11

Property, Plant, and Equipment

and Intangible Assets: Utilization
and Impairment

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

McGraw-Hill/Irwin

Copyright 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

Cost Allocation An Overview

The
The matching
matching principle
principle requires
requires that
that part
part of
of the
the
acquisition
acquisition cost
cost of
of property,
property, plant,
plant, and
and equipment
equipment and
and
intangible
intangible assets
assets be
be expensed
expensed in
in periods
periods when
when the
the
future
future revenues
revenues are
are earned.
earned.

Depreciation,
Depreciation, depletion,
depletion, and
and amortization
amortization are
are
cost
cost allocation
allocation processes
processes used
used to
to help
help meet
meet the
the
matching
matching principle
principle requirements.
requirements.
Some
Some of
of the
the cost
cost is
is expensed
expensed each
each period.
period.
Acquisition
Acquisition
Cost
Cost
11 - 2

(Balance Sheet)

Expense
Expense
(Income Statement)

Cost Allocation An Overview

Caution! Depreciation, depletion, and amortization

are processes of cost allocation, not valuation!

Depreciation
on the
Balance
Sheet
11 - 3

Measuring Cost Allocation

Cost allocation requires three pieces
of information for each asset:
Service
Service
Life
Life

Allocation
Allocation
Base
Base

The
The estimated
estimated expected
expected
use
use from
from an
an asset.
asset.

Allocation
Allocation
Method
Method

The
The systematic
systematic approach
approach
used
used for
for allocation.
allocation.

Total
Total amount
amount of
of cost
cost to
to be
be allocated.
allocated.
Cost
Cost -- Residual
Residual Value
Value (at
(at end
end of
of useful
useful life)
life)
11 - 4

Depreciation

Time-based
Time-based Methods
Methods

Straight-line
Straight-line (SL)
(SL)

Accelerated
Accelerated Methods
Methods

Sum-of-the-years
Sum-of-the-years digits
digits (SYD)
(SYD)

Declining
Declining Balance
Balance (DB)
(DB)

Activity-based
Activity-based methods
methods

Group
Group and
and
composite
composite
methods
methods
Tax
Tax
depreciation
depreciation

Units-of-production
Units-of-production method
method (UOP).
(UOP).
11 - 5

Straight-Line

The
The most
most widely
widely
used
used and
and most
most easily
easily
understood
understood method.
method.

Results
Results in
in the
the same
same
amount
amount of
of depreciation
depreciation in
in
each
each year
year of
of the
the assets
assets
service
service life.
life.

On
On January
January 1,
1, we
we purchase
purchase equipment
equipment for
for $50,000
$50,000 cash.
cash.
The
The equipment
equipment has
has an
an estimated
estimated service
service life
life of
of 55 years
years
and
and estimated
estimated residual
residual value
value of
of $5,000.
$5,000.
What
What is
is the
the annual
annual straight-line
straight-line depreciation?
depreciation?
11 - 6

Depreciation

Straight-Line

Year
1
2
3
4
5

Depreciation
(debit)

Accumulated
Depreciation
(credit)

Accumulated
Depreciation
Balance

11 - 7

Life in Years

9,000
9,000
9,000
9,000
9,000
45,000

9,000
9,000
9,000
9,000
9,000
45,000

9,000
18,000
27,000
36,000
45,000

BV = Residual Value at the

end of the assets useful life.

Undepreciated
Balance
(book value)
$
50,000
41,000
32,000
23,000
14,000
5,000

Residual Value

Accelerated Methods
Accelerated methods result in more depreciation
in the early years of an assets useful life and less
depreciation in later years of an assets useful life.
Note that total depreciation over the assets useful
life is the same as the straight-line method.

Sum-of-the-years-digits (SYD) depreciation

11 - 8

Sum-of-the-Years Digits (SYD)

On January 1, we purchase equipment for $50,000 cash.

