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49 Cards in this Set

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Types of Depreciation - Physical Depreciation

This type of depreciation is related to an asset's deterioration & wear over a period of time.

Types of Depreciation - Functional Depreciation

Functional depreciation arises from obsolescence or inadequacy of the asset to perform efficiently. Obsolescence may result from diminished demand for the product that the depreciable asset produces or from the availability of a new depreciable asset that can perform the same function for substantially less cost.

U.S. GAAP vs. IFRS - Depreciation method requirements

Under IFRS, the depreciation method used should reflect the expected pattern of fixed asset consumption. Additionally, under IFRS, estimated useful life, salvage value, & the depreciation method used should be reviewed for appropriateness at each balance sheet date. These are not requirements under U.S. GAAP.

Advantages of Component Depreciation over Composite Depreciation:

1. Depreciation expense for the year would be more accurate because each component item would be depreciated over its useful life.



2. Repair and maintenance expense would be more accurate because replacements of components would be excluded.

Component Depreciation

This is not available for MACRS recovery property for tax purposes because depreciation expense under the component method is generally higher and MACRS is already high. However, it does appear to be available when straight-line depreciation is elected.

U.S. GAAp vs. IFRS - Component Depreciation

IFRS require component depreciation. Separate significant components of a fixed asset with different lives should be recorded and depreciated separately. The carrying amount of parts or components that are replaced should be derecognized.

Composite (Dissimilar Assets) or Group (Similar Assets) Depreciation

This is the process of averaging the economic lives of a number of property units and depreciating the entire class of assets over a single life (e.g. all at 5 years), thus simplifying record keeping of assets and depreciation calculations.

Composite (Dissimilar Assets) or Group (Similar Assets) Depreciation - Gain or Loss Recognition

No gain or loss is recognized when one asset in the group is retired. The gain or loss that results is absorbed in the accumulated depreciation account. The accumulated depreciation account is debited (credited) for the difference between the original cost and the cash received.

Basic Depreciation Methods: Sum-of-the-Years'-Digits

Calculation: Each year is progressively numbered & then added. E.g., for a 4 year life: 1+2+3+4=10



Formula:


Depreciation expense=(cost-salvage value)x(remaining life of asset/sum-of-the-years' digits)

How to calculate the Sum-of-the-Years' Digits for an asset with a long life:

Use general formula:


S =(N x (N+1))/2



E.g., for an asset w/ a 50-year life:


S = [50 x (50+1)]/2


S = 1,275 Sum-of-the-years' digits for 50 years.

Basic Depreciation Methods: Declining Balance

The most common accelerated method.


Calculation: Each year's depreciation rate is double the straight line rate. In the final year, the asset is depreciated to its salvage value, if any.



Depreciation Expense = 2 x (1/N) x (Cost - Acc. Depreciation)

Which depreciation methods are the only methods that ignore salvage value in the calculation of depreciation.

The declining balance methods. Salvage value is only used as the limitation of total depreciation.

Basic Depreciation Methods: Units-of-Production (productive output)

This method relates depreciation to the estimated production capability of an asset & is expressed in a rate per unit or hour.


Formula:


Rate per unit = (cost-salvage value)/estimated units


Depreciation expense = Rate per unit x number of units produced

Basic Depreciation Methods: Partial Year Depreciation

When an asset is placed in service during the year, the depreciation expense is taken only for the portion of the year that the asset is used. For example, if an asset (of a company on a calendar year basis) is placed in service on July 1, only six months' depreciation is taken.

