Chapter

11-1
 CHAPTER 11

DEPRECIATION, IMPAIRMENTS,
AND DEPLETION

Intermediate Accounting
13th Edition
Kieso, Weygandt, and Warfield

Chapter
11-2
 Learning Objectives

1. Explain the concept of depreciation.

2. Identify the factors involved in the depreciation process.

3. Compare activity, straight-line, and decreasing-charge methods

of depreciation.

4. Explain special depreciation methods.

5. Explain the accounting issues related to asset impairment.

6. Explain the accounting procedures for depletion of natural

resources.

7. Explain how to report and analyze property, plant, equipment,

and natural resources.

Chapter
11-3
 Depreciation, Impairments, and Depletion

Presentation
Depreciation Impairments Depletion
and Analysis

Factors involved Recognizing Establishing a Presentation

Methods of impairments base Analysis
depreciation Measuring Write-off of
Special methods Impairments resource cost
Special issues Restoration of Estimating
loss reserves
Assets to be Liquidating
disposed of dividends
Continuing
controversy

Chapter
11-4
 Depreciation - Method of Cost Allocation

Depreciation is the accounting process of allocating

the cost of tangible assets to expense in a systematic
and rational manner to those periods expected to
benefit from the use of the asset.

Allocating costs of long-term assets:

Fixed assets = Depreciation expense
Intangibles = Amortization expense
Natural resources = Depletion expense

Chapter
11-5 LO 1 Explain the concept of depreciation.
 Depreciation - Method of Cost Allocation

Factors Involved in the Depreciation Process

Three basic questions:
(1) What depreciable base is to be used?
(2) What is the asset’s useful life?
(3) What method of cost allocation is best?

Chapter
11-6 LO 2 Identify the factors involved in the depreciation process.
 Depreciation - Method of Cost Allocation

Factors Involved in the Depreciation Process

Depreciable Base
Illustration 11-1

Chapter
11-7 LO 2 Identify the factors involved in the depreciation process.
 Depreciation - Method of Cost Allocation

Factors Involved in the Depreciation Process

Estimation of Service Lifes

 Service life of an asset often differs from its

physical life.

 Companies retire assets for two reasons:

 physical factors (such as casualty or

expiration of physical life) and

 economic factors (obsolescence).

Chapter
11-8 LO 2 Identify the factors involved in the depreciation process.
 Depreciation - Method of Cost Allocation

Methods of Depreciation
The profession requires the method employed be
“systematic and rational.” Examples include:

(1) Activity method (units of use or production).

(2) Straight-line method.
(3) Sum-of-the-years’-digits.
Accelerated methods
(4) Declining-balance method.
(5) Group and composite methods.
Special methods
(6) Hybrid or combination methods.

Chapter LO 3 Compare activity, straight-line, and decreasing-

11-9 charge methods of depreciation.
 Depreciation - Method of Cost Allocation

Activity Method
Illustration 11-2

Stanley Coal
Mines Facts

Illustration: If Stanley uses the crane for 4,000 hours

the first year, the depreciation charge is:
Illustration 11-3

Chapter LO 3 Compare activity, straight-line, and decreasing-

11-10 charge methods of depreciation.
 Depreciation - Method of Cost Allocation

Straight-Line Method
Illustration 11-2

Stanley Coal
Mines Facts

Illustration: Stanley computes depreciation as follows:

Illustration 11-4

Chapter LO 3 Compare activity, straight-line, and decreasing-

11-11 charge methods of depreciation.
 Depreciation - Method of Cost Allocation

Decreasing-Charge Methods
Illustration 11-2

Stanley Coal
Mines Facts

Sum-of-the-Years’-Digits. Each fraction uses the sum of

the years as a denominator (5 + 4 + 3 + 2 + 1 = 15). The
numerator is the number of years of estimated life
remaining as of the beginning of the year.

