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 bebe expensed
expensed inin periods
periods when
when thethe
future
future revenues
revenues are
are earned.
earned.

Depreciation, depletion, and amortization are

cost allocation processes used to help meet the
matching principle requirements.
Some
Some of
of the
the cost
cost is
is expensed
expensed each
each period.
period.

Acquisition
Acquisition Expense
Expense
Cost
Cost

11 - 2
(Balance Sheet) (Income Statement)
 Cost Allocation – An Overview
Asset
Account Credited
Category Debit
Property, Plant, & Accumulated
Depreciation
Equipment Depreciation
Natural Resource
Natural Resource Depletion
Asset
Intangible Amortization Intangible Asset

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 Allocation
Allocation Allocation
Allocation
Life
Life Base
Base Method
Method

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

Group
Group and
and
Time-based
Time-based Methods
Methods composite
composite
Straight-line
 Straight-line (SL)
(SL) methods
methods
Accelerated
 Accelerated Methods
Methods
Sum-of-the-years’
 Sum-of-the-years’ digits
digits (SYD)
(SYD) Tax
Tax
Declining
 Declining Balance
Balance (DB)
(DB) depreciation
depreciation

Activity-based
Activity-based methods
methods
Units-of-production
Units-of-production method
method (UOP).
(UOP).

11 - 5
 Straight-Line

The
The most
most widely
widely Results
Results in
in the
the same
same
used
used and
and most
most easily
easily amount
amount of
of depreciation
depreciation in in
understood
understood method.
method. each
each year
year of
of the
the asset’s
asset’s
service
service life.
life.
On
On January
January 1,
1, wewe purchase
purchase equipment
equipment forfor $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
 Straight-Line

Depreciation
Life in Years
Accumulated Accumulated Undepreciated
Depreciation Depreciation Depreciation Balance
Year (debit) (credit) Balance (book value)
$ 50,000
1 $ 9,000 $ 9,000 $ 9,000 41,000
2 9,000 9,000 18,000 32,000
3 9,000 9,000 27,000 23,000
4 9,000 9,000 36,000 14,000
5 9,000 9,000 45,000 5,000
$ 45,000 $ 45,000

Residual Value
BV = Residual Value at the
11 - 7
end of the asset’s useful life.
 Accelerated Methods
Accelerated methods result in more depreciation
in the early years of an asset’s useful life and less
depreciation in later years of an asset’s useful life.

Note that total depreciation over the asset’s 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)
Accumulated Undepreciated
Depreciation Depreciation Balance
Fraction (debit) Balance (book value)
$ 50,000
5/15 $ 15,000 $ 15,000 35,000
4/15 12,000 27,000 23,000
3/15 9,000 36,000 14,000
2/15 6,000 42,000 8,000
1/15 3,000 45,000 5,000
$ 45,000

Residual Value
Depreciation

11 - 11 Life in Years
 Declining-Balance (DB) Methods
DB depreciation Stop depreciating
• Based on the straight-line rate when:
multiplied by an acceleration BV = Residual
factor. 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
Accumulated Undepreciated
Depreciation Depreciation Balance
Year (debit) Balance (book value)
$ 50,000
1 $ 20,000 $ 20,000 30,000
2 12,000 32,000 18,000
3 7,200 39,200 10,800
4 4,320 43,520 6,480
5 1,480 45,000 5,000
$ 45,000

Depreciation forced so that BV = Residual Value.

Depreciation

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

• Component depreciation is • Each component of an item of

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.
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.

11 - 18
 Group and Composite Methods
•• Assets
Assets areare grouped
grouped byby 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 raterate remains
remains the the same.
same.
When
 When an an asset
asset in
in the
the group
group is is sold
sold oror retired,
retired,
debit
debit accumulated
accumulated depreciation
depreciation for for the
the
difference
difference between
between the the asset’s
asset’s cost
cost and
and the
the
proceeds.
proceeds.
11 - 19
 U.S. GAAP vs. IFRS
Valuation of Property, Plant, and Equipment

• Property, plant, and equipment • Property, plant, and equipment may

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

11 - 20
 Depletion of Natural Resources
As natural resources are “used
up,” or depleted, the cost of the The approach is based
natural resources must be on the units-of-
allocated to the units extracted. production method.

11 - 21
 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 ABC’s depletion rate?

