerators.
Cash................................................................................ Accumulated depreciation (difference).............................
200 1,300
11-34
Refrigerators...............................................................
1,500
Cost of the equipment: Purchase price $154,000 Freight charges 2,000 Installation charges 4,000 $160,000 Straight-line rate of 12.5% (1 8 years) x 2 = 25% DDB rate.
Year 2011 2012 2013 2014 2015 2016 2017 2018 Total
Book Value Beginning Depreciation of Year X Rate per Year = $160,000 25% 120,000 25% 90,000 25% 67,500 25% 50,625 * 45,625 * 40,625 * 35,625 *
Depreciation $ 40,000 30,000 22,500 16,875 5,000 5,000 5,000 5,000 $129,375
Book Value End of Year $120,000 90,000 67,500 50,625 45,625 40,625 35,625 30,625
11-35
* Switch to straight-line in 2015: Straight-line depreciation: $50,625 - 30,625 = $5,000 per year 4 years
Requirement 2 For plant and equipment used in the manufacture of a product, depreciation is a product cost and is included in the cost of inventory. Eventually, when the product is sold, depreciation will be included in cost of goods sold.
$4,500,000 Depletion per ton = 900,000 tons 2011 depletion = $5.00 x 240,000 tons = $1,200,000 = $5.00 per ton
Requirement 2 Depletion is part of product cost and is included in the cost of the inventory of coal, just as the depreciation on manufacturing equipment is included in inventory cost. The depletion is then included in cost of goods sold in the income statement when the coal is sold.
Exercise 11-12
Timber tract:
$3,200,000 600,000 = $.52 per board foot 5,000,000 board feet
11-36
500,000 x $.52 = $260,000 depletion Logging roads: $240,000 5,000,000 tons = $.048 per board foot 500,000 x $.048 = $24,000 depreciation
11-37
Exercise 11-13
Requirement 1 Cost of copper mine: Mining site $1,000,000 Development costs 600,000 Restoration costs 303,939 $1,903,939
$300,000 x 25% = 400,000 x 40% = 600,000 x 35% =
$ 75,000 160,000 210,000 $445,000 x .68301* = $303,939

*Present value of $1, n = 4, i = 10% (Table 2)
Depletion: $1,903,939 Depletion per pound = 10,000,000 pounds 2011 depletion 2012 depletion Depreciation: $120,000 - 20,000 Depreciation per pound = 10,000,000 pounds 2011 depreciation 2012 depreciation = $.01 x 1,600,000 pounds = $.01 x 3,000,000 pounds = = $16,000 $30,000 = $.01 per pound = $.1904 x 1,600,000 pounds = $304,640 = $.1904 x 3,000,000 pounds = $571,200 = $.1904 per pound
11-38
Requirement 2 Depletion of natural resources and depreciation of assets used in the extraction of natural resources are part of product cost and are included in the cost of the inventory of copper, just as the depreciation on manufacturing equipment is included in inventory cost. The depletion and depreciation are then included in cost of goods sold in the income statement when the copper is sold.
11-39
Exercise 11-14
Requirement 1 a. To record the purchase of a patent.
January 1, 2009 Patent.............................................................................. 700,000 Cash............................................................................ 700,000
To record amortization on the patent.
December 31, 2009 and 2010 Amortization expense ($700,000 10 years)...................... Patent..........................................................................
70,000 70,000
b. To record the purchase of a franchise.
2011 Franchise......................................................................... 500,000 Cash............................................................................ 500,000
c. To record research and development expenses.
2011 Research and development expense................................ 380,000 Cash............................................................................ 380,000
11-40
Exercise 11-14 (concluded) Year-end adjusting entries Patent: To record amortization on the patent.
December 31, 2011 Amortization expense (determined below)......................... 112,000 Patent.......................................................................... 112,000
Calculation of annual amortization after the estimate change:

($ in thousands)
$700 $70 x 2 years 140 560 5 $112
Cost Previous annual amortization ($700 10 years) Amortization to date (2009-2010) Unamortized cost (balance in the patent account) Estimated remaining life New annual amortization
Franchise: To record amortization of franchise.
December 31, 2011 Amortization expense ($500,000 10 years)...................... Franchise..................................................................... Requirement 2 Intangible assets:
50,000 50,000
11-41
Patent Franchise Total intangibles
$448,000 [1] 450,000 [2] $898,000
[1] $560,000 - 112,000 [2] $500,000 - 50,000 To record the purchase of a patent.
Exercise 11-15
January 2, 2011 Patent.............................................................................. 500,000 Cash............................................................................ 500,000
To record amortization of a patent for the year 2011.
Amortization expense ($500,000 8 years)........................ Patent..........................................................................
62,500 62,500
To record amortization of the patent for the year 2012.
Amortization expense ($500,000 8 years)........................ Patent..........................................................................
62,500 62,500
To record costs of successfully defending a patent infringement suit.
January, 2013 Patent.............................................................................. Cash............................................................................
45,000 45,000
11-42

To record amortization of patent for the year 2013.
Amortization expense (determined below)......................... Patent..........................................................................
70,000 70,000
Calculation of revised annual amortization:

($ in thousands)
$500 $62.5 x 2 years 125 375 45 420 6 $ 70
Cost Previous annual amortization ($500 8 years) Amortization to date (2011-2012) Unamortized cost (balance in the patent account) Add New unamortized cost Estimated remaining life (8 years 2 years) New annual amortization
Exercise 11-16
($ in millions)
Amortization expense (determined below)......................... Patent..........................................................................
2.5 2.5
Calculation of annual amortization after the estimate change:

