Acc 318 Chapter 11 Fall 2006

Front 1

What does depreciation account for?

Back 1

Depreciation is not a matter of valuation but a means of cost allocation.

Front 2

What are the major decreasing-charge methods?

Back 2

1. Sum-of-the-years’ digits 2. Declining-balance method.

Front 3

Define depreciation

Back 3

Depreciation is defined as the accounting process of allocating the cost of tangible assets to expense in a systematic and rational manner to those periods expected to benefit from the use of the asset.

Front 4

What three questions need to be answered to set up a depreciation cycle for an asset?

Back 4

1. What depreciable base is to be used for the asset? 2. What is the asset’s useful life? 3. What method of cost apportionment is best for this asset?

Front 5

Define the activity method of depreciation

Back 5

The activity method (also called the variable charge approach) assumes that depreciation is a function of use or productivity instead of the passage of time. It considers either the input or the output measures.

Front 6

Define salvage value

Back 6

It is the estimated amount that will be received at the time the asset is sold or removed from service.

Front 7

Assets are retired for what two reasons?

Back 7

physical factors and economic factors

Front 8

Define physical factors

Back 8

Physical factors are the wear and tear, decay, and casualties that make it difficult for the asset to perform indefinitely.

Front 9

What is the equation for the activity method?

Back 9

[(Cost – salvage)*units] / total estimated units

Front 10

What are the 3 categories of economic factors?

Back 10

inadequacy, supersession, and obsolescence.

Front 11

What is the recording of depreciation an attempt to do?

Back 11

Depreciation is an attempt to match the cost of an asset to the periods that benefit from the use of that asset.

Front 12

define inadequacy

Back 12

It results when an asset ceases to be useful to a give enterprise because the demands of the firm have increased.

Front 13

define supersession

Back 13

Supersession is the replacement of one asset with another more efficient and economical asset.

Front 14

What is the assumption of the straight-line method?

Back 14

The straight-line method considers depreciation a function of time rather than a function of usage.

Front 15

define obsolescence

Back 15

Obsolescence is the catchall for situations not involving inadequacy and supersession.

Front 16

What are the two special depreciation methods

Back 16

(a) group and composite methods (b) hybrid or combination methods
A company may choose these methods because the assets have unique characteristics, or the industry dictates that a special depreciation method be adopted.

Front 17

What are the 3 major methods of depreciation?

Back 17

1. Activity method 2. Straight-line method 3. Decreasing-charge method

Front 18

What is the equation for the straight-line method?

Back 18

(Cost – salvage) / estimated service life

Front 19

What is the assumption of the sum-of-the-year's-digits method?

Back 19

depreciation occurs the most when the asset is the most new

Front 20

What is the equation for the denominator in the sum-of-the-year's-digits method?

Back 20

[N(N+1)]/2

Front 21

What is the equation for the double declining balance method?

Back 21

depreciation = (book value)*[2*(1/estimated service life)]

Front 22

How should you depreciate for partial periods?

Back 22

In computing depreciation expense for partial periods, it is necessary to determine the depreciation expense for the full year and then to prorate this depreciation expense between the two periods involved. This process should continue throughout the useful life of the asset.

Front 23

In what way must a company depreciate its assets?

Back 23

A company is at liberty to adopt any one of these several factional-year policies in allocating cost to the first and last years of an asset’s life so long as the method is applied consistently. However, unless otherwise stipulated, depreciation is normally computed on the basis of the nearest full month.

Front 24

How are changes in depreciation estimates handled?

Back 24

Changes in estimate should be handled in the current and prospective periods. No entry is made at the time the change in estimate occurs, and charges for depreciation in subsequent periods (assuming use of the straight-line method) are based on dividing the remaining book value less any salvage value by the remaining estimated life.

Front 25

How is the lower of cost or market rule applied to property, plant, and equipment?

Back 25

It isn't.

Front 26

What is an impairment?

Back 26

Impairment occurs when the carrying amount of an asset is not recoverable, and therefore a write-off is needed.

Front 27

What are some examples of events that might lead to an impairment?

Back 27

1. A significant decrease in the market value of an asset. 2. A significant change in the extent or manner in which an asset is used. 3. A significant adverse change in legal factors or in the business climate that affects the value of an asset. 4. An accumulation of costs significantly in excess of the amount originally expected to acquire or construct an asset. 5. A projection or forecast that demonstrates continuing losses associated with an asset.

Front 28

Explain the "recoverability test"

Back 28

It is used to determine whether an impairment has occurred. First, estimate the future net cash flows expected from the use of that asset and its eventual disposition. If the sum of the expected future net cash flows (undiscounted) is less than the carrying amount of the asset, the asset is considered impaired.

Front 29

How is the "loss on impairment" measured?

Back 29

The impairment loss is the amount by which the carrying amount of the asset exceeds its fair value. The fair value of an asset is measured by its market value if an active market for it exists. If no active market exists, the present value of expected future net cash flows should be used.

Front 30

What is a common misconception about depreciation?

Back 30

That it provides funds for replacement of fixed assets. It is similar to any other expense in that it reduces net income. It does not involve a current cash flow.

Front 31

Where do the funds for the replacement of the fixed asset come from?

Back 31

The revenues generated through the use of the asset

Front 32

How is a loss on impairment recorded?

Back 32

Debit "Loss on Impairment." Credit "Accumulated Depreciation."

Front 33

How is impairment loss recorded in the income statement?

Back 33

The impairment loss is reported as part of income from continuing operations, generally in the “other expenses and losses” section.

Front 34

When does the lower of cost or market apply to an asset?

Back 34

Assets held for disposal are like inventory and should be reported at the lower of cost or net realizable value.

Front 35

What is the process of determining an impairment loss?

Back 35

1. Review events or changes in circumstances for possible impairment
2. If the review indicates impairment, aplly the recoverability test. If the sum of the expected future net cash flows from the long lived asset is less than the carrying amount of the asset, an impairment has occurred.
3. Assuming an impairment, the impairment loss is the amount by which the carrying amount of the asset is greater than the fair value of the asset.

Front 36

How should losses or gains related to impaired assets be recorded in the income statement?

Back 36

continuing operations

Front 37

What are restoration costs, and how should they be treated?

Back 37

substantial costs to restore property to its natural state after extraction has occurred; should be added to the depletion base

Front 38

Are assets being held for disposal depreciated?

Back 38

No, not during the period they are being held. Assets held for disposal are like inventory and should be reported at the lower of cost or net realizable value

Front 39

Can you restore an impairment loss on an asset held for use?

Back 39

Once an impairment loss is recorded, the reduced carrying amount of an asset held for use becomes its new cost basis.

Front 40

What happens if the impaired asset is intended to be disposed of instead of held for use?

Back 40

The impaired asset is reported at the lower of cost or Net realizable value[fair value - cost to sell]

Front 41

Can an asset being held for disposal be written up or down in future periods?

Back 41

yes as long as the write-up is never to an amount greater than the carrying amount of the asset before the impairment. Losses or Gains should be reported as part of income from continuing operations.

Front 42

The computation of the depletion base involves what four factors?

Back 42

1. acquistion cost of the deposit 2. exploration cost 3. development costs 4. restoration costs