AK2102

INTERMEDIATE ACCOUNTING

CHAPTER 4
Acquisition and Disposition of Property,
Plant, and Equipment
Depreciation, Impairments, and Depletion

ACCOUNTING PROGRAM
 OBJECTIVES
After studying this chapter, you should be able to:

1. Describe property, plant, and equipment. And Identify the costs to include in initial
valuation of property, plant, and equipment.
2. Describe the accounting problems associated with self-constructed assets and
describe the accounting problems associated with interest capitalization.
3. Understand accounting issues related to acquiring and valuing plant assets.
4. Describe the accounting treatment for costs subsequent to acquisition and the
disposal of property, plant, and equipment.
5. Explain the concept of depreciation and Identify the factors involved in the
depreciation process.
6. Compare activity, straight-line, and diminishing-charge methods of
depreciation.
7. Explain component depreciation
8. Explain the accounting procedures for depletion of mineral resources.
CONTENTS
1. Property, Plant, and Equipment
2. Acquisition of property, plant, and equipment
3. Valuation of property, plant, and equipment
4. Costs subsequent to acquisition
5. Dsposition of property, plant, and equipment
6. Depreciation, Impairments and Depletion
7. Impairments
8. Depletion
9. Revaluation
 PROPERTY, PLANT, AND EQUIPMENT

Property, plant, and equipment are assets of a durable nature.

Other terms commonly used are plant assets and fixed assets.

Includes:
► “Used in operations” and not for
 Land,
resale.
 Building structures
► Long-term in nature and usually (offices, factories,
warehouses), and
depreciated.
 Equipment
► Possess physical substance. (machinery, furniture,
tools).

LO 1
 ACQUISITION OF PROPERTY, PLANT,
AND EQUIPMENT (PP&E)

Historical cost measures the cash or cash equivalent price of

obtaining the asset and bringing it to the location and condition
necessary for its intended use.
In general, costs include:

1. Purchase price, including import duties and non-refundable

purchase taxes, less trade discounts and rebates.

2. Costs attributable to bringing the asset to the location and

condition necessary for it to be used in a manner intended
by the company.

LO 2
ACQUISITION OF PROPERTY, PLANT,
AND EQUIPMENT (PP&E)

Companies value property, plant, and equipment in

subsequent periods using either the
 cost method or

 fair value (revaluation) method.

LO 2
 ACQUISITION OF PP&E

Cost of Land
All expenditures made to acquire land and ready it for use.
Costs typically include:
(1) purchase price;
(2) closing costs, such as title to the land, attorney’s fees, and
recording fees;
(3) costs of grading, filling, draining, and clearing;
(4) assumption of any liens, mortgages, or encumbrances on
the property; and
(5) additional land improvements that have an indefinite life.

LO 2
ACQUISITION OF PP&E

Cost of Land
 Improvements with limited lives, such as private
driveways, walks, fences, and parking lots, are recorded
as Land Improvements and depreciated.

 Land acquired and held for speculation is classified as

an investment.

 Land held by a real estate concern for resale should be

classified as inventory.

LO 2
ACQUISITION OF PP&E

Cost of Buildings
Includes all expenditures related directly to acquisition or
construction. Costs include:

 materials, labor, and overhead costs incurred during

construction and

 professional fees and building permits.

Companies consider all costs incurred, from excavation to

completion, as part of the building costs.

LO 2
ACQUISITION OF PP&E

Cost of Equipment
Include all expenditures incurred in acquiring the equipment
and preparing it for use. Costs include:
 purchase price,

 freight and handling charges,

 insurance on the equipment while in transit,

 cost of special foundations if required,

 assembling and installation costs, and

 costs of conducting trial runs.

LO 2
Self-Constructed Assets
Costs include:
 Materials and direct labor
 Overhead can be handled in two ways:
1. Assign no fixed overhead.

2. Assign a portion of all overhead to the construction

process.

Companies use the second method extensively.

LO 3
 ACQUISITION OF PP&E

Interest Costs During Construction

Three approaches have been suggested to account for the
interest incurred in financing the construction.

$0
Increase to Cost of Asset $?