Chapter LO 3 Compare activity, straight-line, and decreasing-

11-12 charge methods of depreciation.
 Depreciation - Method of Cost Allocation

Sum-of-the-Years’-Digits
Illustration 11-6

Chapter LO 3 Compare activity, straight-line, and decreasing-

11-13 charge methods of depreciation.
 Depreciation - Method of Cost Allocation

Decreasing-Charge Methods
Illustration 11-2

Stanley Coal
Mines Facts

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

 Does not deduct the salvage value in computing the

depreciation base.
Chapter LO 3 Compare activity, straight-line, and decreasing-
11-14 charge methods of depreciation.
 Depreciation - Method of Cost Allocation

Declining-Balance Method
Illustration 11-7

Chapter LO 3 Compare activity, straight-line, and decreasing-

11-15 charge methods of depreciation.
 Depreciation - Method of Cost Allocation
E11-5 (Depreciation Computations—Four Methods): KC
Corporation purchased a new machine for its assembly process on
August 1, 2010. The cost of this machine was $150,000. The
company estimated that the machine would have a salvage value of
$24,000 at the end of its service life. Its life is estimated
at 5 years and its working hours are estimated at 21,000 hours.
Year-end is December 31.

Instructions: Compute the depreciation expense under the

following methods.
(a) Straight-line depreciation. (c) Sum-of-the-years’-digits.
(b) Activity method (d) Double-declining balance.

Chapter LO 3 Compare activity, straight-line, and decreasing-

11-16 charge methods of depreciation.
 Depreciation - Method of Cost Allocation

Straight-line Method
Current
Depreciable Annual Partial Year Accum.
Year Base Years Expense Year Expense Deprec.
2010 $ 126,000 / 5 = $ 25,200 x 5/12 = $ 10,500 $ 10,500
2011 126,000 / 5 = 25,200 25,200 35,700
2012 126,000 / 5 = 25,200 25,200 60,900
2013 126,000 / 5 = 25,200 25,200 86,100
2014 126,000 / 5 = 25,200 25,200 111,300
2015 126,000 / 5 = 25,200 x 7/12 = 14,700 126,000
$ 126,000
Journal entry:

2010 Depreciation expense 10,500

Accumultated depreciation 10,500

Chapter LO 3 Compare activity, straight-line, and decreasing-

11-17 charge methods of depreciation.
 Depreciation - Method of Cost Allocation

Activity Method (Assume 800 hours used in 2010)

($126,000 / 21,000 hours = $6 per hour)
(Given) Current
Hours Rate per Annual Partial Year Accum.
Year Used Hours Expense Year Expense Deprec.
2010 800 x $6 = $ 4,800 $ 4,800 $ 4,800
2011 x =
2012 x =
2013 x =
2014 x =
800 $ 4,800

Journal entry:
2010 Depreciation expense 4,800
Accumultated depreciation 4,800
Chapter
11-18 LO 3
 Depreciation - Method of Cost Allocation
5/12 = .416667
Sum-of-the-Years’-Digits Method 7/12 = .583333
Current
Depreciable Annual Partial Year Accum.
Year Base Years Expense Year Expense Deprec.

2010 $ 126,000 x 5/15 = 42,000 x 5/12 $ 17,500 $ 17,500

2011 126,000 x 4.58/15 = 38,500 38,500 56,000

2012 126,000 x 3.58/15 = 30,100 30,100 86,100

2013 126,000 x 2.58/15 = 21,700 21,700 107,800

2014 126,000 x 1.58/15 = 13,300 13,300 121,100

2015 126,000 x .58/15 = 4,900 4,900 126,000
$ 126,000
Journal entry:
2010 Depreciation expense 17,500
Chapter Accumultated depreciation 17,500
11-19 LO 3
 Depreciation - Method of Cost Allocation

Double-Declining Balance Method

Current
Depreciable Rate Annual Partial Year
Year Base per Year Expense Year Expense

2010 $ 150,000 x 40% = $ 60,000 x 5/12 = $ 25,000

2011 125,000 x 40% = 50,000 50,000

2012 75,000 x 40% = 30,000 30,000

2013 45,000 x 40% = 18,000 18,000

2014 27,000 x 40% = 10,800 Plug 3,000

$ 126,000
Journal entry:
2010 Depreciation expense 25,000
Accumultated depreciation 25,000
Chapter
11-20 LO 3
 Depreciation - Method of Cost Allocation

Special Depreciation Methods

The choice of method depends on the nature of the
assets involved:
Group method used when the assets are similar in
nature and have approximately the same useful lives.
Composite approach used when the assets are dissimilar
and have different lives.
Companies are also free to develop tailor-made
depreciation methods, provided the method results in
the allocation of an asset’s cost in a systematic and
rational manner (Hybrid or Combination Methods).
Chapter
11-21 LO 4 Explain special depreciation methods.
 Depreciation - Method of Cost Allocation