The equipment has a service life of 5 years and an
estimated residual value of $5,000. Using SYD
depreciation, compute depreciation for the first two years.

11 - 9

Sum-of-the-Years Digits (SYD)

11 - 10

Sum-of-the-Years Digits (SYD)

Fraction
Fraction

$$

$$

$$

15,000
15,000
12,000
12,000
9,000
9,000
6,000
6,000
3,000
3,000
45,000
45,000

15,000
15,000
27,000
27,000
36,000
36,000
42,000
42,000
45,000
45,000

Undepreciated
Undepreciated
Balance
Balance
(book
(bookvalue)
value)
$$
50,000
50,000
35,000
35,000
23,000
23,000
14,000
14,000
8,000
8,000
5,000
5,000

Residual Value

Depreciation

5/15
5/15
4/15
4/15
3/15
3/15
2/15
2/15
1/15
1/15

Depreciation
Depreciation
(debit)
(debit)

Accumulated
Accumulated
Depreciation
Depreciation
Balance
Balance

11 - 11

Life in Years

Declining-Balance (DB) Methods

DB depreciation
Based on the straight-line rate
multiplied by an acceleration
factor.

Stop depreciating
when:
BV = Residual Value

Computations initially ignore

residual value.

Double-Declining-Balance (DDB) depreciation

is computed as follows:

Note that the Book Value will get lower each year.
11 - 12

Declining-Balance (DB) Methods

On January 1, we purchase equipment for $50,000
cash. The equipment has a service life of 5 years
and an estimated residual value of $5,000.
What is depreciation for the first two years using
double-declining-balance?

11 - 13

Declining-Balance (DB) Methods

Year
Year
11
22
33
44
55

Depreciation
Depreciation
(debit)
(debit)

Accumulated
Accumulated
Depreciation
Depreciation
Balance
Balance

$$

$$

$$

20,000
20,000
12,000
12,000
7,200
7,200
4,320
4,320
1,480
1,480
45,000
45,000

20,000
20,000
32,000
32,000
39,200
39,200
43,520
43,520
45,000
45,000

Undepreciated
Undepreciated
Balance
Balance
(book
(book value)
value)
$$
50,000
50,000
30,000
30,000
18,000
18,000
10,800
10,800
6,480
6,480
5,000
5,000

Depreciation

Depreciation forced so that BV = Residual Value.

11 - 14

Life in Years

Units-of-Production

11 - 15

Units-of-Production
On January 1, we purchased equipment for $50,000 cash.
The equipment is expected to produce 100,000 units during
its life and has an estimated residual value of $5,000.
If 22,000 units were produced this year, what is the amount
of depreciation?

11 - 16

Use of Various Depreciation Methods

11 - 17

U.S. GAAP vs. IFRS

Component Depreciation, Depreciable Base,
and Residual Value

11 - 18

Component depreciation is
allowed but not often used in
practice.
The depreciable base is
determined by subtracting
estimated residual value from
cost. Annual reviews of
residual values are not
required.

Each component of an item of

property, plant, and equipment
is depreciated separately if its
cost is significant to the total
cost of the item.
Depreciable base is
determined by subtracting
estimated residual value from
cost. IFRS requires a review of
residual values annually.

Group and Composite Methods

Assets
Assets are
are grouped
grouped by
by common
common characteristics.
characteristics.
An
An average
average depreciation
depreciation rate
rate is
is used.
used.
Annual
Annual depreciation
depreciation is
is the
the average
average rate
rate the
the total
total
group
group acquisition
acquisition cost.
cost.
Accumulated
Accumulated depreciation
depreciation records
records are
are not
not maintained
maintained
for
for individual
individual assets.
assets.

IfIf assets
assets in
in the
the group
group are
are sold,
sold, or
or new
new assets
assets

added,
added, the
the composite
composite rate
rate remains
remains the
the same.
same.