Basic Depreciation Methods: Disposals - Journal Entries

Sale of an asset during its useful life:


DR: Cash received from sale


DR: Accumulated depreciation of sold asset


CR: Sold asset at cost


CR/DR: The difference is gain/loss


Write-off fully depreciated asset:


DR: Accumulated depreciation (100%)


CR: Old asset at full cost (100%)


Total & permanent impairment:


DR: Accumulated depreciation per records


DR: Loss due to impairment (the difference)


CR: Asset at full cost

Basic Depreciation Methods: Disclosure

The following disclosures of depreciable assets & depreciation are made in the FSs or notes:


1. Depreciation expense for the period.


2. Balance of major classes of depreciable assets by nature or function.


3. Acc. deprec. allowances by classes or in total.


4. The methods used, by major classes, in computing depreciation.

Advantages of the Straight-Line Method of Depreciation:

1. simple to compute


2. applies to virtually all assets


3. consistent from year to year


4. Wide acceptability


5. similar to treatment of prepaid items

Disadvantages of the Straight-Line Method of Depreciation:

1. Does not reflect difference in usage of asset from year to year



2. Does not accurately match costs with revenue

Advantages & Disadvantages of the Machine Hours and Units-of-Production Method

Advantages


1. Matches costs with revenues


2. Reflects activity of the enterprise


Disadvantages


1. If no activity, no depreciation expensed; however, in reality, all assets depreciate


2. Cannot be used for all assets (e.g., buildings).


3. Can be complex because it requires clerical work & records.

Advantages of Declining-balance Methods:

1. Matches costs to revenues since greater utility is reflected in greater depreciation during earlier years.



2. As the amount of depreciation decreases, repairs and maintenance charges increase thereby tending to balance out one another.

Disadvantages of declining-balance Methods:

1. Does not reflect changes in the activity of the asset.


2. Computation can be complex


3. Greater disparity in amount of depreciation between earlier years and later years.


4. Possibility that with decreasing depreciation and increasing repairs and maintenance, income is artificially smoothed over the years.

Depletion - Definition

The allocation of the cost of wasting natural resources such as oil, gas, timber, and minerals to the production process.

Depletion - Purchase Cost

Includes any expenditures necessary to purchase and then prepare the land for the removal of resources, such as drilling costs or the costs for tunnels or shafts for the oil industry (intangible development costs) or to prepare the asset for harvest, such as in the lumber industry.

Depletion - Depletion Base

The depletion base is the cost to purchase the property minus the estimated net residual value remaining after all resources have been removed from the property.



Formula: cost - residual value

Depletion - Cost Depletion Method (GAAP)

Computed by dividing the current estimated recoverable units into unrecovered cost (less salvage) to arrive at a cost depletion rate which is multiplied by units produced to allocate the costs to production.

Depletion - Percentage Depletion (not GAAP/tax only)

(1) It is based on a % of sales. It is allowed by Congress as a tax deduction to encourage exploration in very risky businesses.


(2) Percentage depletion can (and usually does) exceed cost depletion


(3) It is limited to 50% of net income from the depletion property computed before the percentage depletion allowance

Depletion - Unit Depletion Rate (depletion per unit)

Calculated by dividing the depletion base by estimated removal units.

Depletion - Unit Depletion Rate - Depletion Base

The depletion base may be calculated as:


(1) Cost to purchase property.


(2) Plus: Development costs to prepare the land for extraction.


(3) Plus: Any estimated restoration costs.


(4) Less: Residual value of land after the resources (e.g., mineral ore, oil, etc.) are extracted

Calculation of Depletion:

Total depletion is calculated by multiplying unit depletion rate times # of units extracted. If all units extracted are not sold, then depletion must be allocated between COGS & inventory. The amount of depletion to be incl. in COGS is calculated by multiplying the unit depletion rate by the # of units sold. Depletion applicable to units extracted but not sold is allocated to inventory as direct materials.

Pass Key: When computing depletion on land, remember it is REAL property:

Residual value (subtract)


Extraction/development cost


Anticipated restoration cost


Land purchase price

Jan., Vorst purchased a mineral mine for $2,640,000 w/ removable ore estimated at 1,200,000 tons. After extraction, Vorst is required to restore land to original condition at an estimated cost of $180,000. Vorst believes it will can sell property afterwards for $300,000. Vorst incurred $360,000 of development costs preparing mine for production & removed & sold 60,000 tons of ore. In its I/S, what amount should Vorst report as depletion?