Special Depreciation Issues

(1) How should companies compute depreciation for
partial periods?
Companies normally compute depreciation on the
basis of the nearest full month.
(2) Does depreciation provide for the replacement of
assets?
Funds for the replacement of the assets come from
the revenues
(3) How should companies handle revisions in
depreciation rates?
Chapter
11-22 LO 4 Explain special depreciation methods.
 Depreciation - Method of Cost Allocation

Changes in Depreciation Rate

Accounted for in the period of change and
future periods (Change in Estimate)
Not handled retrospectively
Not considered errors or extraordinary items

Chapter
11-23 LO 4 Explain special depreciation methods.
 Change in Estimate Example

Arcadia HS, purchased equipment for $510,000 which

was estimated to have a useful life of 10 years with a
salvage value of $10,000 at the end of that time.
Depreciation has been recorded for 7 years on a
straight-line basis. In 2010 (year 8), it is determined
that the total estimated life should be 15 years with a
salvage value of $5,000 at the end of that time.
Questions:
 What is the journal entry to correct No Entry
the prior years’ depreciation? Required
 Calculate the depreciation expense
for 2010.
Chapter
11-24 LO 4 Explain special depreciation methods.
 Change in Estimate Example After 7 years

Equipment cost $510,000 First, establish

Salvage value - 10,000 NBV at date of
Depreciable base 500,000 change in estimate.
Useful life (original) 10 years
Annual depreciation $ 50,000 x 7 years = $350,000

Balance Sheet (Dec. 31, 2009)

Fixed Assets:
Equipment $510,000
Accumulated depreciation 350,000
Net book value (NBV) $160,000
Chapter
11-25 LO 4 Explain special depreciation methods.
 Change in Estimate Example After 7 years

Net book value $160,000 Depreciation

Salvage value (new) 5,000 Expense calculation
Depreciable base 155,000 for 2010.
Useful life remaining 8 years
Annual depreciation $ 19,375

Journal entry for 2010

Depreciation expense 19,375

Accumulated depreciation
19,375
Chapter
11-26 LO 4 Explain special depreciation methods.
 Impairments

When the carrying amount of an asset is not

recoverable, a company records a write-off referred
to as an impairment.
Events leading to an impairment:
a. Decrease in the market value of an asset.
b. Change in the manner in which an asset is used.
c. Adverse change in legal factors or in the business climate.
d. An accumulation of costs in excess of the amount originally
expected to acquire or construct an asset.
e. A projection or forecast that demonstrates continuing losses
associated with an asset.
Chapter
11-27 LO 5 Explain the accounting issues related to asset impairment.
 Impairments

Measuring Impairments
1. Review events for possible impairment.
2. If the review indicates impairment, apply 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
exceeds the fair value of the asset. The fair value is
the market value or the present value of expected
future net cash flows.
Chapter
11-28 LO 5 Explain the accounting issues related to asset impairment.
 Impairments
Illustration 11-16
Accounting for
Impairments

Chapter
11-29 LO 5 Explain the accounting issues related to asset impairment.
 Impairments
E11-16 (Impairment): Presented below is information related to
equipment owned by Pujols Company at December 31, 2010. Assume
that Pujols will continue to use this asset in the future. As of
December 31, 2010, the equipment has a remaining useful life of 4
years.
Cost $ 9,000,000
Accumulated depreciation to date 1,000,000
Expected future net cash flows 7,000,000
Fair value 4,400,000
Instructions:
(a) Prepare the journal entry (if any) to record the impairment of the
asset at December 31, 2010.
(b) Prepare the journal entry to record depreciation expense for 2011.
(c) The fair value of the equipment at December 31, 2011, is $5,100,000.
Prepare the journal entry (if any) necessary to record this increase in
fair value.
Chapter
11-30 LO 5 Explain the accounting issues related to asset impairment.
 Impairments

(a). Cost $9,000,000

Accumulated depreciation 1,000,000
Carrying amount 8,000,000
Fair value 4,400,000
Loss on impairment $3,600,000

12/31/10

Loss on impairment 3,600,000

Accumulated depreciation
3,600,000
Chapter
11-31 LO 5 Explain the accounting issues related to asset impairment.
 Impairments
(b). Net carrying amount $4,400,000
Useful life 4 years
Depreciation per year $1,100,000

12/31/11

Depreciation expense 1,100,000

Accumulated depreciation
1,100,000

(c). Restoration of any impairment loss is not permitted.