Capitalize no Capitalize
interest during Capitalize actual all costs of
construction costs incurred during funds
construction

IFRS

LO 4
Interest Costs During Construction
 IFRS requires — capitalizing actual interest (with
modification).

 Consistent with historical cost.

 Capitalization considers three items:

1. Qualifying assets.

2. Capitalization period.

3. Amount to capitalize.

LO 4
 Interest Costs During Construction

Qualifying Assets
Require a substantial period of time to get them ready for
their intended use or sale.
Two types of assets:
 Assets under construction for a company’s own use.

 Assets intended for sale or lease that are constructed or

produced as discrete projects.

LO 4
Interest Costs During Construction

Capitalization Period
Begins when:
1. Expenditures for the assets are being incurred.
2. Activities for readying the asset for use or sale are in
progress .
3. Interest costs are being incurred.

Ends when:
The asset is substantially complete and ready for use.

LO 4
Interest Costs During Construction

Amount to Capitalize
Capitalize the lesser of:
1. Actual interest cost incurred.
2. Avoidable interest - the amount of interest cost during
the period that a company could theoretically avoid if it
had not made expenditures for the asset.

LO 4
Interest Costs During Construction

Illustration: Assume a company borrowed $200,000 at 12% interest

from State Bank on Jan. 1, 2015, for specific purposes of constructing
special-purpose equipment to be used in its operations. Construction on
the equipment began on Jan. 1, 2015, and the following expenditures
were made prior to the project’s completion on Dec. 31, 2015:

Actual Expenditures during 2015: Other general debt existing on

January 1 $ 100,000 Jan. 1, 2015:
April 30 150,000
$500,000, 14%, 10-year
November 1 300,000 bonds payable
December 31 100,000
Total expenditures $ 650,000 $300,000, 10%, 5-year
note payable

LO 4
Interest Costs During Construction

Step 1 - Determine which assets qualify for capitalization of

interest.
Special purpose equipment qualifies because it requires a period of
time to get ready and it will be used in the company’s operations.

Step 2 - Determine the capitalization period.

The capitalization period is from Jan. 1, 2015 through Dec. 31, 2015,
because expenditures are being made and interest costs are being
incurred during this period while construction is taking place.

LO 4
Interest Costs During Construction

Step 3 - Compute weighted-average accumulated expenditures.

Weighted
Average
Actual Capitalization Accumulated
Date Expenditures Period Expenditures
Jan. 1 $ 100,000 12/12 $ 100,000
Apr. 30 150,000 8/12 100,000
Nov. 1 300,000 2/12 50,000
Dec. 31 100,000 0/12 -
$ 650,000 $ 250,000

A company weights the construction expenditures by the amount of time

(fraction of a year or accounting period) that it can incur interest cost on the
expenditure.
LO 4
Interest Costs During Construction

Step 4 - Compute the Actual and Avoidable Interest.

Selecting Appropriate Interest Rate:

1. For the portion of weighted-average accumulated expenditures that
is less than or equal to any amounts borrowed specifically to
finance construction of the assets, use the interest rate incurred on
the specific borrowings.

2. For the portion of weighted-average accumulated expenditures that

is greater than any debt incurred specifically to finance construction
of the assets, use a weighted average of interest rates incurred on
all other outstanding debt during the period.

LO 4
 Interest Costs During Construction
Step 4 - Compute the Actual and Avoidable Interest.

Actual Interest
Interest Actual
Debt Rate Interest Weighted-average
Specific Debt $ 200,000 12% $ 24,000 interest rate on
general debt
General Debt 500,000 14% 70,000 $100,000
= 12.5%
300,000 10% 30,000 $800,000
$ 1,000,000 $ 124,000

Accumulated Interest Avoidable

Avoidable Interest Expenditures Rate Interest
$ 200,000 12% $ 24,000
50,000 12.5% 6,250
$ 250,000 $ 30,250
LO 4
Interest Costs During Construction

Step 5 – Capitalize the lesser of Avoidable interest or Actual

interest.

