Chapter 11

Intermediate Accounting
Seventeenth Edition
Kieso ● Weygandt ● Warfield
Chapter 11
Depreciation, Impairments,
and Depletion
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Learning Objectives
After studying this chapter, you should be able to:
1. Understand depreciation concepts and methods of
depreciation.
2. Discuss special depreciation methods and other
depreciation issues.
3. Identify the accounting issues related to asset impairment.
4. Explain the accounting procedures for depletion of natural
resources.
5. Demonstrate how to report and analyze property, plant,
equipment, and natural resources.
Copyright ©2019 John Wiley & Sons, Inc. 2

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

Impairments
• Recognizing impairments
• Measuring impairments
• Restoration of loss
• Assets to be disposed of

Depletion
• Establishing a base
• Write-off of resource cost
• Estimating reserves
• Liquidating dividends
• Continuing controversy

Presentation and Analysis
• Presentation
• Analysis

Learning Objective 1
Describe Depreciation Concepts and
Methods of Depreciation
LO 1 Copyright ©2019 John Wiley & Sons, Inc. 7

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:
• Fixed assets = Depreciation expense
• Intangibles = Amortization expense
• Natural resources = Depletion expense
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 apportionment is best for this
asset?

Factors Involved in Depreciation
Depreciable Base for the Asset
Original cost $10,000

Less: Salvage value 1,000
Depreciation base $ 9,000

Factors Involved in Depreciation
Estimation of Service Lives
• Service life often differs from physical life
• Companies retire assets for two reasons:
1. Physical factors (casualty or expiration of
physical life).
2. Economic factors (inadequacy, supersession,
and obsolescence).

The profession requires the method employed be “systematic
and rational.” Methods used include:
1. Activity method (units of use or production).
2. Straight-line method.
3. Decreasing-charge methods (accelerated)
a. Sum-of-the-years’-digits.
b. Declining-balance method.
4. Special depreciation methods:
a. Group and composite methods.
b. Hybrid or combination methods.
Activity Method
Cost of crane $500,000
Stanley Coal Estimated useful life 5 years
Mines Facts Estimated salvage value $ 50,000
Productive life in hours 30,000 hours
Illustration: If Stanley uses the crane for 4,000 hours the first year,
the depreciation charge is:

Straight-Line Method
Illustration: Stanley computes depreciation as follows:

Decreasing-Charge Methods
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.
Alternate sum-of-the-
years’ calculation

Sum-of-the-Years’-Digits
Depreciation Schedule
Depreciation Remaining Depreciation Depreciation Book Value,
Year Base Life in Years Fraction Expense End of Year
1 $450,000 5 5/15 $150,000 $350,000
2 450,000 4 4/15 120,000 230,000
3 450,000 3 3/15 90,000 140,000
4 450,000 2 2/15 60,000 80,000
5 450,000 1 1/15 30,000 50,000a
15 15/15 $450,000
aSalvage value.

Decreasing-Charge Methods
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.

Declining-Balance Method
Book Value Rate on Balance
of Asset Declining Depreciation Accumulated Book Value,
Year First of Year Balancea Expense Depreciation End of Year
1 $500,000 40% $200,000 $200,000 $300,000
2 300,000 40% 120,000 320,000 180,000
3 180,000 40% 72,000 392,000 108,000
4 108,000 40% 43,000 435,200 64,800
5 64,800 40% 14,800b 450,000 50,000
a Based on twice the straight-line rate of 20% ($90,000/$450,000 = 20%; 20% × 2 = 40%).
b Limited to $14,800 because book value should not be less than salvage value.

Illustration—(Four Methods): Maserati Corporation purchased a new
machine for its assembly process on August 1, 2017. 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.
(b) Activity method
(c) Sum-of-the-years’-digits.
(d) Double-declining balance.