$ in millions)
$9 $1
Cost Previous annual amortization ($9 9 years)
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x 4 years
4 5 2 $2.5
Amortization to date (2007-2010) Unamortized cost (balance in the patent account) Estimated remaining life (6 years 4 years) New annual amortization
11-44
Exercise 11-17
Requirement 1 2011 amortization: $1,200,000 10 = $120,000 x 6/12 = $60,000 Requirement 2 Franchise ($1,180,000 [1,200,000 60,000]) Revaluation surplusOCI 40,000 40,000
Requirement 3 2012 amortization: $1,180,000 9.5 = $124,211
11-45
Exercise 11-18
Requirement 1
Depreciation expense (determined below).......................... Accumulated depreciation - computer........................
3,088 3,088
Calculation of annual depreciation after the estimate change: $40,000 $7,200 x 2 years 14,400 25,600 900 24,700 8 $ 3,088 Cost Previous annual depreciation ($36,000 5 years) Depreciation to date (2009-2010) Undepreciated cost Revised residual value Revised depreciable base Estimated remaining life (10 years - 2 years) New annual depreciation
Requirement 2
Depreciation expense (determined below).......................... Accumulated depreciation - computer........................
3,889 3,889
Calculation of annual depreciation after the estimate change: $40,000 $12,000 9,600 Cost Previous depreciation: 2009 - ($36,000 x 5/15) 2010 - ($36,000 x 4/15)
11-46
21,600 18,400 900 17,500 x 8/36 $ 3,889
Depreciation to date (2009-2010) Undepreciated cost Revised residual value Revised depreciable base Estimated remaining life - 8 years 2011 depreciation
11-47
Exercise 11-19
SYD depreciation [10+9+8 x ($1.5 - .3) million] = $589,091 55 $1,500,000 589,091 910,909 300,000 610,909 7 yrs. $ 87,273 Cost Depreciation to date, SYD (2008 - 2010) Undepreciated cost as of 1/1/11 Less residual value Depreciable base Remaining life (10 years - 3 years) New annual depreciation
Adjusting entry (2011 depreciation):
Depreciation expense (calculated above)............................ Accumulated depreciation..........................................
87,273 87,273
11-48
Exercise 11-20
Requirement 1 In general, we report voluntary changes in accounting principles retrospectively. However, a change in depreciation method is considered a change in accounting estimate resulting from a change in accounting principle. In other words, a change in the depreciation method reflects a change in the (a) estimated future benefits from the asset, (b) the pattern of receiving those benefits, or (c) the companys knowledge about those benefits, and therefore the two events should be reported the same way. Accordingly, Clinton reports the change prospectively; previous financial statements are not revised. Instead, the company simply employs the straight-line method from now on. The undepreciated cost remaining at the time of the change would be depreciated straight-line over the remaining useful life. A disclosure note should justify that the change is preferable and should describe the effect of the change on any financial statement line items and per share amounts affected for all periods reported. Requirement 2 Assets cost Accumulated depreciation to date (given) Undepreciated cost, Jan. 1, 2011 Estimated residual value To be depreciated over remaining 3 years Annual straight-line depreciation 2011-2013 Adjusting entry: Depreciation expense (calculated above)............ Accumulated depreciation .......................... 199,667 199,667 $2,560,000 (1,801,000) $ 759,000 (160,000) $ 599,000 3 years $ 199,667 (rounded)
11-49
Exercise 11-21
11-50
Requirement 1 Analysis: Correct (Should Have Been Recorded) 2008 Machine Cash 350,000 350,000
Incorrect (As Recorded) Expense Cash 350,000 350,000
2008 Expense 70,000 Accum. deprec. 70,000 2009 Expense 70,000 Accum. deprec. 70,000 2010 Expense 70,000 Accum. deprec. 70,000
Depreciation entry omitted
During the three-year period, depreciation expense was understated by $210,000, but other expenses were overstated by $350,000, so net income during the period was understated by $140,000, which means retained earnings is currently understated by that amount. During the three-year period, accumulated depreciation was understated, and continues to be understated by $210,000. To correct incorrect accounts Machine .............................................................. Accumulated depreciation ($70,000 x 3 years)... Retained earnings ($350,000 210,000)............. Requirement 2 Correcting entry:
350,000 210,000 140,000
11-51
Assuming that the machine had been disposed of, no correcting entry would be required because, after five years, the accounts would show appropriate balances.
11-52
Exercise 11-22
Requirement 1 Book value Fair value Impairment loss $6.5 million 3.5 million 3.0 million
Requirement 2 Because the undiscounted sum of future cash flows of $6.8 million exceeds book value of $6.5 million, there is no impairment loss.
11-53
Exercise 11-23
Requirement 1 IFRS requires an impairment loss to be recognized when an assets book value exceeds the higher of the assets value-in-use (present value of estimated future cash flows) and fair value less costs to sell. In this case, value-in-use and fair value less costs to sell are the same, $3.5 million. Because book value ($6.5 million) exceeds this amount, a loss is indicated. The loss is the difference between book value and the recoverable amount, which also is the higher of the assets value-in-use (present value of estimated future cash flows) and fair value less costs to sell. Therefore, the amount of impairment loss is the same as under U.S. GAAP, $3 million. Book value Fair value Impairment loss $6.5 million 3.5 million 3.0 million
Requirement 2 An impairment loss also is indicated because book value ($6.5 million) exceeds fair value less costs to sell/value-in-use ($5 million). The amount of impairment loss is $1.5 million. Book value Fair value Impairment loss $6.5 million 5.0 million 1.5 million
Under U.S. GAAP, because the undiscounted sum of future cash flows of $6.8 million exceeds book value of $6.5 million, there is no impairment loss.
11-54
Exercise 11-24
Requirement 1 An impairment loss is indicated because the estimated undiscounted sum of future cash flows of $15 million is less than the book value of $18.3 million. The amount of the loss to be reported is calculated using the estimated fair value rather than the undiscounted future cash flows: Book value Estimated fair value Impairment loss $18,300,000 11,000,000 $ 7,300,000
Requirement 2 The loss would appear in the income statement along with other operating expenses. Requirement 3 Loss on impairment ............................................ Accumulated depreciation .................................. Plant assets...................................................... 7,300,000 14,200,000 21,500,000
Requirement 4 An impairment loss is indicated because the estimated undiscounted sum of future cash flows of $12 million is less than the book value of $18.3 million. The amount of the loss to be reported is calculated using the estimated fair value rather than the undiscounted future cash flows: Book value Estimated fair value $18,300,000 11,000,000
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Impairment loss
$ 7,300,000
Requirement 5 Because the estimated undiscounted sum of future cash flows of $19 million exceeds the book value of $18.3 million, no impairment loss is indicated.
11-56
Determination of implied goodwill: Fair value of Centerpoint, Inc. Fair value of Centerpoints net assets (excluding goodwill) Implied value of goodwill Measurement of impairment loss: Book value of goodwill Implied value of goodwill Impairment loss $220 million 200 million $ 20 million
$50 million 20 million $30 million
Requirement 2 Because the fair value of the reporting unit, $270 million, exceeds book value, $250 million, there is no impairment loss.
Exercise 11-26
Under IFRS, the impairment loss is the difference between book value and the recoverable amount of the cash-generating unit. The recoverable amount is $225 million, the higher of the $225 million value-inuse (present value of estimated future cash flows) and the $220 million fair value less costs to sell. Book value Recoverable amount Impairment loss $250 million 225 million $ 25 million
11-57
Calculation of goodwill: Consideration exchanged Less fair value of net assets: Assets Less: Liabilities assumed Goodwill Requirement 2 Because the book value of the net assets ($410 million) exceeds fair value ($400 million) an impairment loss is indicated. Determination of implied goodwill: Fair value of Harman, Inc. Fair value of Harmans net assets (excluding goodwill) Implied value of goodwill Measurement of impairment loss: Book value of goodwill (determined in requirement 1) Implied value of goodwill Impairment loss Requirement 3 Entry to record the impairment loss:
($ in millions)
$420 million $512 million (150) million
(362) million $ 58 million
$ 58 million 30 million $ 28 million
Loss on impairment of goodwill ............................... Goodwill .........................................................
28 28
11-58
Exercise 11-28
Requirement 1 The Codification topic number that provides guidance on accounting for the impairment of long-lived assets is FASB ASC 360: Property, Plant, and Equipment. Requirement 2 The specific citation that discusses the disclosures required in the notes to the financial statements for the impairment of long-lived assets classified as held and used is FASB ASC 36010502: Property, Plant, and EquipmentOverallDisclosure Impairment or Disposal of Long-Lived Assets.
Requirement 3 All of the following information shall be disclosed in the notes to financial statements that include the period in which an impairment loss is recognized: a. A description of the impaired long-lived asset (asset group) and the facts and circumstances leading to the impairment b. If not separately presented on the face of the statement, the amount of the impairment loss and the caption in the income statement or the statement of activities that includes that loss c. The method or methods for determining fair value (whether based on a quoted market price, prices for similar assets, or another valuation technique) d. If applicable, the segment in which the impaired long-lived asset (asset group) is reported under Topic 280.
11-59
Exercise 11-29
The FASB Accounting Standards Codification represents the single source of authoritative U.S. generally accepted accounting principles. The specific citation for each of the following items is: 1. Depreciation involves a systematic and rational allocation of cost rather than a process of valuation: FASB ASC 36010354: Property, Plant, and EquipmentOverall Subsequent MeasurementDepreciation. The cost of a productive facility is one of the costs of the services it renders during its useful economic life. Generally accepted accounting principles (GAAP) require that this cost be spread over the expected useful life of the facility in such a way as to allocate it as equitably as possible to the periods during which services are obtained from the use of the facility. This procedure is known as depreciation accounting, a system of accounting which aims to distribute the cost or other basic value of tangible capital assets, less salvage (if any), over the estimated useful life of the unit (which may be a group of assets) in a systematic and rational manner. It is a process of allocation, not of valuation. 2. The calculation of an impairment loss for property, plant, and equipment: FASB ASC 360103517: Property, Plant, and EquipmentOverall Subsequent Measurement. An impairment loss shall be recognized only if the carrying amount of a long-lived asset (asset group) is not recoverable and exceeds its fair value. The carrying amount of a long-lived asset (asset group) is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset (asset group). That assessment shall be based on the carrying amount of the asset (asset
11-60
group) at the date it is tested for recoverability, whether in use or under development. An impairment loss shall be measured as the amount by which the carrying amount of a long-lived asset (asset group) exceeds its fair value.
11-61
3. Accounting for a change in depreciation method: FASB ASC 250104518: Accounting Changes and Error Correction OverallOther Presentation Matters. Distinguishing between a change in an accounting principle and a change in an accounting estimate is sometimes difficult. In some cases, a change in accounting estimate is effected by a change in accounting principle. One example of this type of change is a change in method of depreciation, amortization, or depletion for long-lived, nonfinancial assets (hereinafter referred to as depreciation method). The new depreciation method is adopted in partial or complete recognition of a change in the estimated future benefits inherent in the asset, the pattern of consumption of those benefits, or the information available to the entity about those benefits. The effect of the change in accounting principle, or the method of applying it, may be inseparable from the effect of the change in accounting estimate. Changes of that type often are related to the continuing process of obtaining additional information and revising estimates and, therefore, shall be considered changes in estimates for purposes of applying this Subtopic. 4. Goodwill should not be amortized: FASB ASC 35020351: Intangibles-Goodwill and OtherGoodwill Subsequent Measurement. Goodwill shall not be amortized. Instead, goodwill shall be tested for impairment at a level of reporting referred to as a reporting unit.
11-62
Exercise 11-30
1. To record the replacement of the heating system.
Accumulated depreciation - building.............................. 250,000 Cash............................................................................ 250,000
2. To record the addition to the building.
Building.......................................................................... 750,000 Cash............................................................................ 750,000
3. To expense annual maintenance costs.
Maintenance expense...................................................... Cash............................................................................
14,000 14,000
4. To capitalize rearrangement costs.
Machinery....................................................................... Cash............................................................................
50,000 50,000
11-63
Exercise 11-31
Requirement 1 2009 amortization: $6,000,000 10 = $600,000 x 3/12 = $150,000 2010 amortization: $6,000,000 10 = $600,000
Requirement 2 Patent Cash Requirement 3 Calculation of revised annual amortization: $6,000,000 750,000 5,250,000 500,000 5,750,000 8 3/4 $ 657,143 Cost Amortization to date (above) Unamortized cost (balance in the patent account) Add New unamortized cost Estimated remaining life (10 years 1 1/4 years) New annual amortization 500,000 500,000
Requirement 4 Requirement 2: Litigation expense Cash 500,000 500,000
11-64
Requirement 3: 2011 amortization: $6,000,000 10 = $600,000
11-65
Exercise 11-32
Requirement 1
Cash................................................................................ Accumulated depreciation - lathe (determined below)....... Loss on sale (difference)................................................... Lathe (balance)..............................................................
17,000 56,250 6,750 80,000
Accumulated depreciation: $80,000 - 5,000 = $15,000 5 years $ 7,500 15,000 15,000 15,000 3,750 $56,250
Annual depreciation =
2007 2008 2009 2010 2011 Total
$15,000 x 1/2 =
$15,000 x 1/4 =
11-66
Exercise 11-32 (concluded) Requirement 2
Cash................................................................................ Accumulated depreciation - lathe (determined below)....... Gain on sale (difference)............................................... Lathe (balance)..............................................................
17,000 67,500 4,500 80,000
Accumulated depreciation: Sum-of-the-digits is ([5 (5 + 1)]/2) = 15 2007 2008 + 2009 + 2010 + 2011 $75,000 x 5/15 x 6/12 = $75,000 x 5/15 x 6/12 = $75,000 x 4/15 x 6/12 = $75,000 x 4/15 x 6/12 = $75,000 x 3/15 x 6/12 = $75,000 x 3/15 x 6/12 = $75,000 x 2/15 x 6/12 = $75,000 x 2/15 x 3/12 = Total $12,500 10,000 $10,000 7,500 $ 7,500 5,000 $12,500
22,500
17,500
12,500 2,500
$67,500
11-67
Exercise 11-33
List A g 1. Depreciation d 2. Service life f 3. Depreciable base e 4. List B
m h j k a
5. 6. 7. 8. 9.
l 10. b 11. i 12. c 13.
a. Cost allocation for natural resource. b. Accounted for prospectively. c. When there has been a significant decline in value. Activity-based method d. The amount of use expected from plant and equipment and finite-life intangible assets. Time-based method e. Estimates service life in units of output. Double-declining balance f. Cost less residual value. Group method g. Cost allocation for plant and equipment. Composite method h. Does not subtract residual value from cost. Depletion i. Accounted for the same way as a change in estimate. Amortization j. Aggregates assets that are similar. Change in useful life k. Aggregates assets that are physically unified. Change in depreciation l. Cost allocation for an intangible asset. method Write-down of asset m. Estimates service life in years.
11-68
Exercise 11-34
Requirement 1 To record the acquisition of small tools.
2009 Small tools ..................................................................... Cash............................................................................
8,000 8,000
To record additional small tool acquisitions. 2011 Small tools.................................................................. ............................................................................ Cash ........................................................................... 2,500 To record the sale/depreciation of small tools.
2,500
2011 Cash ............................................................................... Depreciation expense (difference)..................................... Small tools..................................................................
250 1,750 2,000
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Exercise 11-34 (concluded) Requirement 2 To record the acquisition of small tools.
2009 Small tools ..................................................................... Cash............................................................................
8,000 8,000
To record the replacement/depreciation of small tools.
2011 Depreciation expense ..................................................... Cash............................................................................
2,500 2,500
To record the sale of small tools.
2011 Cash ............................................................................... Depreciation expense..................................................
250 250
CPA / CMA REVIEW QUESTIONS