Avoidable interest $ 30,250

Actual interest 124,000

Journal entry to Capitalize Interest:

Equipment 30,250
Interest Expense 30,250

LO 4
Interest Costs During Construction

Comprehensive Illustration: On November 1, 2014, Shalla

Company contracted Pfeifer Construction Co. to construct a building
for $1,400,000 on land costing $100,000 (purchased from the
contractor and included in the first payment). Shalla made the
following payments to the construction company during 2015.

LO 4
Interest Costs During Construction

Pfeifer Construction completed the building, ready for occupancy, on

December 31, 2015. Shalla had the following debt outstanding at
December 31, 2015.
Specific Construction Debt
1. 15%, 3-year note to finance purchase of land and
construction of the building, dated December 31, 2014, with
interest payable annually on December 31 $750,000
Other Debt
2. 10%, 5-year note payable, dated December 31, 2011, with
interest payable annually on December 31 $550,000
3. 12%, 10-year bonds issued December 31, 2010, with
interest payable annually on December 31 $600,000

Compute weighted-average accumulated expenditures for 2015.

LO 4
Interest Costs During Construction

Compute weighted-average accumulated expenditures for 2015.

LO 4
Interest Costs During Construction

Compute the avoidable interest.

LO 4
Interest Costs During Construction

Compute the actual interest cost, which represents the maximum

amount of interest that it may capitalize during 2015.

The interest cost that Shalla capitalizes is the

lesser of $120,228 (avoidable interest) and
$239,500 (actual interest), or $120,228.

LO 4
Interest Costs During Construction

Shalla records the following journal entries during 2015:

January 1 Land 100,000

Buildings (or CIP) 110,000
Cash 210,000
March 1 Buildings 300,000
Cash 300,000
May 1 Buildings 540,000
Cash 540,000
December 31 Buildings 450,000
Cash 450,000
Buildings (Capitalized Interest) 120,228
Interest Expense 119,272
Cash 239,500

LO 4
Interest Costs During Construction

Special Issues Related to Interest Capitalization

1. Expenditures for Land
 If land is purchased as a site for a structure, interest
costs capitalized during the period of construction are
part of the cost of the plant, not the land.

 Conversely, if the company develops land for lot sales,

it includes any capitalized interest cost as part of the
acquisition cost of the developed land.

2. Interest Revenue
 In general, companies should not offset interest revenue
against interest cost unless earned on specific borrowings.
LO 4
 VALUATION OF PROPERTY, PLANT &
EQUIPMENT

Companies should record property, plant, and equipment:

 at the fair value of what they give up or

 at the fair value of the asset received,

whichever is more clearly evident.

LO 5
 VALUATION OF PP&E

Cash Discounts — Discounts for prompt payment.

Deferred-Payment Contracts — Assets purchased on
long-term credit contracts are valued at the present value of the
consideration exchanged.

Lump-Sum Purchases — Allocate the total cost among the

various assets on the basis of their relative fair market values.

Issuance of Shares — The market price of the shares issued

is a fair indication of the cost of the property acquired.

LO 5
VALUATION OF PP&E

Exchanges of Non-Monetary Assets

Ordinarily accounted for on the basis of:
 the fair value of the asset given up or

 the fair value of the asset received,

whichever is clearly more evident.

Companies should recognize immediately any gains or losses on

the exchange when the transaction has commercial substance.

LO 5
Exchanges of Non-Monetary Assets

Meaning of Commercial Substance

Exchange has commercial substance if the future cash flows
change as a result of the transaction. That is, if the two parties’
economic positions change, the transaction has commercial
substance.

LO 5
Exchanges of Non-Monetary Assets

Exchanges—Loss Situation
Companies recognize a loss immediately whether the exchange
has commercial substance or not.

Rationale: Companies should not value assets at more than their

cash equivalent price; if the loss were deferred, assets would be
overstated.

LO 5
Exchanges of Non-Monetary Assets

Illustration: Information Processing, Inc. trades its used machine for a

new model at Jerrod Business Solutions Inc. The exchange has
commercial substance. The used machine has a book value of €8,000
(original cost €12,000 less €4,000 accumulated depreciation) and a fair
value of €6,000. The new model lists for €16,000. Jerrod gives
Information Processing a trade-in allowance of €9,000 for the used
machine. Information Processing computes the cost of the new asset
as follows.