Chapter
11-32 LO 5 Explain the accounting issues related to asset impairment.
 Depletion

Natural resources, often called wasting assets,

include petroleum, minerals, and timber.
They have two main features:
1. complete removal (consumption) of the asset, and
2. replacement of the asset only by an act of nature.

Depletion is the process of allocating the cost of

natural resources.

Chapter
11-33 LO 6 Explain the accounting procedures for depletion of natural resources.
 Depletion

Establishing a Depletion Base

Computation of the depletion base involves four factors:
(1) Acquisition cost of the deposit,
(2) Exploration costs,
(3) Development costs, and
(4) Restoration costs.

Chapter
11-34 LO 6 Explain the accounting procedures for depletion of natural resources.
 Depletion

Write-off of Resource Cost

Normally, companies compute depletion on a units-of-
production method (an activity approach). Thus,
depletion is a function of the number of units extracted
during the period.
Calculation:
Total cost – Salvage value
= Depletion cost per unit
Total estimated units available

Units extracted x Cost per unit = Depletion

Chapter
11-35 LO 6 Explain the accounting procedures for depletion of natural resources.
 Depletion
E11-19 (Depletion Computations—Timber): Hernandez Timber
Company owns 9,000 acres of timberland purchased in 1999 at a
cost of $1,400 per acre. At the time of purchase the land without
the timber was valued at $400 per acre. In 2000, Hernandez built
fire lanes and roads, with a life of 30 years, at a cost of $87,000.
Every year Hernandez sprays to prevent disease at a cost of
$3,000 per year and spends $7,000 to maintain the fire lanes and
roads. During 2001, Hernandez selectively logged and sold 700,000
board feet of timber, of the estimated 3,000,000 board feet. In
2002, Hernandez planted new seedlings to replace the trees cut at
a cost of $100,000.
Instructions:
Determine the depreciation expense and the cost of timber sold
related to depletion for 2001.
Chapter
11-36 LO 6 Explain the accounting procedures for depletion of natural resources.
 Depletion
E11-19 (Depletion Computations—Timber)

Depreciation Expense:
Fire lanes and roads $ 87,000
Useful life 30
Depreciation expense per year $ 2,900

Chapter
11-37 LO 6 Explain the accounting procedures for depletion of natural resources.
 Depletion
E11-19 (Depletion Computations—Timber)

Depletion:
Cost of timberland per acre $ 1,400
Cost of land per acre (400)
Cost of timber only per acre $ 1,000
Total acres 9,000
Value of timber $ 9,000,000
Estimated total board feet 3,000,000
Cost per board foot $ 3.00
Board feet of timber sold 700,000
Cost of timber sold related to depletion $ 2,100,000

Chapter
11-38 LO 6 Explain the accounting procedures for depletion of natural resources.
 Depletion

Estimating Recoverable Reserves

 Same as accounting for changes in estimates.

 Revise the depletion rate on a prospective basis.

 Divides the remaining cost by the new estimate of the

recoverable reserves.

Chapter
11-39 LO 6 Explain the accounting procedures for depletion of natural resources.
 Depletion

Liquidating Dividends - Dividends greater than the

amount of accumulated net income.

Illustration: Callahan Mining had a retained earnings

balance of $1,650,000 and paid-in capital in excess of par
of $5,435,493. Callahan’s board declared a dividend of $3
a share on the 1,000,000 shares outstanding. It records
the $3,000,000 cash dividend as follows.

Retained Earnings 1,650,000

Paid-in Capital in Excess of Par 1,350,000
Cash
Chapter
11-40
3,000,000
LO 6 Explain the accounting procedures for depletion of natural resources.
 Depletion

Continuing Controversy
Oil and Gas Industry:
Full cost concept

Successful efforts concept

Chapter
11-41 LO 6 Explain the accounting procedures for depletion of natural resources.
 Presentation and Analysis

Presentation of Property, Plant, Equipment,

and Natural Resources
Depreciating assets, use Accumulated Depreciation.
Depleting assets may include use of Accumulated Depletion
account, or the direct reduction of asset.

Basis of valuation (cost)

Pledges, liens, and other commitments
Depreciation expense for the period.
Disclosures
Balances of major classes of depreciable assets.
Accumulated depreciation.
A description of the depreciation methods used.
Chapter LO 7 Explain how to report and analyze property,
11-42
plant, equipment, and natural resources.
 Presentation and Analysis

The assets turnover is a measure of a firm’s ability to

generate sales from a particular investment in assets.