CPA Exam Questions
1. a. Double declining balance depreciation rate = 2 x 1/8 = or 25% First year depreciation will be $7,500 x 0.25 = $1,875
11-70
Second year depreciation will be ($7,500 - $1875) x 0.25 = $1,406 2. b. The depreciation method used must be straight line because year 1 depreciation is $7,400 (($40,000 - $3,000) / 5 = $7,400). Year 2 depreciation would also be $7,400. 3. b. $20,000/5,000,000 gallons = $0.004/gallon ($0.004/gallon) x (250,000 gallons) = $1,000 4. d. Goodwill is an indefinite life intangible asset and is therefore not amortized. 5. c. $50,000 10 years = $5,000 per year in amortization. $50,000 5,000 = $45,000. The 3% franchise fee is a period expense and is not capitalized. 6. c. First two years = ($60,000 0) 10 = $6,000 per year Year 2011 = [$60,000 (2 x $6,000) 3,000] 3 = $15,000
7. d. The book value of the stamping machine is its cost less accumulated depreciation. Depreciation taken through 2011 was (($22,000,000 $4,000,000) / 12 x 7 =) $10,500,000 so book value is ($22,000,000 $10,500,000 =) $11,500,000. Because the $11,500,000 book value is more than expected future cash flows of ((5 x $1,500,000) + $1,000,000 =) $8,500,000, the stamping machine is impaired. 8. d. $147,000. All of the expenditures are capitalized.
11-71
CMA Exam Questions