When
When an
an asset
asset in
in the
the group
group is
is sold
sold or
or retired,
retired,
debit
debit accumulated
accumulated depreciation
depreciation for
for the
the
difference
difference between
between the
the assets
assets cost
cost and
and the
the
proceeds.
proceeds.
11 - 19

U.S. GAAP vs. IFRS

Valuation of Property, Plant, and Equipment

11 - 20

Property, plant, and equipment

is reported in the balance
sheet at cost less accumulated
depreciation (book value).
Revaluation is prohibited.

Property, plant, and equipment

may be reported at cost less
accumulated depreciation, or
alternatively, at fair value
(revaluation).
If revaluation is chosen, all
assets within a class of
property, plant, and equipment
must be revalued on a regular
basis.

Depletion of Natural Resources

As natural resources are used
up, or depleted, the cost of the
natural resources must be
allocated to the units extracted.

11 - 21

The approach is based

on the units-ofproduction method.

Depletion of Natural Resources

ABC Mining acquired a tract of land containing ore
deposits. Total costs of acquisition and development were
$1,100,000. ABC estimated the land contained 40,000 tons
of ore, and that the land will be sold for $100,000 after the
coal is mined. What is ABCs depletion rate?
Depletion
Depletionrate
rate==1,000,000
1,000,00040,000
40,000Tons
Tons==$25
$25Per
PerTon
Ton
For the year ABC mined 13,000 tons. What is
the total amount of depletion for the year?
Depletion
Depletion== 13,000
13,000tons
tons$25per
$25perton
ton ==$325,000
$325,000
11 - 22

U.S. GAAP vs. IFRS

Valuation of Biological Assets

11 - 23

Biological assets, such as

timber tracts, are valued at
cost less accumulated
depletion.

Biological assets are valued at

fair value less estimated costs
to sell.

Amortization of Intangible Assets

The amortization process uses the straight-line
method, but usually assumes residual value = 0.
Amortization period is the shorter of
the assets legal or contractual life.
The amortization entry is:
Amortization expense ..................................
Intangible asset ........

$$$
$$$

To record amortization expense.

A contra-asset account is generally not used when

recording the amortization of intangible assets.
11 - 24

Amortization of Intangible Assets

Torch, Inc. has developed a new device. Patent
registration costs consisted of $2,000 in attorney fees and
$1,000 in federal registration fees. The device has a
contractual (useful) life of 5 years. The legal life is 20
years.
For year 1, what is Torchs amortization expense?

Amortization expense ...................................

Patent ........................
To record amortization of patent.
11 - 25

600
600

Intangible Assets not

Subject to Amortization

Goodwill and Trademarks

Not amortized.

11 - 26

Subject to assessment
for impairment of
value and may be
written down.

U.S. GAAP vs. IFRS

Valuation of Intangible Assets

Intangible assets are reported

at cost less accumulated
amortization.
U.S.GAAP prohibits
revaluation of any intangible
asset.

11 - 27

Intangible assets may be

reported at (1) cost less
accumulated amortization or
(2) fair value, if fair value can
be determined in an active
market.
If revaluation is chosen, all
assets within the class of
intangibles must be revalued
on a regular basis.
Goodwill cannot be revalued.

Partial-Period Depreciation
Pro-rating the depreciation based on the
date of acquisition is time-consuming
and costly. A commonly used alternative
is the . . .
Half-Year
Half-Year Convention
Convention

Take
Take
of
of aa year
year of
of depreciation
depreciation in
in the
the

year
year of
of acquisition,
acquisition, and
and the
the other
other
in
in
the
the year
year of
of disposal.
disposal.
11 - 28

Changes in Estimates
ESTIMATED
ESTIMATED
service
service life
life

ESTIMATED
ESTIMATED
residual
residual value
value

Changes in estimates are accounted for prospectively.