Straight-Line Method
Current
Depreciable Annual Partial Year Accum.
Year Base Years Expense Year Expense Deprec.
2017 $126,000 / 5 = $25,200 × 5/12 = $ 10,500 $ 10,500
2018 126,000 / 5 = 25,200 × = 25,200 35,700
2019 126,000 / 5 = 25,200 × = 25,200 60,900
2020 126,000 / 5 = 25,200 × = 25,200 86,100
2021 126,000 / 5 = 25,200 × = 25,200 111,300
2022 126,000 / 5 = 25,200 × 7/12 = 14,700 126,000
$126,000
Journal entry:
2017 Depreciation Expense 10,500
Accumultated Depreciation 10,500

(Assume 800 hours used in 2017)
Activity Method ($126,000/21,000 hours = $6 per hour)
Current
(Given) Rate per Annual Partial Year Accum.
Year Hours Hours Expense Year Expense Deprec.
2017 800 × $6 = $4,800 $4,800 $4,800
2018 × =
2019 × =
2020 × =
2021 × =
800 $4,800
Journal entry:

Sum-of-the-Years’-Digits Method
Depreciation Schedule (7/12 = .58333)
Current
Depreciable Annual Partial Year Accum.
Year Base Years Expense Year Expense Deprec.
2017 $126,000 × 5/15 = $42,000 × 5/12 = $ 17,500 $ 17,500
2018 126,000 × 4.583/15 = 38,500 × = 38,500 56,000
2019 126,000 × 3.583/15 = 30,100 × = 30,100 86,100
2020 126,000 × 2.583/15 = 21,700 × = 21,700 107,800
2021 126,000 × 1.583/15 = 13,300 × = 13,300 121,100
2022 126,000 × .583/15 = 4,900 × = 4,900 126,000
$126,000
Journal entry:

Double-Declining Balance Method
Depreciable Rate Per Annual Partial Current Year Accum.
Year Base Year Expense Year Expense Deprec.
2017 $150,000 × 40% = $60,000 × 5/15 = $ 25,000 $ 17,500
2018 125,000 × 40% = 50,000 × = 50,000 56,000
2019 75,000 × 40% = 30,000 × = 30,000 86,100
2020 45,000 × 40% = 18,000 × = 18,000 107,800
2021 27,000 × 40% = 10,800 × Plug = 3,000 121,100
$126,000 $126,000
Journal entry:

Discuss Special Depreciation Methods
and Other Depreciation Issues

Special Depreciation Methods and
Other Issues
Special Depreciation Methods
Two methods of depreciating multiple-asset accounts exist:
• Group method used when the assets are similar in nature and
have approximately the same useful lives.
• Composite method used when the assets are dissimilar and
have different lives.
Choice of method depends on the nature of the assets involved.
The computation for group or composite methods is essentially the
same: find an average and depreciate on that basis.
Group and Composite Methods
Depreciation Calculation
Illustration: Mooney Motors establishes the composite
depreciation rate for its fleet of vehicles as shown below.

Journal Entry
If Mooney retires an asset before or after the average service
life of the group is reached, it buries the resulting gain or loss
in the Accumulated Depreciation account.
Illustration: Suppose that Mooney Motors sold one of the
campers with a cost of $5,000 for $2,600 at the end of the
third year. The entry is:
Accumulated Depreciation 2,400
Cash 2,600
Cars, Trucks, and Campers 5,000
Disclosure
If Mooney purchases a new type of asset (mopeds, for
example), it must compute a new depreciation rate and apply
this rate in subsequent periods.

Hybrid or Combination Methods
Companies are also free to develop tailor-made depreciation
methods, provided the method results in the allocation of an
asset’s cost over the asset’s life in a systematic and rational
manner.

Other Depreciation Issues
1. How should companies See slides for
compute depreciation for LO 1
partial periods?
2. Does depreciation provide for Funds for the
the replacement of assets? replacement of
assets come from
revenues.
3. How should companies
handle revisions in
depreciation rates?

Other Depreciation Issues
Revision of Depreciation Rates
• Changes in estimates are a continual and inherent
part of any estimation process.
• Accounted for in the current period and prospective
periods.
• No change to previously reported results.