1. d. Because 50% of the original estimate of quality ore was recovered during the years 2002 through 2009, recorded depletion of $250,000 [50% x ($600,000 - $100,000 salvage value)]. In 2010, the earlier depletion of $250,000 is deducted from the $600,000 cost along with the $100,000 salvage value. The remaining depletable cost of $250,000 will be allocated over the 250,000 tons believed to remain in the mine. The $1 per ton depletion is then multiplied times the tons mined each year.
2. a. Given that the company paid $6,000,000 for net assets acquired with a fair
value of $5,496,000, goodwill was $504,000. According to GAAP, purchased goodwill is not amortized but is tested annually for impairment.
3. a. The cost should be amortized over the remaining legal life or useful life,
whichever is shorter. In addition to the initial costs of obtaining a patent, legal fees incurred in the successful defense of a patent should be capitalized as part of the cost, whether it was internally developed or purchased from an inventor. The legal fees capitalized then should be amortized over the remaining useful life of the patent.
11-72
PROBLEMS
Problem 11-1Requirement 1
Determine useful life: $200,000 depreciable base = 20-year useful life $10,000 annual depreciation Determine age of assets: $40,000 accumulated depreciation = 4 years old $10,000 annual depreciation Double-declining balance in 4th year of life: Year 1 (2008) $200,000 x 10% = $20,000 Year 2 (2009) 180,000 x 10% = 18,000 Year 3 (2010) 162,000 x 10% = 16,200 Year 4 (2011) 145,800 x 10% = 14,580 Requirement 2 Depreciation expense (below) ....................... Accumulated depreciation .................... $200,000 30,000 $170,000 20,000 20,000
Cost Depreciation to date, SL 3 years (2008-2010) Undepreciated cost as of 1/1/11
Seventeen-year remaining life, or 1/17 x 2 = 2/17 = x $170,000 = $20,000 A disclosure note reports the effect of the change on net income and earnings per share along with clear justification for changing depreciation methods.
11-73
Problem 11-2
Requirement 1 Cord Company ANALYSIS OF CHANGES IN PLANT ASSETS For the Year Ending December 31, 2011
Balance 12/31/10 $ 175,000 -1,500,000 1,125,000 172,000 216,000 $3,188,000 Balance 12/31/11 $ 487,500 192,000 2,437,500 1,493,000 160,500 216,000 $4,986,500
Land Land improvements Buildings Machinery and equipment Automobiles and trucks Leasehold improvements
Increase $ 312,500 [1] 192,000 937,500 [1] 385,000 [2] 12,500 -$1,839,500
Decrease $ ---17,000 24,000 -$41,000
Explanations of Amounts: [1] Plant facility acquired from King 1/6/11 allocation to Land and Building: Fair value 25,000 shares of Cord common stock at $50 per share fair value $1,250,000 Allocation in proportion to appraised values at date of exchange: % of Amount Total Land $187,500 25 Building 562,500 75 $750,000 100 Land Building $1,250,000 x 25% = $1,250,000 x 75% = $ 312,500 937,500 $1,250,000
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[2]
Machinery and equipment purchased 7/1/11: Invoice cost $325,000 Delivery cost 10,000 Installation cost 50,000 Total acquisition cost $385,000
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Problem 11-2 (continued) Requirement 2 Cord Company DEPRECIATION AND AMORTIZATION EXPENSE For the Year Ended December 31, 2011 Land Improvements: Cost Straight-line rate (1 12 years) Annual depreciation Depreciation on land improvements for 2011:
(3/25 to 12/31/11)
$192,000 x 8 1/3% 16,000 x 3/4 $ 12,000
Buildings: Book value, 1/1/11 ($1,500,000 - 328,900) Building acquired 1/6/11 Total amount subject to depreciation 150% declining balance rate:
(1 25 years = 4% x 1.5)
$1,171,100 937,500 2,108,600 x 6% 126,516
Machinery and equipment: Balance, 1/1/11 Straight-line rate (1 10 years)
$1,125,000 x 10%
112,500 19,250 131,750
Purchased on 7/1/11 385,000 Depreciation for one-half year x 5% Depreciation on machinery and equipment for 2011 Automobiles and trucks: Book value, 1/1/11 ($172,000 - 100,325) Deduct 1/1/11 book value of truck sold on 9/30 ($9,100 + 2,650) Amount subject to depreciation 150% declining balance rate:
(1 5 years = 20% x 1.5)
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$71,675 (11,750) 59,925 x 30% 17,978
Automobile purchased 8/30/11 Depreciation for 2011 (30% x 4/12) Truck sold on 9/30/11 - depreciation (given) Depreciation on automobiles and trucks
12,500 x 10%
1,250 2,650 21,878
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Problem 11-2 (concluded) Leasehold improvements: Book value, 1/1/11 ($216,000 - 108,000) $108,000 Amortization period (1/1/11 to 12/31/15) 5 years Amortization of leasehold improvements for 2011 Total depreciation and amortization expense for 2011
21,600 $313,744
Problem 11-3
Pell Corporation DEPRECIATION EXPENSE For the Year Ended December 31, 2011
Land improvements: Cost Straight-line rate (1 15 years) Building: Book value 12/31/10 ($1,500,000 - 350,000) 150% declining balance rate:
(1 20 years = 5% x 1.5)
$ 180,000 x 6 2/3%
$ 12,000
$1,150,000 x 7.5% 86,250
Machinery and Equipment: Balance, 12/31/10 Deduct machine sold Straight-line rate (1 10 years) Purchased 1/2/11 Depreciation
$1,158,000 (58,000) $1,100,000 x 10% 287,000 x 10% 58,000 x 2.5%
110,000
28,700
Machine sold 3/31/11 Depreciation for three months Total depreciation on machinery and equipment
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1,450 140,150
Automobiles: Book value on 12/31/10 ($150,000 - 112,000) 150% declining balance rate:
(1 3 years = 33.333% x 1.5)
$38,000 x 50% 19,000 $257,400
Total depreciation expense for 2011
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Problem 11-4
1. Depreciation for 2009 and 2010.
December 31, 2009 Depreciation expense ($48,000 8 years x 9/12)................. Accumulated depreciation - equipment......................
4,500 4,500
December 31, 2010 Depreciation expense ($48,000 8 years)...................... ......................Accumulated depreciation - equipment ........................................................................... 6,000 2. The year 2011 expenditure.
6,000
January 4, 2011 Repair and maintenance expense.................................... Equipment....................................................................... Cash............................................................................
2,000 10,350 12,350
3. Depreciation for the year 2011.
December 31, 2011 Depreciation expense (determined below).......................... Accumulated depreciation - equipment......................
5,800 5,800
Calculation of annual depreciation after the estimate change: $ 48,000 Cost
11-80
10,500 37,500 10,350 47,850 8 1/4 $ 5,800
Depreciation to date ($4,500 + 6,000) Undepreciated cost Asset addition New depreciable base Estimated remaining life (10 years - 1 3/4 years) New annual depreciation $65,000 Allocation in proportion to
Problem 11-5(1)
appraised values at date of exchange: % of Amount Total Land $72,000 8 Building 828,000 92 $900,000 100 Land $812,500 x 8% = Building $812,500 x 92% = (2) $747,500 (3) 50 years $747,500 - 47,500 $14,000 annual depreciation (4) (5) $ 14,000 $ 85,400 Same as prior year, since method used is straight-line. 3,000 shares x $25 per share = Plus demolition of old building No depreciation before use. Fair value. $75,000 10,400 $85,400 $ 65,000 747,500 $812,500
(6) (7)
None $ 16,000
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(8) (9)
$ 2,400 $ 2,040
$16,000 x 15% (1.5 x Straight-line rate of 10%). ($16,000 - 2,400) x 15%. Total cost of $110,000 - $11,000 in normal repairs. ($99,000 - 5,500) x 10/55. ($99,000 - 5,500) x 9/55 x 4/12. PVAD = $4,000 (7.71008 )
Present value of an annuity due of $1: n = 11, i = 8% (from Table 6)
(10) $ 99,000 (11) $ 17,000 (12) $ 5,100 (13) $ 30,840
(14) $ 2,056
$30,840 15 years
Problem 11-6Requirement 1
Building: $500,000 = $20,000 per year x 9/12 = $15,000 25 years Machinery: $240,000 - (10% x $240,000) = $27,000 per year x 9/12 = $20,250 8 years Equipment:
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Sum-of-the-digits is ([6 (6 + 1)]2) = 21 ($160,000 - 13,000) x 6/21 = $42,000 x 9/12 = $31,500 Requirement 2 (1) June 29, 2012 Depreciation expense (determined below).......................... Accumulated depreciation - machinery......................
5,625 5,625
$100,000 - (10% x $100,000) = $11,250 x 6/12 = $5,625 8 years
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Problem 11-6 (concluded) (2) June 29, 2012 Cash................................................................................ Accumulated depreciation - machinery (below)............... Loss on sale of machinery (difference).............................. Machinery...................................................................
80,000 14,063 5,937 100,000
Accumulated depreciation on machinery sold: 2011 depreciation = $11,250 x 9/12 = 2012 depreciation = $11,250 x 6/12 Total Requirement 3 Building: $500,000 = $20,000 25 years Machinery: $140,000 - (10% x $140,000) = $15,750 8 years Equipment: ($160,000 - 13,000) x 6/21 = $42,000 x 3/12 =
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$ 8,438 5,625 $14,063
$10,500
($160,000 - 13,000) x 5/21 = $35,000 x 9/12 =
26,250 $36,750
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Problem 11-7
Requirement 1 Cost of mineral mine: Purchase price Development costs $1,600,000 600,000 $2,200,000
Depletion: $2,200,000 - 100,000 Depletion per ton = 400,000 tons 2011 depletion = $5.25 x 50,000 tons = $262,500 = $5.25 per ton
2012 depletion: Revised depletion rate =
($2,200,000 - 262,500) - 100,000 = $4.20 487,500 - 50,000 tons
2012 depletion Depreciation: Structures:
= $4.20 x 80,000 tons = $336,000
$150,000 Depreciation per ton = 400,000 tons 2011 depreciation = $.375 x 50,000 tons = $18,750 = $.375 per ton
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2012 depreciation: Revised depreciation rate =
$150,000 - 18,750 = $.30 487,500 - 50,000 tons
2012 depreciation = $.30 x 80,000 tons = $24,000
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Problem 11-7 (continued) Equipment: $80,000 - 4,000 Depreciation per ton = 400,000 tons 2011 depreciation = $.19 x 50,000 tons = $9,500 = $.19 per ton
2012 depreciation: Revised depreciation rate =
($80,000 - 9,500) - 4,000 = $.152 487,500 - 50,000 tons
2012 depreciation = $.152 x 80,000 tons = $12,160 Requirement 2 Mineral mine: Cost Less accumulated depletion: 2011 depletion 2012 depletion Book value, 12/31/12 Structures: Cost Less accumulated depreciation: 2011 depreciation 2012 depreciation Book value, 12/31/12 Equipment: Cost
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$ 2,200,000 $262,500 336,000
598,500 $1,601,500
$ 150,000 $18,750 24,000
42,750 $107,250
$ 80,000
Less accumulated depreciation: 2011 depreciation 2012 depreciation Book value, 12/31/12
$ 9,500 12,160
21,660 $58,340
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Problem 11-7 (concluded) Requirement 3 Depletion of natural resources and depreciation of assets used in the extraction of natural resources are part of product cost and are included in the cost of the inventory of the mineral, just as the depreciation on manufacturing equipment is included in inventory cost. The depletion and depreciation are then included in cost of goods sold in the income statement when the mineral is sold. In 2011, since all of the ore was sold, all of 2011s depletion and depreciation is included in cost of goods sold. In 2012, since not all of the extracted ore was sold, a portion of both 2012s depletion and depreciation remains in inventory.
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Problem 11-8
Requirement 1 Calculation of goodwill: Consideration exchanged Less: Fair value of net identifiable assets $2,000,000 1,700,000 $ 300,000
The cost of goodwill is not amortized.
To record amortization of patent.
Amortization ($80,000 8 years x 6/12)............................... Patent..........................................................................
5,000 5,000
To record amortization of franchise.
Amortization expense ($200,000 10 years x 3/12)............. Franchise.....................................................................
5,000 5,000
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Problem 11-8 (concluded) Requirement 2 Intangible assets: Goodwill Patent Franchise Total intangibles [1] $300,000 [2] $ 80,000 - 5,000 [3] $200,000 - 5,000 $300,000 [1] 75,000 [2] 195,000 [3] $570,000
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Problem 11-9
Requirement 1 Machine 101: $70,000 - 7,000 = $6,300 per year x 3 years = 10 years Machine 102: $80,000 - 8,000 = $9,000 per year x 1.5 years = 8 years Machine 103: $30,000 - 3,000 = $3,000 per year x 4/12 9 years Accumulated depreciation, 12/31/10 Requirement 2 To record depreciation on machine 102 through date of sale. $33,400 = 1,000 13,500 $ 18,900
March 31, 2011 Depreciation expense ($9,000 per year x 3/12)..................... Accumulated depreciation - equipment......................
2,250 2,250
To record sale of equipment.
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March 31, 2011 Cash................................................................................ Accumulated depreciation ($13,500 + 2,250)..................... Loss on sale of equipment (determined below)................... Equipment...................................................................
52,500 15,750 11,750 80,000
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Problem 11-9 (continued) Loss on sale of machine 102: Proceeds Less book value on 3/31/11: Cost Less accumulated depreciation: Depreciation through 12/31/10 Depreciation from 1/1/11 to 3/31/11 ($9,000 x 3/12) Loss on sale Requirement 3 Building: Useful life of the building: $200,000 = $40,000 in depreciation per year 5 years
(2006-2010)
$52,500 $80,000 $13,500 2,250 15,750 64,250 $11,750
$840,000 - 40,000 = 20-year useful life $40,000 To record depreciation on the building.
Depreciation expense [($840,000 - 40,000) 20 years]........ Accumulated depreciation - building..........................
40,000 40,000
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Problem 11-9 (concluded) To record depreciation on the equipment.
Depreciation expense (determined below).......................... Accumulated depreciation - equipment......................
15,775 15,775
Equipment: Machine 103 (determined above) Machine 101: Cost Less: Accumulated depreciation Book value, 12/31/10 Revised remaining life (7 years - 3 years)
$ 3,000 $70,000 18,900 51,100 4 years
12,775 $15,775
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Problem 11-10
a. This is a change in estimate.
No entry is needed to record the change. 2011 adjusting entry: Depreciation expense (determined below) ......................... 370,000 Accumulated depreciation ......................................... 370,000
Calculation of annual depreciation after the estimate change: Cost $250,000 Previous depreciation ($10,000,000 40 years) x 3 yrs (750,000) Depreciation to date (2008-2010) 9,250,000 Undepreciated cost 25 yrs. Estimated remaining life (25 years: 2011-2035) $ 370,000 New annual depreciation A disclosure note should describe the effect of a change in estimate on income before extraordinary items, net income, and related per-share amounts for the current period. $10,000,000
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Problem 11-10 (concluded) b. This is a change in accounting principle that is accounted for as a change in estimate. Depreciation expense (below) .......................21,000 Accumulated depreciation ............ 21,000 SYD 2007 depreciation 2008 depreciation 2009 depreciation 2010 depreciation $ 60,000 54,000 48,000 42,000 Accumulated depreciation $204,000 $330,000 204,000 126,000 0 126,000 6 yrs. $ 21,000
($330,000 x 10/55) ($330,000 x 9/55) ($330,000 x 8/55) ($330,000 x 7/55)
Cost Depreciation to date, SYD (above) Undepreciated cost as of 1/1/11 Less residual value Depreciable base Remaining life (10 years - 4 years) New annual depreciation
A disclosure note reports the effect of the change on net income and earnings per share along with clear justification for changing depreciation methods. c. This is a change in accounting principle accounted for as a change in estimate. Because the change will be effective only for assets placed in service after the date of change, depreciation schedules do not require revision because the change does not affect assets depreciated in prior periods. A disclosure note still is required to provide justification for the change and to report the effect of the change on current years income.
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Problem 11-11
Requirement 1 Analysis: Correct (Should Have Been Recorded) 2009 Equipment Expense Cash 1,900,000 100,000 2,000,000 Expense 500,000 [2] Accum. deprec. 500,000 Expense 375,000 [4] Accum. deprec. 375,000
Incorrect (As Recorded) Equipment Cash 2,000,000 2,000,000
2009 Expense 475,000 [1] Accum. deprec. 475,000 2010 Expense 356,250 [3] Accum. deprec. 356,250
[1] $1,900,000 x 25% (2 times the straight-line rate of 12.5%) [2] $2,000,000 x 25% [3] ($1,900,000 - 475,000) x 25% [4] ($2,000,000 - 500,000 ) x 25%
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During the two-year period, depreciation expense was overstated by $43,750, but other expenses were understated by $100,000, so net income during the period was overstated by $56,250, which means retained earnings is currently overstated by that amount. During the two-year period, accumulated depreciation was overstated, and continues to be overstated by $43,750. To correct incorrect accounts Retained earnings................................................. Accumulated depreciation ................................................. Equipment.........................................................
56,250 43,750 100,000
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Problem 11-11 (concluded) Requirement 2 This is a change in accounting principle accounted for as a change in estimate. No entry is needed to record the change. 2011 adjusting entry: Depreciation expense (determined below)................... 178,125 Accumulated depreciation ...................................... 178,125 A change in depreciation method is considered a change in accounting estimate resulting from a change in accounting principle. Accordingly, the Collins Corporation reports the change prospectively; previous financial statements are not revised. Instead, the company simply employs the straight-line method from now on. The undepreciated cost remaining at the time of the change is depreciated straight-line over the remaining useful life. Assets cost (after correction) Accumulated depreciation to date ($475,000 + 356,250) Undepreciated cost, Jan. 1, 2011 Estimated residual value To be depreciated over remaining 6 years Annual straight-line depreciation 2011-2016 $1,900,000 (831,250) 1,068,750 (0) 1,068,750 6 $ 178,125
years
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Problem 11-12 Requirement 1 Plant and equipment: Depreciation to date: $150 million 10 years = $15 million per year x 3 years = $45 million Book value: $150 million $45 million = $105 million Patent: Amortization to date: $40 million 5 years = $8 million per year x 3 years = $24 million Book value: $40 million $24 million = $16 million Requirement 2 Property, plant, and equipment and finite-life intangible assets are tested for impairment only when events or changes in circumstances indicate book value may not be recoverable. Requirement 3 Goodwill should be tested for impairment on an annual basis and in between annual test dates if events or circumstances indicate that the fair value of the reporting unit is below its book value. Requirement 4 Plant and equipment: An impairment loss is indicated because the book value of the assets, $105 million, is greater than the $80 undiscounted sum of future cash flows. The amount of the impairment loss is determined as follows: Book value Fair value Impairment loss $105 million (60) million 45 million
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Patent: There is no impairment loss because the undiscounted sum of future cash flows, $20 million, exceeds book value of $16 million.
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Problem 11-12 (concluded) Goodwill: An impairment loss is indicated because the book value of the assets of the reporting unit, $470 million, is greater than the $450 million fair value of the reporting unit. The amount of the impairment loss is determined as follows: Determination of implied goodwill: Fair value of Ellison Technology Fair value of Ellisons net assets (excluding goodwill) Implied value of goodwill Measurement of impairment loss: Book value of goodwill Implied value of goodwill Impairment loss
$450 million (390) million $ 60 million
$100 million (60) million $40 million
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Problem 11-13
Requirement 1 Hecalas cost of the mineral mine is $13,721,871 determined as follows: Mining site $10,000,000 Development costs 3,200,000 Restoration costs 521,871 $13,721,871
$600,000 x 30% = 700,000 x 30% = 800,000 x 40% =
$180,000 210,000 320,000 $710,000 x .73503* = $521,871