LO 5
 Exchanges of Non-Monetary Assets

Illustration: Information Processing records this transaction as follows:

Equipment 13,000
Accumulated Depreciation—Equipment 4,000
Loss on Disposal of Equipment 2,000
Equipment 12,000
Cash 7,000

Loss on
Disposal

LO 5
Exchanges of Non-Monetary Assets

Exchanges—Gain Situation
Has Commercial Substance. Company usually records the
cost of a non-monetary asset acquired in exchange for
another non-monetary asset at the fair value of the asset
given up, and immediately recognizes a gain.

LO 5
Exchanges of Non-Monetary Assets

Illustration: Interstate Transportation Company exchanged a number

of used trucks plus cash for a semi-truck. The used trucks have a
combined book value of $42,000 (cost $64,000 less $22,000
accumulated depreciation). Interstate’s purchasing agent,
experienced in the secondhand market, indicates that the used
trucks have a fair market value of $49,000. In addition to the trucks,
Interstate must pay $11,000 cash for the semi-truck. Interstate
computes the cost of the semi-truck as follows.

LO 5
 Exchanges of Non-Monetary Assets

Illustration: Interstate records the exchange transaction as follows:

Truck (semi) 60,000

Accumulated Depreciation—Trucks 22,000
Trucks (used) 64,000
Gain on Disposal of Trucks 7,000
Cash 11,000

Gain on
Disposal

LO 5
Exchanges of Non-Monetary Assets

Exchanges—Gain Situation
Lacks Commercial Substance. Now assume that Interstate
Transportation Company exchange lacks commercial
substance.

Interstate defers the gain of $7,000 and reduces the basis of

the semi-truck.

LO 5
Exchanges of Non-Monetary Assets

Illustration: Interstate records the exchange transaction as

follows:

Trucks (semi) 53,000

Accumulated Depreciation—Trucks 22,000
Trucks (used) 64,000
Cash 11,000

LO 5
 Exchanges of Non-Monetary Assets

Summary of Gain and Loss Recognition on

Exchanges of Non-Monetary Assets

Disclosure include
 nature of the transaction(s),
 method of accounting for the assets exchanged, and
 gains or losses recognized on the exchanges.

LO 5
VALUATION OF PP&E

Government Grants
Government Grants are assistance received from a
government in the form of transfers of resources to a
company in return for past or future compliance with certain
conditions relating to the operating activities of the
company.

IFRS requires grants to be recognized in income (income

approach) on a systematic basis that matches them with the
related costs that they are intended to compensate.

LO 5
 COSTS SUBSEQUENT TO ACQUISITION

Recognize costs subsequent to acquisition as an asset when

the costs can be measured reliably and it is probable that the
company will obtain future economic benefits.
Evidence of future economic benefit would include increases in
1. useful life,
2. quantity of product produced, and
3. quality of product produced.

LO 6
 DISPOSITION OF PROPERTY, PLANT, AND
EQUIPMENT

A company may retire plant assets voluntarily or dispose of

them by
 Sale,

 Exchange,

 Involuntary conversion, or
 Abandonment.

Depreciation must be taken up to the date of disposition.

LO 7
 DISPOSITION OF PP&E

Sale of Plant Assets

Illustration: Barret Company recorded depreciation on a machine
costing €18,000 for nine years at the rate of €1,200 per year. If it
sells the machine in the middle of the tenth year for €7,000, Barret
records depreciation to the date of sale as:

Depreciation Expense (€1,200 x ½) 600

Accumulated Depreciation—Machinery 600

LO 7
DISPOSITION OF PP&E

Illustration: Barret Company recorded depreciation on a machine

costing $18,000 for 9 years at the rate of $1,200 per year. If it sells
the machine in the middle of the tenth year for $7,000, Barret
records depreciation to the date of sale. Record the entry to record
the sale of the asset:

Cash 7,000
Accumulated Depreciation—Machinery 11,400
Machinery 18,000
Gain on Disposal of Machinery 400

LO 7
DISPOSITION OF PP&E

Involuntary Conversion
Sometimes an asset’s service is terminated through some type of
involuntary conversion such as fire, flood, theft, or condemnation.