Arcadia HS, purchased equipment for $510,000 which was
estimated to have a useful life of 10 years with a residual
value of $10,000 at the end of that time. Depreciation has
been recorded for 7 years on a straight-line basis. In 2020
(year 8), it is determined that the total estimated life should
be 15 years with a residual value of $5,000 at the end of that
time.
Questions:
• What is the journal entry to correct the No Entry
prior years’ depreciation? Required
• Calculate depreciation expense for 2020.
Calculation of Book Value After 7 Years
Equipment cost $510,000
Salvage value − 10,000
Depreciable base 500,000
Useful life (original) ÷ 10 years
Annual depreciation $ 50,000 × 7 years = $350,000
First, establish net book value at date of change in estimate.
Balance Sheet (Dec. 31, 2019)

Equipment $510,000
Accumulated depreciation 350,000
Net book value (NBV) $160,000

Calculation of Depreciation Expense for 2020
Net book value $160,000
Salvage value (new) − 5,000
Depreciable base 155,000
Useful life (original) ÷ 8 years
Annual depreciation $ 19,375
Journal entry for 2020

Depreciation Expense 19,375

Identify the Accounting Issues Related
to Asset Impairment

Impairments
Recognizing Impairments
Write-off of long-lived assets.
Events leading to an impairment:
• A significant decrease in the fair value of an asset.
• A significant change in the manner in which an asset is used.
• A significant adverse change in legal factors or in the business
climate that affects the value of an asset.
• An accumulation of costs in excess of the amount originally
expected to acquire or construct an asset.
• A projection or forecast that demonstrates continuing losses
associated with an asset.
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.

Accounting for Impairments
Loss reported as part of

income from continuing
operations, in the “Other
expenses and losses”
section.

Impairment—Example 1
M. Alou Inc. has equipment that it reviews for possible impairment.
The equipment’s carrying amount is $600,000 ($800,000 cost less
$200,000 accumulated depreciation). Alou determines the
expected future net cash flows (undiscounted) from the use of the
equipment and its eventual disposal to be $650,000. Determine
whether an impairment has occurred.
Expected future cash flows $650,000
Carrying value of asset:
Cost $800,000
Accumulated depreciation − 200,000 600,000
$ 50,000
No Impairment
M. Alou Inc. has equipment that, due to changes in its use, it reviews
for possible impairment. The equipment’s carrying amount is
$600,000 ($800,000 cost less $200,000 accumulated depreciation).
Alou determines the expected future net cash flows (undiscounted)
from the use of the equipment and its eventual disposal to be
$580,000. Determine whether an impairment has occurred.
Expected future cash flows $580,000
Cost $800,000
− $ 20,000
Impairment
Measurement of Loss
The recoverability test indicates that the expected future net cash
flows of $580,000 from the use of the asset are less than its carrying
amount of $600,000. Therefore, an impairment has occurred.
Assume this asset has a fair value of $525,000. Determine the
impairment loss, if any.
Fair value of equipment $525,000
Cost $800,000
− $ 75,000
Impairment Loss
Loss Journal Entry
Fair value of equipment $525,000
Cost $800,000
− $ 75,000
M. Alou records the impairment loss as follows:

Loss on Impairment 75,000

Impairments
Restoration of Impairment Loss
After recording an impairment loss:
• Reduced carrying amount becomes its new cost basis
• No change in new cost basis except for depreciation
or amortization in future periods or for additional
impairments
• No restoration of impairment loss for an asset held
for use as new cost basis puts impaired asset on an
equal basis with other assets that are unimpaired

Impairments
Impairment of Assets to Be Disposed Of
Assets held for disposal are like inventory; companies
• Should report at lower-of-cost-or-net realizable value
• Can write up or down an asset held for disposal in
future periods, as long as carrying value after write-
up never exceeds carrying amount of asset before
impairment
• Should report losses or gains related to impaired
assets as part of income from continuing operations

Explain the Accounting Procedures for
Depletion of Natural Resources

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.

Depletion
Establishing a Depletion Base
Computation of the depletion base involves four factors:
1) Acquisition cost.
2) Exploration costs.
3) Development costs.
4) Restoration costs.

Depletion
Write-off of Resource Cost
Normally, companies compute depletion (cost depletion)
on a units-of-production method (activity approach).
Depletion is a function of the number of units extracted
during the period.
Calculation:

Depletion
Illustration
MaClede Co. acquired the right to use 1,000 acres of land in
Alaska to mine for silver. The lease cost is $50,000, and the
related exploration costs on the property are $100,000.
Intangible development costs incurred in opening the mine are
$850,000. MaClede estimates that the mine will provide
approximately 100,000 ounces of silver.