*Present value of $1, n = 4, i = 8%
Requirement 2 Depletion: $13,721,871 800,000 tons = $17.1523 per ton 120,000 tons x $17.1523 = $2,058,276 Depreciation of machinery: $140,000 - 10,000 = $.1625 per ton 800,000 tons 120,000 tons x $.1625 = $19,500 Depreciation of structures:
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$68,000 800,000 tons = $.085 per ton 120,000 tons x $.085 = $10,200
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Problem 11-13 (continued)
Requirement 3 Depletion of natural resources and depreciation of assets used in the extraction of natural resources are part of product cost and therefore are included in the cost of the inventory of the mineral, just as the depreciation on manufacturing equipment is included in inventory cost. The depletion and depreciation are then included in cost of goods sold in the income statement when the mineral is sold.
Requirement 4 A change in the service life of plant and equipment and finite-life intangible assets is accounted for as a change in an estimate. The change is accounted for prospectively by simply depreciating/depleting the remaining depreciable/depletable base of the asset (book value at date of change less estimated residual value) over the revised remaining service life (tons of ore in this case). 2012 Depletion: Original cost Less: 2011 depletion Remaining depletable cost Revised estimate of tons remaining (1,000,000 120,000) Depletion rate x Tons extracted 2012 Depletion $13,721,871 (2,058,276) $11,663,595 880,000 tons $13.2541 per ton 150,000 tons $1,988,115
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Problem 11-13 (concluded) 2012 Depreciation of machinery: Original cost Less: 2011 depreciation Less: residual value Remaining depreciable cost Revised estimate of tons remaining (1,000,000 120,000) Depreciation rate x Tons extracted 2012 Depreciation $140,000 (19,500) $120,500 (10,000) $110,500 880,000 tons $.1256 per ton 150,000 tons $18,840
2012 Depreciation of structures: Original cost Less: 2011 depreciation Remaining depreciable cost Revised estimate of tons remaining (1,000,000 120,000) Depreciation rate x Tons extracted 2012 Depreciation $68,000 (10,200) $57,800 880,000 tons $.0657 per ton 150,000 tons $9,855
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CASES
The terms depreciation, depletion, and amortization all Analysis Case 11-1refer to the same process of allocating the cost of property and equipment and finite-life intangible assets to the periods benefited by their use. However, each term is applied to a different type of long-lived asset; depreciation is used for plant and equipment, depletion for natural resources, and amortization for intangibles. There are differences in determining the factors necessary to calculate depreciation, depletion, and amortization but the concepts involved are the same. The service life of plant and equipment and natural resources is limited to physical life, while the service life of intangible assets is limited to the assets legal or contractual life, or 40 years, whichever is shorter. The majority of companies use straight-line depreciation and straight-line amortization. Natural resources usually are depleted using the units-of-production method.
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Communication Case 11-2