Illustration 11-20

Solution on
Chapter
notes page LO 7 Explain how to report and analyze property,
11-43
plant, equipment, and natural resources.
 Presentation and Analysis

The profit margin on sales is a measure of the ability to

generate operating income from a particular level of sales.

Illustration 11-21

Solution on
Chapter
notes page LO 7 Explain how to report and analyze property,
11-44
plant, equipment, and natural resources.
 Presentation and Analysis

Rate of Return on Assets measures a firm’s success in using

assets to generate earnings.

Illustration 11-22

Solution on
Chapter
notes page LO 7 Explain how to report and analyze property,
11-45
plant, equipment, and natural resources.
 Presentation and Analysis

The analyst obtains further insight into the behavior of ROA

by disaggregating it into components of profit margin on
sales and asset turnover as follows:

Rate of Return Profit Margin on Asset

= x
on Assets Sales Turnover

Net Income Net Income Net Sales

= x
Average Total Assets Net Sales Average Total Assets

Chapter LO 7 Explain how to report and analyze property,

11-46
plant, equipment, and natural resources.
 Presentation and Analysis

The analyst obtains further insight into the behavior of ROA

by disaggregating it into components of profit margin on
sales and asset turnover as follows:

Rate of Return Profit Margin on Asset

= x
on Assets Sales Turnover

$64.2 $64.2 $420.1

= x
($811.8 + 665.3) / 2 $420.1 ($811.8 + 665.3) / 2

8.7% = 15.28% x .569

Chapter LO 7 Explain how to report and analyze property,

11-47
plant, equipment, and natural resources.
  Under both iGAAP and U.S. GAAP, interest costs incurred during
construction must be capitalized.

 iGAAP, like U.S. GAAP, capitalizes all direct costs in self-

constructed assets.

 The accounting for exchanges of nonmonetary assets has recently

converged between iGAAP and U.S. GAAP.

 iGAAP permits the same depreciation methods (straight-line,

accelerated, units-of-production) as U.S. GAAP.

Chapter
11-48
  As discussed in the Chapter 4 Convergence Corner, iGAAP permits
asset revaluations (which are not permitted in U.S. GAAP).
Consequently, companies that use the revaluation framework must
follow revaluation depreciation procedures.

 iGAAP also uses a fair value test to measure the impairment loss.
However, iGAAP does not use the first-stage recoverability test
used under U.S. GAAP—comparing the undiscounted cash flows to
the carrying amount. Thus, the iGAAP test is more strict than U.S.
GAAP.

Chapter
11-49
 Modified Accelerated Cost Recovery System

MACRS differs from GAAP in three respects:

1. a mandated tax life, which is generally shorter than

the economic life;

2. cost recovery on an accelerated basis; and

3. an assigned salvage value of zero.

Chapter
11-50 LO 8 Describe income tax methods of depreciation.
 Modified Accelerated Cost Recovery System
Tax Lives (Recovery Periods) Illustration 11A-1

Chapter
11-51 LO 8 Describe income tax methods of depreciation.
 Modified Accelerated Cost Recovery System
Tax Depreciation Methods
Illustration 11A-2

Chapter
11-52 LO 8 Describe income tax methods of depreciation.
 Modified Accelerated Cost Recovery System

Illustration: Computer and peripheral equipment purchased

by Denise Rode Company on January 1, 2009.

Chapter
11-53 LO 8 Describe income tax methods of depreciation.
 Modified Accelerated Cost Recovery System

Illustration:
Illustration 11A-3

Chapter
11-54 LO 8 Describe income tax methods of depreciation.
 Modified Accelerated Cost Recovery System
Illustration 11A-4
Illustration: Using the rates
from the MACRS
depreciation rate schedule
for a 5-year class of
property, Rode computes
depreciation as follows
Illustration 11A-5

Chapter
11-55 LO 8 Describe income tax methods of depreciation.
 Modified Accelerated Cost Recovery System

Additional Issues

Optional straight-line method

Tax versus book depreciation

Chapter
11-56 LO 8 Describe income tax methods of depreciation.
 Copyright

Copyright © 2009 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted
in Section 117 of the 1976 United States Copyright Act
without the express written permission of the copyright owner
is unlawful. Request for further information should be
addressed to the Permissions Department, John Wiley & Sons,
Inc. The purchaser may make back-up copies for his/her own
use only and not for distribution or resale. The Publisher
assumes no responsibility for errors, omissions, or damages,
caused by the use of these programs or from the use of the
information contained herein.

Chapter
11-57