Intermediate Accounting Seventeenth Edition Kieso ● Weygandt ● Warfield Chapter 11 Depreciation, Impairments, and Depletion This slide deck contains animations Please disable animations if they cause issues with your device Learning Objectives After studying this chapter, you should be able to: Understand depreciation concepts and methods of depreciation Discuss special depreciation methods and other depreciation issues Identify the accounting issues related to asset impairment Explain the accounting procedures for depletion of natural resources Demonstrate how to report and analyze property, plant, equipment, and natural resources Copyright ©2019 John Wiley & Sons, Inc Preview of Chapter 11 Depreciation, Impairments, and Depletion Depreciation • Factors involved • Methods of depreciation Special Methods and Other Issues • Special depreciation methods • Other depreciation issues Copyright ©2019 John Wiley & Sons, Inc Preview of Chapter 11 Impairments • Recognizing impairments • Measuring impairments • Restoration of loss Assets to be disposed of Copyright â2019 John Wiley & Sons, Inc Preview of Chapter 11 Depletion • Establishing a base • Write-off of resource cost • Estimating reserves Liquidating dividends Continuing controversy Copyright â2019 John Wiley & Sons, Inc Preview of Chapter 11 Presentation and Analysis Presentation Analysis Copyright â2019 John Wiley & Sons, Inc Learning Objective Describe Depreciation Concepts and Methods of Depreciation LO Copyright ©2019 John Wiley & Sons, Inc Depreciation—A Method of Cost Allocation Depreciation is the accounting process of allocating the cost of tangible assets to expense in a systematic and rational manner to those periods expected to benefit from the use of the asset Allocating costs of long-lived assets: LO • Fixed assets = Depreciation expense • Intangibles = Amortization expense • Natural resources = Depletion expense Copyright ©2019 John Wiley & Sons, Inc Factors Involved in the Depreciation Process Three basic questions: LO 1) What depreciable base is to be used? 2) What is the asset’s useful life? 3) What method of cost apportionment is best for this asset? Copyright ©2019 John Wiley & Sons, Inc Factors Involved in Depreciation Depreciable Base for the Asset Original cost LO $10,000 Less: Salvage value 1,000 Depreciation base $ 9,000 Copyright ©2019 John Wiley & Sons, Inc 10 Appendix 11A: Income Tax Depreciation Modified Accelerated Cost Recovery System MACRS differs from GAAP in three respects: LO a mandated tax life, which is generally shorter than the economic life; cost recovery on an accelerated basis; and an assigned salvage value of zero Copyright ©2019 John Wiley & Sons, Inc 61 Modified Accelerated Cost Recovery System Tax Lives (Recovery Periods) 3-year property Includes small tools, horses, and assets used in research and development activities 5-year property Includes automobiles, trucks, computers and peripheral equipment, and office machines 7-year property Includes office furniture and fixtures, agriculture equipment, oil exploration and development equipment, railroad track, manufacturing equipment, and any property not designated by law as being in any other class LO Copyright ©2019 John Wiley & Sons, Inc 62 Tax Lives (Recovery Periods) MACRS Property Classes 10-year property Includes railroad tank cars, mobile homes, boilers, and certain public utility property 15-year property Includes roads, shrubbery, and certain low-income housing 20-year property Includes roads, shrubbery, and certain low-income housing 27.5-year property Includes residential rental property 39-year property includes nonresidential real property LO Copyright ©2019 John Wiley & Sons, Inc 63 Modified Accelerated Cost Recovery System Tax Depreciation Methods M A CR S Property Class LO Depreciation Method 3-, 5-, 7-, and 10-year property Double-declining-balance 15- and 20-year property 150% declining-balance 27.5- and 39-year property Straight-line Copyright ©2019 John Wiley & Sons, Inc 64 Example of MACRS Illustration: Computer and peripheral equipment purchased by Denise Rode Company on January 1, 2019 Acquisition Date LO January 1, 2019 Cost $100,000 Estimated useful life years Estimated salvage value $16,000 MACRS class life years MACRS method 200% declining-balance GAAP method Straight-line