Suggested Grading Concepts and Grading Scheme: Content (70%) _______ 50 Explains the concept of depreciation as a process of cost allocation, not valuation. ______ Rational match versus market fluctuations. ______ Numerical example. _______ 10 Purpose of the balance sheet is to provide information about financial position, not to directly measure company value. _______ 10 Purpose of the income statement is to provide cash flow information, not to directly measure the change in company value. ______ _______ 70 points Writing (30%) _______ 6 Terminology and tone appropriate to the audience of a company president. _______ 12 Organization permits ease of understanding. ______ Introduction that states purpose. ______ Paragraphs that separate main points. _______ 12 English ______ Sentences grammatically clear and well organized, concise. ______ Word selection. ______ Spelling. ______ Grammar and punctuation. ______
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_______ 30 points
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Judgment Case 11-3

Requirement 1 Portland should have selected the straight-line depreciation method when approximately the same amount of an assets service potential is used up each period. If the reasons for the decline in service potential are unclear, then the selection of the straight-line method could be influenced by the ease of recordkeeping, its use for similar assets, and its use by others in the industry. Requirement 2 a. By associating depreciation with a group of machines instead of each individual machine, Portlands bookkeeping process is greatly simplified. Also, since actual machine lives vary from the average depreciable life, unrecognized net losses on early dispositions are expected to be offset by continuing depreciation on machines usable beyond the average depreciable life. Periodic income does not fluctuate as a result of recognizing gains and losses on machine dispositions. b. Portland should divide the depreciable base of each machine by its estimated life to obtain its annual depreciation. The sum of the individual annual depreciation amounts should then be divided by the sum of the individual capitalized costs to obtain the annual composite depreciation rate.
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Judgment Case 11-4

Requirement 1 a. The capitalized cost for the computer includes all costs reasonable and necessary to prepare it for its intended use. Examples of such costs are the purchase price, delivery, installation, testing, and setup. b. The objective of depreciation accounting is to allocate the depreciable base of an asset over its estimated useful life in a systematic and rational manner. This process matches the depreciable base of the asset with revenues generated from its use. Depreciable base is the capitalized cost less its estimated residual value. Requirement 2 The rationale for using accelerated depreciation methods is based on the assumption that an asset is more productive in the earlier years of its estimated useful life. Therefore, larger depreciation charges in the earlier years would be matched against the larger revenues generated in the earlier years. An accelerated depreciation method also would be appropriate when benefits derived from the asset are approximately equal over the assets life, but repair and maintenance costs increase significantly in later years. The early years record higher depreciation expense and lower repairs and maintenance expense, while the later years have lower depreciation and higher repairs and maintenance. There is no necessarily correct answer to the question. Judgment Case 11-5The support made for the answer given is more important than the answer itself. Materiality is the critical consideration. Information is material if it can have an effect on a decision made by users. One consequence of materiality is that GAAP needs to be followed only if an item is material. The threshold for materiality will depend principally on the relative dollar amount of the transaction. In this case, is the $70,000 material? Net-of-tax income would be $49,000 higher if the expenditures were capitalized instead of expensed [$70,000 x (1-.30)]. This represents a 4.45% increase in income ($49,000 $1,100,000). The effect on the balance sheet is small. Shareholders' equity would be higher by $49,000 if the
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expenditures were capitalized. This represents an increase of less than one-half of one percent. Would these differences have an effect on decision-makers? There is no single answer to this question. The FASB has been reluctant to establish any quantitative materiality guidelines. The threshold for materiality has been left to subjective judgment of the company preparing the financial statement and its auditors. There is no right or wrong answer to this Communication Case 11-6case. Both views, expense and capitalize, can be defended once consideration is given to the materiality issue. The process of developing and synthesizing the arguments will likely be more beneficial than any single solution. Each student should benefit from participating in the process, interacting first with his or her partner, then with the class as a whole. It is important that each student actively participate in the process. Domination by one or two individuals should be discouraged. A significant benefit of this case is that it is forcing students to consider the subjective nature of materiality when applying GAAP.
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Integrating Case 11-7