Companies report the difference between the amount recovered

(e.g., from a condemnation award or insurance recovery), if any,
and the asset’s book value as a gain or loss.

They treat these gains or losses like any other type of disposition.

LO 7
DISPOSITION OF PP&E

Illustration: Camel Transport Corp. had to sell a plant located on

company property that stood directly in the path of an interstate
highway. Camel received $500,000, which substantially exceeded the
book value of the land of $150,000 and the book value of the building
of $100,000 (cost of $300,000 less accumulated depreciation of
$200,000). Camel made the following entry.

Cash 500,000
Accumulated Depreciation—Buildings 200,000
Buildings 300,000
Land 150,000
Gain on Disposal of Plant Assets 250,000

LO 7
Depreciation, Impairments, and
Depletion
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-lived assets:

 Fixed assets = Depreciation expense

 Intangibles = Amortization expense

 Mineral resources = Depletion expense

LO 1
DEPRECIATION—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 apportionment is best?

LO 2
Factors Involved in Depreciation Process

Depreciable Base for the Asset

LO 2
Factors Involved in Depreciation Process

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).

LO 2
DEPRECIATION—COST ALLOCATION

Methods of Depreciation
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. Diminishing (accelerated)-charge methods:

a) Sum-of-the-years’-digits.

b) Declining-balance method.

LO 3
Methods of Depreciation

Activity Method

Data for
Stanley Coal
Mines

Illustration: If Stanley uses the crane for 4,000 hours the first
year, the depreciation charge is:

LO 3
Methods of Depreciation

Straight-Line Method

Data for
Stanley Coal
Mines

Illustration: Stanley computes depreciation as follows:

LO 3
Methods of Depreciation

Diminishing-Charge Methods

Data for
Stanley Coal
Mines

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- n(n+1) 5(5+1)

= = 15
years’ calculation 2 2
LO 3
Methods of Depreciation

Sum-of-the-Years’-Digits

LO 3
Methods of Depreciation

Diminishing-Charge Methods

Data for
Stanley Coal
Mines

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.

LO 3
Methods of Depreciation

Declining-Balance Method

LO 3
DEPRECIATION—COST ALLOCATION

Component Depreciation
IFRS requires that each part of an item of property, plant,
and equipment that is significant to the total cost of the
asset must be depreciated separately.

LO 4
Component Depreciation

Illustration: EuroAsia Airlines purchases an airplane for

€100,000,000 on January 1, 2016. The airplane has a useful life of
20 years and a residual value of €0. EuroAsia uses the straight-
line method of depreciation for all its airplanes. EuroAsia identifies
the following components, amounts, and useful lives.

LO 4
Component Depreciation

Computation of depreciation expense for

EuroAsia for 2016.

Depreciation journal entry for 2016.

Depreciation Expense 8,600,000

Accumulated Depreciation—Airplane 8,600,000

LO 4
Component Depreciation

On the statement of financial position at the end of 2016,

EuroAsia reports the airplane as a single amount.

LO 4
DEPRECIATION—COST ALLOCATION

Special Depreciation Issues

1. How should companies compute depreciation for
partial periods?

2. Does depreciation provide for the replacement of

assets?

3. How should companies handle revisions in

depreciation rates?

LO 4
DEPRECIATION—COST ALLOCATION

Special Depreciation Issues

1. How should companies compute depreciation for partial
periods?
 Companies determine the depreciation expense for
the full year and then

 prorate this depreciation expense between the two

periods involved.

This process should continue throughout the useful life of

the asset.

LO 4
Depreciation and Partial Periods

Illustration—(Four Methods): Maserati Corporation purchased a new

machine for its assembly process on August 1, 2015. 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.