$144,000


The depletion base equals the purchase price ($2,640,000) plus the development costs ($360,000) plus the estimated restoration costs ($180,000) less the expected salvage value ($300,000). Depletion is $2.40 per ton ($2,880,000 / 1,200,000 tons). Depletion expense is $144,000 ($2.40 per ton x 60,000 tons sold).

Rye Co. purchased a machine with a four-year estimated useful life and an estimated 10% salvage value for $80,000 on January 1, 1992. In its income statement, what would Rye report as the depreciation expense for 1994 using the double-declining-balance method?

$10,000. The double-declining-balance rate is 50% (2 x 25% straight-line rate). 1992 expense is $40,000 (.5 x book value of $80,000). 1993 expense is $20,000 [50% x book value of $40,000 ($80,000 - $40,000)]. 1994 expense is $10,000 [50% x book value of $20,000 ($40,000 - $20,000)].

Turtle purchased equipment Jan 2, Yr 1, for $50,000. Equipment had estimated 5-yr service life. Turtle's policy is to use double-declining depreciation for first 2 yrs of asset's life, and then switch to the straight-line depreciation method. In its December 31, Year 3, balance sheet, what amount should Turtle report as accumulated depreciation for equipment?

$38,000.

Jan 2 of yr 1, Lem bought machinery under a contract that required a down payment of $10,000, plus 24 monthly payments of $5,000 each. The cash equivalent price of the machinery was $110,000. The machinery has estimated useful life of 10 yrs & estimated salvage value of $5,000. Lem uses straight-line depreciation. In its year-end I/S, what amount should Lem report as depreciation?

$10,500. On the transaction date, the machinery would be recorded at its fair market value ($110,000), cash would be credited ($10,000), and notes/payable would be credited for $100,000. The cash payments include interest as well as principal. Straight-line depreciation = ($110,000 cost - $5,000 salvage value) / 10 years life = $10,500.

Is land depreciated?

Nope.

In which situation is the units-of-production method of depreciation most appropriate?


a. Asset's service potential declines with the passage of time.


b. Asset's service potential declines with use.


c. Asset incurs increasing repairs and maintenance with use.


d. An asset is subject to rapid obsolescence.

An asset's service potential declines with use.

When is the straight-line depreciation method most appropriate?

When an asset's service potential declines with the passage of time

When are the accelerated depreciation methods most appropriate?

When an asset is subject to rapid obsolescence or when an asset incurs increasing repairs and maintenance with use.

4 yrs ago on Jan 2, Randall purchased a building for $250,000, w/ no salvage value. Est. useful life was 10 years. Randall used straight-line depreciation method. An impairment loss on the asset of $30,000 was recognized on Dec 31 of the current year. Estimated useful life of the asset at Dec 31 of the current year did not change. What amount should Randall report as depreciation expense in its I/S for next yr?

$20,000. After 4 years, the accumulated depreciation is $100,000 and the net book value would be $150,000 ($250,000 - $100,000). In Year 5, an impairment loss of $30,000 is recorded and the net book value of the asset is $120,000 ($150,000 - $30,000). With 6 years remaining, the straight-line depreciation is $120,000 / 6 years = $20,000 per year.

On January 1, Year 1, Crater, Inc. purchased equipment having an estimated salvage value equal to 20% of its original cost at the end of a 10-year life. The equipment was sold December 31, Year 5, for 50% of its original cost. If the equipment's disposition resulted in a reported loss, which of the following depreciation methods did Crater use?

Straight-line method. After 5 years of straight-line depreciation over a 10-year life, accumulated depreciation would equal 50% of the net unrecoverable cost (80% times cost) or 40% of the original cost, leaving a book value of 60% times the original cost. When the asset was sold for 50% of its original cost, this amount was less than book value, resulting in a loss.

Which of the following uses the straight-line depreciation method?



- Group depreciation?


- Composite depreciation?