Requirement 1 a. Inventory (understatement of 2012 beginning inventory)......... Retained earnings (understatement of 2011 income).........
($ in millions)
10 10
Note: The 2010 error requires no adjustment because it has self-corrected by 2012.
b. Retained earnings (2010-2011 patent amortization).............. Patent [($18 million 6 years) x 2].................................. 2012 adjusting entry: Patent amortization expense ($18 million 6 years) ......... Patent ........................................................................ c. 2012 adjusting entry: Depreciation expense (below) ......................................... Accumulated depreciation ........................................
6 6
3 3
4 4
($ in millions)
SYD 2010 depreciation 2011 depreciation

Accumulated depreciation
$10 ($30 x 5/15) 8 ($30 x 4/15) $18
$30 18 12 0 12 3 yrs.
Cost Depreciation to date, SYD (above) Undepreciated cost as of 1/1/12 Less residual value Depreciable base Remaining life (5 years - 2 years)
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$ 4
New annual depreciation
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Case 11-7 (concluded) Requirement 2 Assets 2010 2010 inventory Patent amortization Depreciation $640 (12) (3) ____ $625 2011 2010 inventory 2011 inventory Patent amortization Depreciation $820 10 (6) ____ ____ $824 $400 Shareholders Net Liabilities Equity Income $330 $310 (12) (3)
adjustments
Expenses $150 12 3
prior years
$210 (12) (3)

to
no
____ $330 $400
____ $295 $420 10 (6) ____ $424
____ $195 $230 12 10 (3) ____ $249
____ $165 $175 (12) (10) 3 ____ $156
no adjustments to prior years
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Judgment Case 11-8

Requirement 1 A change from the sum-of-the-years digits method of depreciation to the straight-line method for previously recorded assets is a change in accounting principle that is accounted for as a change in estimate. Both the sum-of-the-years digits method and the straight-line method are generally accepted. A change in accounting principle results from the adoption of a generally accepted accounting principle different from the generally accepted principle used previously for reporting purposes. Requirement 2 A change in the expected service life of an asset arising because of more experience with the asset is a change in accounting estimate. A change in accounting estimate occurs because future events and their effects cannot be perceived with certainty. Estimates are an inherent part of the accounting process. Therefore, accounting and reporting for certain financial statement elements requires the exercise of judgment, subject to revision based on experience.
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Research Case 11-9

Requirement 1 The reference locations for the impairment of property, plant, and equipment and intangible assets include: FASB ASC 36010: Property, Plant and EquipmentOverall, and FASB ASC 350-20: Intangibles-Goodwill and OtherGoodwill. Requirement 2 Property, plant, and equipment and finite-life intangible assets are tested for impairment only when events or changes in circumstances indicate book value may not be recoverable. Intangible assets with indefinite useful lives, including goodwill, should be tested for impairment on an annual basis and in between annual test dates if events or circumstances indicate that the fair value of the reporting unit is below its book value. Requirement 3 Property, plant, and equipment and finite-life intangible assets: Determining whether to record an impairment loss and actually recording the loss is a two-step process. The first step is a recoverability test - an impairment loss is required only when the undiscounted sum of estimated future cash flows from an asset is less than the assets book value. The measurement of impairment lossstep 2is the difference between the assets book value and its fair value. Intangible assets with indefinite useful lives (other than goodwill): The measurement of an impairment loss for indefinite-life intangible assets other than goodwill is a one-step process. We compare the fair value of the asset with its book value. If book value exceeds fair value, an impairment loss is recognized for the difference. Goodwill: Determining whether to record an impairment loss and actually recording the loss is a two-step process. Step 1: A goodwill impairment loss is indicated when the fair value of the reporting unit is less than its book value. Step 2: A goodwill impairment loss is measured as the excess of the book value of the goodwill over its implied fair value. The implied fair value of goodwill is calculated in the same way that goodwill is
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determined in a business combination. That is, its a residual amount measured by subtracting the fair value of all identifiable net assets from the consideration exchanged using the units previously determined fair value as the consideration exchanged.
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Case 11-9 (concluded) Requirement 4 Property, plant, and equipment and intangible assets to be sold should be classified as held-for-sale in the period in which all of the following criteria are met: a. Management, having the authority to approve the action, commits to a plan to sell the asset. b. The asset or asset group is available for immediate sale in its present condition. c. An active program to locate a buyer and other actions required to complete the plan to sell the asset or asset group have been initiated. d. The sale is probable. e. The asset or asset group is being actively marketed for sale at a price that is reasonable in relation to its current fair value. f. Actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. The specific reference for these criteria is FASB ASC 36010459. Requirement 5 Property, plant, and equipment and intangible assets or groups of these assets classified as held-for-sale is measured at the lower of its (a) book value or (b) fair value less cost to sell. An impairment loss is recognized for any write-down to fair value less cost to sell.
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Ethics Case 11-10

Requirement 1 2011 expense using CEO's approach: $42,000,000 $4,200,000 x 2 years 8,400,000 33,600,000 3 $11,200,000 Cost Previous annual depreciation ($42,000,000 10 years) Depreciation to date (2009-2010) Book value Estimated remaining life (2011-2013) New annual depreciation
2011 income would include only depreciation expense of $11,200,000. 2011 expense using Heather's approach: $42,000,000 $4,200,000 x 2 years 8,400,000 33,600,000 12,900,000 20,700,000 3 $ 6,900,000 Cost Previous annual depreciation ($42,000,000 10 years) Depreciation to date (2009-2010) Book value Write-down New depreciable base Estimated remaining life (2011-2013) New annual depreciation
2011 income would include depreciation expense of $6,900,000 and an asset writedown of $12,900,000 for a total income reduction of $19,800,000. Using Heather's approach, 2011's before tax income would be lower by $8,600,000 ($19,800,000 - 11,200,000).
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Case 11-10 (concluded) Requirement 2 Discussion should include these elements. Facts: GAAP provides guidance for recording impairment losses on partial write-downs of property, plant, and equipment and intangible assets remaining in use. Assets should be written down if there has been a significant impairment of value such as in decreased product demand and full recovery of book value through use or resale is not expected. Although the decision and computation to record an impairment loss often is very subjective and difficult to measure, Heather is able to estimate an equipment impairment of $12,900,000, presumably using the best information available. The simple revision in service life approach is clearly an effort to enhance net income on the part of the CEO. Ethical Dilemma: Is Heather's obligation to challenge the questionable application of revision in service life more important than her obligation to her boss and to the company's effort to reflect a favorable net income? Who is affected? Heather CEO and other managers Other employees Shareholders Potential shareholders Creditors Company auditors
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Judgment Case 11-11

Requirement 1 By changing its depreciation method, a company can shift reported income between periods. For example, a shift from an accelerated method to the straight-line method increases income in the year of the change. However, in some future period or periods, income will be lower than it would have been if the change had not been made. This is not an effective way to manage earnings because the effect on income of switching from one method to another must be disclosed. Requirement 2 A company can manage earnings by changing the estimated useful lives of depreciable assets. For example, reducing useful lives causes a decrease in income in one or more years including the year of the change, and increases income in some future years. This is not an effective way to manage earnings because the effect on income of changing useful lives, if material, must be disclosed. Requirement 3 One possible approach to answering this question is to assume a company overstates its impairment loss. For example, assume that the book value of depreciable assets is $20 million. The fair value of these assets is estimated to be $13 million, indicating an impairment loss of $7 million. If these assets are written down to $8 million, the company has effectively shifted $5 million in pre-tax income from the current period to future periods. By writing down the assets to $8 million instead of $13 million, future depreciation is $5 million less than it would have been with a more appropriate write-down.
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Judgment Case 11-12

Transaction 1. Disposition Transaction is correctly recorded as repairs and maintenance expense. Transaction is correctly recorded as repairs and maintenance expense. Transaction is incorrectly recorded. The amount should be capitalized as part of the cost of the plant. Transaction is incorrectly recorded. The amount should be capitalized either as part of the cost of the plant or as a reduction in the accumulated depreciation of the plant. Transaction is correctly recorded as repairs and maintenance expense. Transaction is correctly recorded as repairs and maintenance expense. Transaction is incorrectly recorded. The amount should be capitalized as equipment. Transaction is correctly recorded as repairs and maintenance expense.
2.
3.
4.
5.
6.
7.
8.
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Real World Case 11-13