Depletion
Illustration Journal Entries
If MaClede extracts 25,000 ounces in the first year, then the
depletion for the year is $250,000 (25,000 ounces x $10).
Inventory (silver) 250,000
Silver Mine 250,000
Some companies use an Accumulated Depletion account. In that
case, MaClede’s balance sheet would presented as follows:
Silver mine (at cost) $1,000,000
Less: Accumulated depletion 250,000 $750,000
MaClede debits Cost of Goods Sold when the silver is sold.

Depletion
Estimating Recoverable Reserves
• Same as accounting for changes in estimates.
• Revise the depletion rate on a prospective basis.
• Divide the remaining cost by the new estimate of the
recoverable reserves.

Depletion
Liquidating Dividends
Dividends greater than the amount of accumulated net income.
Illustration: Callahan Mining had a retained earnings balance of
$1,650,000, accumulated depletion on mineral properties of
$2,100,000, 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 3,000,000
Depletion
Continuing Controversy
Oil and Gas Industry:
Full Cost Concept
• Cost of drilling a dry hole is a cost needed to find the
commercially profitable wells
Successful efforts concept
• Companies should capitalize only the costs of
successful projects

Demonstrate How to Report and
Analyze Property, Plant, Equipment,
and Natural Resources

Presentation of Property, Plant, Equipment, and
Natural Resources
Companies should disclose the following.
1. Depreciation expense for the period.
2. Balances of major classes of depreciable assets, by nature
and function.
3. Accumulated depreciation.
4. A general description of the method or methods used in
computing depreciation with respect to major classes of
depreciable assets.
Analysis of Property, Plant, and Equipment
Asset Turnover Ratio
Kellogg (in millions)
Net sales $ 12,923
Total assets, 12/28/17 16,350
Total assets, 12/24/16 15,111
Net income 1,269
Measure of a firm’s ability to

generate sales from a particular
investment in assets.

Analysis of PP&E
Profit Margin on Sales
Kellogg (in millions)
Net sales $ 12,923
Total assets, 12/28/17 16,350
Total assets, 12/24/16 15,111
Net income 1,269
Measure of the ability to generate

operating income from a particular
level of sales.

Analysis of PP&E
Return on Assets
Kellogg (in millions) Measures a firm’s
Net sales $ 12,923 success in using assets
Total assets, 12/28/17 16,350 to generate earnings.
Total assets, 12/24/16 15,111
Net income 1,269

Return on Assets
Return on assets (ROA) is computed directly by dividing
net income by average total assets. Using the Kellogg
data, we compute the ratio as shown

Describe Income Tax Methods of
Depreciation

Appendix 11A: Income Tax Depreciation
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.

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

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

Modified Accelerated Cost Recovery
System
Tax Depreciation Methods
MACRS
Property Class 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

Example of MACRS
Illustration: Computer and peripheral equipment purchased
by Denise Rode Company on January 1, 2019.
Acquisition Date January 1, 2019
Cost $100,000
Estimated useful life 7 years
Estimated salvage value $16,000
MACRS class life 5 years
MACRS method 200% declining-balance
GAAP method Straight-line
Disposal proceeds-January 2, 2026 $11,000

MACRS
IRS Table of MACRS Depreciation Rates, by Property
Class

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 7 years.
Optional Straight-line Method
• Applies to six classes of property previously described
• Applies the straight-line method to the MACRS
recovery periods
• Ignores salvage value

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 GAAP.

Compare the Accounting for Property,
Plant, and Equipment Under GAAP and
IFRS

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.

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.

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 IFRS impairment test is stricter. However, unlike GAAP,
reversals of impairment losses are permitted.

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.

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.

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Intermediate Accounting

Kieso ● Weygandt ● Warfield

Copyright ©2019 John Wiley & Sons, Inc. 2

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Original cost $10,000

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Illustration: Stanley computes depreciation as follows:

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

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• Utilizes a depreciation rate (percentage) that is some multiple of

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First, establish net book value at date of change in estimate.

Balance Sheet (Dec. 31, 2019)

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Journal entry for 2020

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Loss reported as part of

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M. Alou records the impairment loss as follows:

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MaClede debits Cost of Goods Sold when the silver is sold.

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Measure of a firm’s ability to

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Measure of the ability to generate

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