LO 4
 Depreciation and Partial Periods

Straight-line Method
Current
Depreciable Annual Partial Year Accum.
Year Base Years Expense Year Expense Deprec.
2015 € 126,000 / 5 = $ 25,200 x 5/12 = € 10,500 $ 10,500
2016 126,000 / 5 = 25,200 25,200 35,700
2017 126,000 / 5 = 25,200 25,200 60,900
2018 126,000 / 5 = 25,200 25,200 86,100
2019 126,000 / 5 = 25,200 25,200 111,300
2020 126,000 / 5 = 25,200 x 7/12 = 14,700 126,000
€ 126,000
Journal entry:

2015 Depreciation expense 10,500

Accumultated depreciation 10,500

LO 4
Depreciation and Partial Periods

Activity Method (Assume 800 hours used in 2015)

(€126,000 / 21,000 hours = €6 per hour)
(Given) Current
Hours Rate per Annual Partial Year Accum.
Year Used Hours Expense Year Expense Deprec.
2015 800 x $6 = € 4,800 € 4,800 € 4,800
2016 x =
2017 x =
2018 x =
2019 x =
800 € 4,800

Journal entry:
2015 Depreciation expense 4,800
Accumultated depreciation 4,800

Advance slide in presentation mode to reveal answer. LO 4

 Depreciation and Partial Periods
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.

2015 € 126,000 x 5/15 = 42,000 x 5/12 € 17,500 € 17,500

2016 126,000 x 4.58/15 = 38,500 38,500 56,000

2017 126,000 x 3.58/15 = 30,100 30,100 86,100

2018 126,000 x 2.58/15 = 21,700 21,700 107,800

2019 126,000 x 1.58/15 = 13,300 13,300 121,100

2020 126,000 x .58/15 = 4,900 4,900 126,000

€ 126,000
Journal entry:
2015 Depreciation expense 17,500
Accumultated depreciation 17,500
Advance slide in presentation mode to reveal answer.
LO 4
Depreciation and Partial Periods

Double-Declining Balance Method

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

2015 € 150,000 x 40% = € 60,000 x 5/12 = € 25,000

2016 125,000 x 40% = 50,000 50,000

2017 75,000 x 40% = 30,000 30,000

2018 45,000 x 40% = 18,000 18,000

2019 27,000 x 40% = 10,800 Plug 3,000

€ 126,000
Journal entry:
2015 Depreciation expense 25,000
Accumultated depreciation 25,000
Advance slide in presentation mode to reveal answer. LO 4
DEPRECIATION—COST ALLOCATION

Special Depreciation Issues

2. Does depreciation provide for the replacement of
assets?
 Does not involve a current cash outflow.

 Funds for the replacement of the assets come from

the revenues.

LO 4
DEPRECIATION—COST ALLOCATION

Special Depreciation Issues

3. How should companies handle revisions in depreciation
rates?
 Accounted for in the current and prospective periods

 Not handled retrospectively

 Not considered errors or extraordinary items

LO 4
Revision of Depreciation Rates

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 2015 (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 No Entry
the prior years’ depreciation? Required

 Calculate the depreciation expense

for 2015.

LO 4
 After 7
Revision of Depreciation Rates years

Equipment cost $510,000 First, establish NBV

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

Balance Sheet (Dec. 31, 2014)

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

LO 4
 After 7
Revision of Depreciation Rates years

Net book value $160,000 Depreciation

Salvage value (new) 5,000 Expense calculation
Depreciable base 155,000 for 2015.
Useful life remaining 8 years
Annual depreciation $ 19,375

Journal entry for 2015

Depreciation Expense 19,375

Accumulated Depreciation 19,375

LO 4
IMPAIRMENTS

Recognizing Impairments
A long-lived tangible asset is impaired when a company is not
able to recover the asset’s carrying amount either through
using it or by selling it.

On an annual basis, companies review the asset for indicators

of impairments—that is, a decline in the asset’s cash-generating
ability through use or sale.

LO 5
Recognizing Impairments

If impairment indicators are present, then an impairment test

must be conducted.

LO 5
DEPLETION

Natural resources can be divided into two categories:

1. Biological assets (timberlands)

► Fair value approach (chapter 9)

2. Mineral resources (oil, gas, and mineral mining).

► Complete removal (consumption) of the asset.

► Replacement of the asset only by an act of nature.

Depletion - process of allocating the cost of mineral resources.

LO 6
DEPLETION

Establishing a Depletion Base

Computation of the depletion base involves:
1. Pre-exploratory costs.