The book value less any residual value at the date of
change is depreciated over the remaining useful life. A
disclosure note should describe the effect of a change.
On January 1, equipment was purchased that cost $30,000, has
a useful life of 10 years and no salvage value. At the beginning
of the fourth year, it was decided that there were only 5 years
remaining, instead of 7 years.
Calculate depreciation expense for the fourth
year using the straight-line method.
11 - 29

Changes in Estimates
Asset
Asset cost
cost
Accumulated
Accumulated depreciation
depreciation
($3,000
($3,000 per
per year
year 33 years)
years)
Remaining
Remaining book
book value
value
Divide
Divide by
by remaining
remaining life
life
Revised
Revised annual
annual depreciation
depreciation

$$ 30,000
30,000
9,000
9,000
21,000
21,000
55
$$ 4,200
4,200

What happens if we change

depreciation methods?
11 - 30

Change in Depreciation Method

A
A change
change in
in depreciation,
depreciation, amortization,
amortization, or
or depletion
depletion
method
method is
is considered
considered aa change
change in
in accounting
accounting estimate
estimate
that
that is
is achieved
achieved by
by aa change
change in
in accounting
accounting principle.
principle.
We
We account
account for
for these
these changes
changes prospectively
prospectively,,
exactly
exactly as
as we
we would
would any
any other
other change
change in
in estimate.
estimate.
On January 1, 2009, Matrix, Inc., purchased equipment for $400,000.
Matrix expected a residual value $40,000, and a service life of 5
years. Matrix uses the double-declining-balance method to
depreciate this type of asset. During 2011, the company switched
from double-declining balance to straight-line depreciation. The
residual value remained at $40,000. Lets determine the amount of
depreciation to be recorded at the end of 2011.
11 - 31

Change in Depreciation Method

December 31, 2011:

Depreciation expense ...................................
Accumulated depreciation................
To record depreciation expense.

11 - 32

34,667
34,667

Error Correction
Errors found in a subsequent
accounting period are corrected by . . .
Entries that
restate the
incorrect account
balances to the
correct amount.

Restating the
prior periods
financial
statements.

Reporting the
correction as a
prior period
adjustment to
Beginning R/E.

In addition, a disclosure note is needed to describe the nature

of the error and the impact of its correction on net income,
income before extraordinary items, and earnings per share.
11 - 33

Impairment of Value
Accounting
Accounting treatment
treatment differs.
differs.
Long-term
Long-term assets
assets
to
to be
be held
held and
and used
used

Tangible
Tangible and
and
intangible
intangible
with
with finite
finite
useful
useful lives
lives

Intangible
Intangible
with
with
indefinite
indefinite
useful
useful lives
lives

Test for
impairment
of value
when
considered
for sale.

Long-term
Long-term assets
assets
held
held for
for sale
sale

Goodwill
Goodwill
Test for impairment of
value at least annually.

Test for impairment of value when it is suspected

that book value may not be recoverable
11 - 34

Finite-life Assets to be Held and Used

Measurement
Measurement Step
Step 11
An asset is impaired when . . .

The undiscounted
sum of its estimated
future cash flows

11 - 35

<

Its
book
value

Finite-life Assets to be Held and Used

Measurement Step 2
Impairment
loss

Reported as part
of income from
continuing operations.

$0

Book
value

Market value, price of similar assets,

or PV of future net cash inflows.

Fair Value
$125

Case 1: $50 book value.

No loss recognized

Fair
value

Undiscounted future
cash flows
$250
Case 3: $275 book value.
Loss = $275 - $125

Case 2: $150 book value. No loss recognized

11 - 36

Assets Held for Sale

Assets held for sale
include assets that management
has committed to sell immediately in
their present condition and
for which sale is probable.

Impairment
loss
11 - 37

Book
value

Fair value less

cost to sell

U.S. GAAP vs. IFRS

Impairment of Value: Property, Plant, and
Equipment and Finite-life Intangible Assets

11 - 38

Assets are tested for

impairment when events or
changes in indicators suggest
that book value may not be
recoverable.
An impairment loss is required
when an assets book value
exceeds the undiscounted
sum of the estimated future
cash flows.