Requirement 1
($ in millions)
Property, plant and equipment (Cost): Balance, beginning of 2008 Add: Acquisitions during 2008 Less: Balance end of 2008 Dispositions during 2008 Property, plant and equipment (Accumulated depreciation): Balance, beginning of 2008 Add: Depreciation for 2008 Less: Balance end of 2008 Accumulated depreciation of 2008 dispositions Gain (loss) on 2008 dispositions: Cost of dispositions Less: Accumulated depreciation of dispositions Book value of dispositions Proceeds from dispositions Less: Book value of dispositions Gain on 2008 dispositions Requirement 2 2008 depreciable assets: Property, plant and equipment Less: Land Cost of depreciable assets
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$19,208 4,597 (23,487) $ 318
$ 9,211 1,919 (10,963) $ 167
$ 318 (167) $ 151 $982 (151) $831
$23,487 (575) $22,912
Assuming that Caterpillar uses the straight-line depreciation method, $22,912 $1,919 (2008 depreciation) = 11.94 years. The approximate average service life of Caterpillar's depreciable assets is 12 years.
11-128
Real World Case 11-14

Requirement 3 The following was taken from the companys 2008 financial statements. Your results could differ if the company changes any of its policies in years after 2008. a. The company's depreciation and depletion policies, disclosed in Note 1. Summary of Significant Account Policies, are as follows: Depreciation and depletion of all capitalized costs of proved crude oil and natural gas producing properties, except mineral interests, are expensed using the unit-of-production method generally by individual field as the proved developed reserves are produced. Depletion expenses for capitalized costs of proved mineral interests are recognized using the unit-of-production method by individual field as the related proved reserves are produced. Periodic valuation provisions for impairment of capitalized costs of unproved mineral interests are expensed. Depreciation and depletion expenses for mining assets are determined using the unit-of-production method as the proven reserves are produced. The capitalized costs of all other plant and equipment are depreciated or amortized over their estimated useful lives. In general, the declining-balance method is used to depreciate plant and equipment in the United States; the straight-line method generally is used to depreciate international plant and equipment and to amortize all capitalized leased assets. b. Expenditures for maintenance (including those for planned major maintenance projects), repairs and minor renewals to maintain facilities in operating condition are generally expensed as incurred. Major replacements and renewals are capitalized.
11-129
IFRS Case 11-15

Requirement 2 Cadbury Schweppes values its property, plant and equipment at cost less accumulated depreciation. IFRS also allows the valuation of these assets at fair value (revaluation). If revaluation is chosen, all assets within a class of PP&E must be revalued on a regular basis. U.S. GAAP does not allow the revaluation option. Property, plant and equipment must be valued at cost less accumulated depreciation.
11-130
Analysis Case 11-16

Requirement 1 The statement of cash flows reports depreciation and amortization of $769 million. Requirement 2 Dell uses the straight-line depreciation method over the estimated economic lives of the assets, which range from ten to 30 years for buildings and two to five years for all other assets.
11-131
British Airways Case

Requirement 1
( in millions)
March 31, 2009

Equipment Accumulated depreciation Book value
Before Revaluation 783 x

517 x x
After Revaluation 280/266 = 824

280/266 = 280/266 = 544
266
280
The entry to revalue the equipment and the accumulated depreciation accounts (and thus the book value) is: Equipment (824 783) Accumulated depreciation (544 517) Revaluation surplusOCI (280 266) 41 27 14
Requirement 2 Under U.S. GAAP, property, plant, and equipment is valued at cost less accumulated depreciation. U.S. GAAP prohibits revaluation. Requirement 3 IFRS 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.
Requirement 4 Per note 2, BA reviews the residual values of its depreciable assets annually. This annual review is required under IFRS. Under U.S. GAAP, there is no requirement to review residual value each year.
11-132
British Airways Case (continued)
Requirement 5 Per note 2, goodwill is tested for impairment annually and at other times when such indicators exist. Other non-financial assets are tested for impairment when there are indicators that the carrying amount (book value) may not be recoverable. This approach is similar to U.S. GAAP. However, under IFRS, assets must be assessed for indicators of impairment at the end of each reporting period.
Requirement 6 In note 19, BA states that a goodwill impairment review is carried out at the level of a cash-generating unit, defined as the smallest identifiable group of assets, liabilities and associated goodwill that generates cash inflows that are largely independent of the Groups other cash flows from other assets or groups of assets. The carrying value (book value) of the cash-generating unit is compared to the recoverable amount. If the carrying value exceeds the recoverable amount, goodwill is considered impaired. The amount of impairment loss is measured as the difference between the carrying value and the recoverable amount. The recoverable amount is the higher of fair value less costs to sell and value in use (present value of estimated future cash flows). Under U.S. GAAP, impairment is assessed at the level of the reporting unit a segment or a component of an operating segment for which discrete financial information is available. The measurement of an impairment loss is a two-step process. Step 1 compares the fair value of the reporting unit with its book value. A loss is indicated if fair value is less than book value. If step 2 is necessary, an impairment loss is measured as the excess of book value over the implied fair value of goodwill. The implied fair value of goodwill is calculated in the same way that goodwill is determined in a business combination. That is, its a residual amount measured by subtracting the fair value of all identifiable net assets from the purchase price using the units previously determined fair value as the purchase price.
11-133
British Airways Case (concluded)
Requirement 7
( in millions)
Revaluation expense Landing rights (205 190)
15 15
11-134

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Chapter 11 - Property, Plant, and Equipment and Intangible Assets: Utilization and Impairment

Property, Plant, and Equipment and

Intangible Assets: Utilization and Impairment

QUESTIONS FOR REVIEW OF KEY TOPICS

Answers to Questions (continued) Question 11-6

Answers to Questions (continued) Question 11-11

Answers to Questions (continued) Question 11-16

Answers to Questions (concluded)

Brief Exercise 11-2

a. Straight-line: = $7,000 per year

= 50% DDB rate = $15,000 = $ 7,500

2,200 hours x $2.80 = $6,160 3,000 hours x $2.80 = $8,400

Brief Exercise 11-3

($30,000 11,250) x 50%

Brief Exercise 11-4

Brief Exercise 11-5

= $2.75 per foot

Year 1 depletion Year 2 depletion

Brief Exercise 11-6

Goodwill is not amortized. amortized.

In-process research and development is not

Amortization of the patent: ($4,000,000 5) x 6/12

*Amortization of the developed technology: ($3,000,000 5) x 6/12 = $300,000

Brief Exercise 11-7Calculation of annual depreciation after the estimate

Brief Exercise 11-8

$9,000,000 (640,000) $8,360,000 x 2/23 $ 726,957

*$8,000,000 25 = $320,000 x 2 years = $640,000

Remaining life is 23 years. Twice the straight-line rate is 2/23.

Brief Exercise 11-9

Brief Exercise 11-10

Brief Exercise 11-11

Fair value Impairment loss

21.0 million $ 5.5 million

Brief Exercise 11-12

Brief Exercise 11-13

$40 million 31 million $ 9 million

$15 million 9 million $ 6 million

Brief Exercise 11-14

Brief Exercise 11-15

Brief Exercise 11-16

Year 2011 2012 2013 2014 2015 Total

Depreciable Base $30,000 30,000 30,000 30,000 30,000

Depreciation X Rate per Year =

Depreciation $10,000 8,000 6,000 4,000 2,000 $30,000

Exercise 11-1 (concluded)

Straight-line rate of 20% (1 5 years) x 2 = 40% DDB rate.

Year 2011 2012 2013 2014

Book Value Beginning of Year X $33,000 19,800 11,880 7,128

Depreciation Rate per Year = 40% 40% 40% 40%

Depreciation $ 13,200 7,920 4,752 2,851

Book Value End of Year $19,800 11,880 7,128 4,277

* Amount necessary to reduce book value to residual value

Year 2011 2012 2013 2014 2015 Totals

Actual Miles Driven X 22,000 24,000 15,000 20,000 21,000 102,000

Depreciation Rate per Mile = $.30 .30 .30 .30 *

Depreciation $6,600 7,200 4,500 6,000 5,700 * $30,000

Book Value End of Year $26,400 19,200 14,700 8,700 3,000

* Amount necessary to reduce book value to residual value

5. Units-of-production: $115,000 - 5,000

($115,000 - 5,750) x 20%

$ 4,313 $12,937 3,666 $16,603 $16,603

($115,000 - 4,313) x 15%