2. Exploratory and evaluation costs.

3. Development costs.

LO 6
DEPLETION

Write-off of Resource Cost

Normally, companies compute depletion on a units-of-production
method (activity approach). Depletion is a function of the
number of units extracted during the period.

Calculation:

Total Cost – Residual value

= Depletion Cost Per Unit
Total Estimated Units Available

Units Extracted x Cost Per Unit = Depletion

LO 6
DEPLETION

Illustration: MaClede Co. acquired the right to use 1,000 acres of

land in South Africa 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 gold.

LO 6
DEPLETION

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 250,000
Accumulated Depletion 250,000

MaClede’s statement of financial position:

Depletion cost related to inventory sold is part of cost of goods sold.

LO 6
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.

LO 6
DEPLETION

Presentation on the Financial Statements

Disclosures related to E&E expenditures should include:
1. Accounting policies for exploration and evaluation
expenditures, including the recognition of E&E assets.

2. Amounts of assets, liabilities, income and expense, and

operating cash flow arising from the exploration for and
evaluation of mineral resources.

LO 6
REVALUATIONS

Recognizing Revaluations
Companies may value long-lived tangible asset subsequent to
acquisition at cost or fair value.
Network Rail (GBR) elected to use fair values to account for its
railroad network.

► Increased long-lived tangible assets by £4,289 million.

► Change in the fair value accounted for by adjusting the asset

account and establishing an unrealized gain.

► Unrealized gain is often referred to as revaluation surplus.

LO 7
Recognizing Revaluation

Revaluation—Land
Illustration: Siemens Group (DEU) purchased land for €1,000,000
on January 5, 2015. The company elects to use revaluation
accounting for the land in subsequent periods. At December 31,
2015, the land’s fair value is €1,200,000. The entry to record the
land at fair value is as follows.

Land 200,000
Unrealized Gain on Revaluation - Land 200,000

Unrealized Gain on Revaluation—Land increases other comprehensive

income in the statement of comprehensive income.

LO 7
Recognizing Revaluation

Revaluation—Depreciable Assets
Illustration: Lenovo Group (CHN) purchases equipment for
¥500,000 on January 2, 2015. The equipment has a useful life of
five years, is depreciated using the straight-line method of
depreciation, and its residual value is zero. Lenovo chooses to
revalue its equipment to fair value over the life of the equipment.
Lenovo records depreciation expense of ¥100,000 (¥500,000 ÷ 5)
at December 31, 2015, as follows.

Depreciation Expense 100,000

Accumulated Depreciation—Equipment 100,000

LO 7
Recognizing Revaluation

Revaluation—Depreciable Assets
After this entry, Lenovo’s equipment has a carrying amount of
¥400,000 (¥500,000 - ¥100,000). Lenovo receives an independent
appraisal for the fair value of equipment at December 31, 2015,
which is ¥460,000.

Accumulated Depreciation—Equipment 100,000

Equipment 40,000
Unrealized Gain on Revaluation—Equipment 60,000

LO 7
Recognizing Revaluation

Revaluation—Depreciable Assets

Under no circumstances can the Accumulated Other Comprehensive Income

account related to revaluations have a negative balance.

LO 7
Recognizing Revaluation

Revaluations Issues
Company can select to value only one class of assets, say
buildings, and not revalue other assets such as land or equipment.
If a company selects only buildings,
► revaluation applies to all assets in that class of assets.
► A class of assets is a grouping of items that have a similar nature
and use in a company’s operations.
► Companies must also make every effort to keep the assets’
values up to date.

LO 7
PRESENTATION AND ANALYSIS

Analysis of Property, Plant, and Equipment

Asset Turnover Ratio
Measures how efficiently
adidas AG
a company uses its
assets to generate sales.

LO 8
PRESENTATION AND ANALYSIS

Analysis of Property, Plant, and Equipment

Profit Margin on Sales
Measure of the ability to
adidas AG generate operating
income from a
particular level of sales.

LO 8
PRESENTATION AND ANALYSIS

Analysis of Property, Plant, and Equipment

Return on Assets (ROA)
Measures a firm’s
adidas AG success in using
assets to generate
earnings.

LO 8