Assets must be assessed for

circumstances of impairment
at the end of each reporting
period.
An impairment loss is required
when an assets book value
exceeds the higher of the
assets value-in-use (present
value of estimated future cash
flow) and fair value less costs
to sell.

U.S. GAAP vs. IFRS

Impairment of Value: Property, Plant, and
Equipment and Finite-life Intangible Assets

The impairment loss is the

difference between book value
and fair value.
Reversals of impairment
losses are prohibited.

11 - 39

The impairment loss is the

difference between book value
and the recoverable amount,
the higher of the assets valuein-use and fair value less costs
to sell.
An impairment loss is reversed
if the circumstances that
caused the impairment is
resolved.

Finite-life Assets to be Held and Used

Because Acme Auto Parts has seen its sales steadily decrease due
to the decline in new car sales, Acmes management believes that
equipment that originally cost $350 million, with a $200 million book
value may not be recoverable. Management estimates that future
undiscounted cash flows associated with the equipments
remaining useful life will be only $140 million, and that the
equipment could be sold now for $120 million. Has Acme suffered
an impairment loss and if so, how should it be recorded?

Step 1
$140 million < $200 million
Impairment loss is indicated.
11 - 40

Finite-life Assets to be Held and Used

Because Acme Auto Parts has seen its sales steadily decrease due
to the decline in new car sales, Acmes management believes that
equipment that originally cost $350 million, with a $200 million book
value may not be recoverable. Management estimates that future
undiscounted cash flows associated with the equipments
remaining useful life will be only $140 million, and that the
equipment could be sold now for $120 million. Has Acme suffered
an impairment loss and if so, how should it be recorded?

Step 2
Impairment loss = $200 million $120 million = $80 million
Impairment loss ...................................
Accumulated depreciation ...................
Equipment .
To record impairment loss.
11 - 41

80,000,000
150,000,000
230,000,000

Indefinite-life Intangibles
Goodwill
Goodwill
Step
Step 11 IfIf BV
BV of
of reporting
reporting
unit
unit >> FV,
FV, impairment
impairment
indicated.
indicated.
Step
Step 22 Loss
Loss == BV
BV of
of
goodwill
goodwill less
less implied
implied value
value
of
of goodwill.
goodwill.
11 - 42

Other
Other Indefinite
Indefinite
Life
Life Intangibles
Intangibles

One-step
One-step Process
Process
IfIf BV
BV of
of asset
asset >>
FV,
FV, recognize
recognize
impairment
impairment loss.
loss.

U.S. GAAP vs. IFRS

Impairment of Value: Indefinite-life Intangible
Assets Other than Goodwill

11 - 43

Indefinite-life intangible assets

other than goodwill are tested
for impairment at least annually.
The impairment loss is the
difference between book value
and fair value.

Indefinite-life intangible assets

other than goodwill are tested
for impairment at least annually.
The impairment loss is the
difference between book value
and the recoverable amount,
the higher of the assets valuein-use (present value of
estimated future cash flows)
and fair value less costs to sell.

U.S. GAAP vs. IFRS

Impairment of Value: Indefinite-life Intangible
Assets Other than Goodwill

11 - 44

Reversals of impairment losses

are prohibited.
If certain criteria are met,
indefinite-life intangible assets
are combined for the required
annual impairment test.

An impairment loss is reversed

if the circumstances that
caused the impairment is
resolved.
Indefinite-life intangible assets
may not be combined with
other indefinite-life intangible
assets for the required annual
impairment test.

U.S. GAAP vs. IFRS

Impairment of Value: Goodwill

11 - 45

Goodwill is tested for

impairment at least annually.
Reversals of impairment
losses are prohibited.
The level of testing (reporting
unit) is a segment or a
component of an operating
segment for which discrete
financial information is
available.