Both group and composite depreciation are based on the straight-line depreciation method. The group method is for groups of similar assets while the composite method is for a collection of dissimilar assets.

Cantor purchased a coal mine for $2,000,000. It cost $500,000 to prepare for coal extraction. It was estimated 750,000 total tons would be extracted from the mine. Cantor planned to sell the property for $100,000 at the end of its useful life. During the current year, 15,000 tons of coal were extracted & sold. What would be Cantor's depletion amount per ton for the yr?

$3.20. The total cost is $2,400,000 ($2,000,000 + $500,000 - $100,000 = $2,400,000). That total cost is divided by the estimated 750,000 tons of coal, for a per unit depletion amount of $3.20. Note that the depletion amount per unit would be the same for every year unless additional expenditures were incurred.

Which depreciation methods do not incorporate salvage value?

Double - declining method.

In Yr 6, Spirit determined the 12-yr estimated life of a machine purchased for $48,000 in Jan Yr 1 should be extended by three years. The machine is being depreciated using the straight-line method and has no salvage value. What amount of depreciation expense should Spirit report in its financial statements for the year ending December 31, Year 6?

$2,800. From Year 1 through Year 5, annual depreciation of $4,000 ($48,000 / 12 years) was recorded on the machine, for total accumulated depreciation of $20,000. On January 1, Year 6, the NBV of the machine was $28,000. Extension of the machine's useful life by 3 years means there are 10 years remaining.

A depreciable asset has an estimated 15% salvage value. Under which of the following methods, properly applied, would the accumulated depreciation equal the original cost at the end of the asset's estimated useful life?



Straigh-line? Double-declining?

Neither. If accumulated depreciation equals original cost, then the asset has been depreciated to $0. Depreciable assets should not depreciated below salvage value under any depreciation method.

Jan 1, Yr 1, an entity using IFRS acquired machinery for $300,000 & est. life of 15 years. Machinery cost included $55,000 cost of a component replaced every 10 yrs & initial $5000 inspection fee. Machinery must be re-inspected every 5 yrs at $5,000 per inspection. The entity uses straight-line depreciation. What is depreciation expense for Dec 31, Yr 1?

$22,500. IFRS requires component depreciation.



Machinery: ($300,000 - $55,000 - $5,000) / 15 years = $240,000 / 15 years = $16,000


Component: $55,000 / 10 years = $5,500


Inspection Cost: $5,000 / 5 years = $1,000


Total annual straight line depreciation = $16,000 + $5,500 + $1,000 = $22,500

A manufacturing firm purchased used equipment for $135,000. Original owners estimated the residual value of the equipment was $10,000. Carrying amount of the equipment was $120,000 when ownership transferred. New owners estimate the expected remaining life of equipment was 10 yrs, w/ a $15,000 salvage value. What is the depreciable base used by the new owners?

$120,000. The depreciable base of an asset is cost minus salvage value. The cost of the equipment to the manufacturing firm was $135,000 and the salvage value estimate by the manufacturing firm was $15,000, so the depreciable base is $120,000 ($135,000 - $15,000).

Gei determined, due to obsolescence, equipment w/ original cost of $900,000 & acc. deprec. at Jan 1, 1992, of $420,000 had suffered permanent impairment, & should have a carrying value of only $300,000 at beginning of the year. The remaining life of equipment reduced from 8 years to 3. In its Dec 31, 1992, B/S what should Gei report as accumulated depreciation?

$700,000. When a permanent impairment occurs, the book value is reduced and a loss is recorded. The loss is credited to accumulated depreciation. In addition, the current year's depreciation expense should be added. The new book value is depreciated over the new life.

Newt Co. sold a warehouse and used the proceeds to acquire a new warehouse. The excess of the proceeds over the carrying amount of the warehouse sold should be reported as a(an):


a. Gain from discontinued operations, net of income taxes.


b. Extraordinary gain, net of taxes.


c. Part of continuing operations.


d. Reduction of the cost of the new warehouse.