Disposal proceeds-January 2, 2026 $11,000 Copyright ©2019 John Wiley & Sons, Inc 65 MACRS IRS Table of MACRS Depreciation Rates, by Property Class LO Copyright ©2019 John Wiley & Sons, Inc 66 MACRS Illustration Using the rates from the MACRS depreciation rate schedule for a 5-year class of property, Rode computes depreciation as follows For GAAP, Rode used straight-line, with $16,000 salvage value and a useful life of years LO Copyright ©2019 John Wiley & Sons, Inc 67 Optional Straight-line Method LO • Applies to six classes of property previously described • Applies the straight-line method to the MACRS recovery periods • Ignores salvage value Copyright ©2019 John Wiley & Sons, Inc 68 Tax Versus Book Depreciation Tax laws and financial reporting have different objectives The purpose of: • Taxation is to raise revenue from constituents in an equitable manner • Financial reporting is to reflect the economic substance of a transaction as closely as possible and to help predict amounts, timing, and uncertainty of future cash flows The adoption of one method for both tax and book purposes in all cases is not in accordance with G AAP LO Copyright ©2019 John Wiley & Sons, Inc 69 Learning Objective Compare the Accounting for Property, Plant, and Equipment Under GAAP and IFRS LO Copyright ©2019 John Wiley & Sons, Inc 70 IFRS Insights Relevant Facts – Similarities • The definition of property, plant, and equipment is essentially the same under GAAP and IFRS • Under both GAAP and IFRS, changes in depreciation method and changes in useful life are treated in the current and future periods Prior periods are not affected • The accounting for plant asset disposals is the same under GAAP and IFRS • The accounting for the initial costs to acquire natural resources is similar under GAAP and IFRS • Under both GAAP and IFRS, interest costs incurred during construction must be capitalized Recently, IFRS converged to GAAP LO Copyright ©2019 John Wiley & Sons, Inc 71 IFRS Insights Relevant Facts – Similarities • The accounting for exchanges of nonmonetary assets has recently converged between IFRS and GAAP GAAP now requires that gains on exchanges of nonmonetary assets be recognized if the exchange has commercial substance This is the same framework used in IFRS • GAAP also views depreciation as allocation of cost over an asset’s life GAAP permits the same depreciation methods (straight-line, diminishing-balance, units-of-production) as IFRS LO Copyright ©2019 John Wiley & Sons, Inc 72 IFRS Insights Relevant Facts – Differences • IFRS requires component depreciation Under GAAP, component depreciation is permitted but is rarely used • Under IFRS, companies can use either the historical cost model or the revaluation model GAAP does not permit revaluations of property, plant, and equipment or mineral resources • In testing for impairments of long-lived assets, GAAP uses a two-step model to test for impairments As long as future undiscounted cash flows exceed the carrying amount of the asset, no impairment is recorded The I FRS impairment test is stricter However, unlike GAAP, reversals of impairment losses are permitted LO Copyright ©2019 John Wiley & Sons, Inc 73 IFRS Insights On The Horizon With respect to revaluations, as part of the conceptual framework project, the Boards will examine the measurement bases used in accounting It is too early to say whether a converged conceptual framework will recommend fair value measurement (and revaluation accounting) for property, plant, and equipment However, this is likely to be one of the more contentious issues, given the long-standing use of historical cost as a measurement basis in GAAP LO Copyright ©2019 John Wiley & Sons, Inc 74 Copyright Copyright © 2019 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States 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 Copyright ©2019 John Wiley & Sons, Inc 75 ... special depreciation methods and other depreciation issues Identify the accounting issues related to asset impairment Explain the accounting procedures for depletion of natural resources Demonstrate... Copyright ©2019 John Wiley & Sons, Inc Depreciation—A Method of Cost Allocation Depreciation is the accounting process of allocating the cost of tangible assets to expense in a systematic and rational