Goodwill is tested for

impairment at least annually.
Reversals of impairment
losses are prohibited.
The level of testing (cashgenerating unit) is the smallest
identifiable group of assets
that generates cash flows that
are largely independent of the
cash flows from other assets.

U.S. GAAP vs. IFRS

Impairment of Value: Goodwill
Measurement of an impairment
loss is a two-step process. In
step one the fair value of the
reporting unit is compared to
its book value. A loss is
indicated if the fair value is less
than the book value. In step
two, the impairment loss is
calculated as the excess of
book value of goodwill over the
implied fair value of goodwill.
11 - 46

Measurement of an
impairment loss is a one-step
process. The recoverable
amount of the cash-generating
unit is compared to its book
value. If the recoverable
amount is less, goodwill is
reduced before other assets
are reduced.

Impairment of Goodwill
Simmons Company recorded $150 million of goodwill when it
acquired Blake Company. Blake continues to operate as a separate
company and is considered to be a reporting unit. At the end of the
current year Simmons noted the following related to Blake: (1) book
value of net assets, including $150 million of goodwill is $500 million;
(2) fair value of Blake is $400 million; and (3) fair value of Blakes
identifiable net assets, excluding goodwill is $350 million. Is goodwill
impaired and if so, by what amount?

Step 1
$500 million > $400 million
Impairment loss is indicated.
11 - 47

Impairment of Goodwill
Simmons Company recorded $150 million of goodwill when it
acquired Blake Company. Blake continues to operate as a separate
company and is considered to be a reporting unit. At the end of the
current year Simmons noted the following related to Blake: (1) book
value of net assets, including $150 million of goodwill is $500 million;
(2) fair value of Blake is $400 million; and (3) fair value of Blakes
identifiable net assets, excluding goodwill is $350 million. Is goodwill
impaired and if so, by what amount?

11 - 48

Expenditures Subsequent
to Acquisition
Type of
Expenditure
Repairs and
Maintenance
Additions

Definition
Expenditures to maintain
a given level of benefits

Usual Accounting Treatment

Expense in the period incurred

The addition of a new major Capitalize and depreciate over the

component to an existing asset remaining useful life of the original
asset, or over the useful life of the
addition, whichever is shorter

Improvements

The replacement of
a major component

Capitalize and depreciate over the

useful life of the improved asset

Rearrangements

Expenditures to restructure
an asset without addition,
replacement, or improvement

If expenditures are material and

clearly increase future benefits,
capitalize and depreciate over
the future periods benefited

11 - 49

U.S. GAAP vs. IFRS

Costs of Defending Intangible Rights

11 - 50

Litigation costs to successfully

defend intangible rights are
capitalized and amortized over
the remaining useful life of the
asset.

Litigation costs are expensed,

except in rare situations when
an expenditure increases
future benefits.

Appendix 11A Comparison with

MACRS (Tax Depreciation)
Most
Most corporations
corporations use
use the
the Modified
Modified
Accelerated
Accelerated Cost
Cost Recovery
Recovery System
System
(MACRS)
(MACRS) for
for tax
tax purposes.
purposes.

Provides
for rapid
write-off
11 - 51

Ignores
residual
value

Rates based
on asset
class lives

Appendix 11B Retirement and

Replacement Methods of Depreciation
Used for groups of similar, low-valued
assets with short service lives.
Retirement Method
Replacement Method
Acquisitions:
Acquisitions:
Record initial acquisitions
of assets at cost in the
asset account.
Record subsequent
acquisitions of assets at
cost in the asset account

Dispositions:
Credit the asset account
for cost.
Debit depreciation expense
for cost less the proceeds
received.
11 - 52

Record initial acquisitions of

assets at cost in the asset
account.
Record subsequent
acquisitions with a debit to
depreciation expense.

Dispositions:
Credit depreciation expense
for the proceeds received.

End of Chapter 11