Depletion rate = 1,000,000 ÷ 40,000 Tons = $25 Per Ton

For the year ABC mined 13,000 tons. What is

the total amount of depletion for the year?

Depletion = 13,000 tons × $25per ton = $325,000

11 - 22
 U.S. GAAP vs. IFRS
Valuation of Biological Assets

• Biological assets, such as • Biological assets are valued at

timber tracts, are valued at fair value less estimated costs
cost less accumulated to sell.
depletion.

11 - 23
 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 asset’s 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 Torch’s amortization expense?

Amortization expense ................................... 600

Patent ………………........................ 600
To record amortization of patent.
11 - 25
 Intangible Assets not
Subject to Amortization

Goodwill and Trademarks

Subject to assessment
for impairment of
Not amortized.
value and may be
written down.

11 - 26
 U.S. GAAP vs. IFRS
Valuation of Intangible Assets

• Intangible assets are reported • Intangible assets may be

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

11 - 27
 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 ½
Take ½ 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 ½
½ in
in
the
the year
year of
of disposal.
disposal.

11 - 28
 Changes in Estimates
ESTIMATED
ESTIMATED ESTIMATED
ESTIMATED
service
service life
life 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 cost $ 30,000

Accumulated depreciation
($3,000 per year × 3 years) 9,000
Remaining book value 21,000
Divide by remaining life ÷ 5
Revised annual depreciation $ 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 byby 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 anyany 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. Let’s determine the amount of
depreciation to be recorded at the end of 2011.
11 - 31
 Change in Depreciation Method
Depreciation - 2009 $ 160,000 ($400,000 × 40%)
Depreciation - 2010 96,000 [($400,000 - $160,000) × 40%]
Total Depreciation $ 256,000

Cost of asset $ 400,000

Undepreciated balance $ 144,000
Less: residual value (40,000)
New depreciable amount 104,000
Remaining service life ÷ 3
Annual depreciation $ 34,667

December 31, 2011:

Depreciation expense ................................... 34,667
Accumulated depreciation................ 34,667
To record depreciation expense.

11 - 32
 Error Correction
Errors found in a subsequent
accounting period are corrected by . . .

 Entries that  Restating the  Reporting the

restate the prior period’s correction as a
incorrect account financial prior period
balances to the statements. adjustment to
correct amount. 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
 Test for
impairment
Impairment of Value of value when

Accounting
Accounting treatment
treatment differs.
differs. considered
for sale.

Long-term
Long-term assets
assets Long-term
Long-term assets
assets
to
to be
be held
held and
and used
used held
held for
for sale
sale

Tangible
Tangible and and Intangible
Intangible Goodwill
Goodwill
intangible
intangible with
with
with
with finite
finite indefinite
indefinite Test for impairment of
useful
useful lives
lives useful
useful lives
lives 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 Its

sum of its estimated
future cash flows
< book
value

11 - 35
 Finite-life Assets to be Held and Used
Measurement – Step 2
Impairment Book Fair
loss = value – value

Reported as part
Market value, price of similar assets,
of income from
or PV of future net cash inflows.
continuing operations.

Undiscounted future
Fair Value cash flows
$0 $125 $250

Case 1: $50 book value. Case 3: $275 book value.

No loss recognized 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 Book Fair value less

loss = value – cost to sell

11 - 37
 U.S. GAAP vs. IFRS
Impairment of Value: Property, Plant, and
Equipment and Finite-life Intangible Assets

• Assets are tested for • Assets must be assessed for

impairment when events or
changes in indicators suggest
that book value may not be
recoverable.
• when an asset’s book value
An impairment loss is required
when an asset’s book value
exceeds the undiscounted
sum of the estimated future
cash flows.
circumstances of impairment
at the end of each reporting
period.
• An impairment loss is required
exceeds the higher of the
asset’s value-in-use (present
value of estimated future cash
flow) and fair value less costs
to sell.

11 - 38
 U.S. GAAP vs. IFRS
Impairment of Value: Property, Plant, and
Equipment and Finite-life Intangible Assets

• The impairment loss is the • The impairment loss is the

difference between book value
and fair value.
• Reversals of impairment
losses are prohibited.
• An impairment loss is reversed
difference between book value
and the recoverable amount,
the higher of the asset’s value-
in-use and fair value less costs
to sell.
if the circumstances that
caused the impairment is
resolved.

11 - 39
 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, Acme’s 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 equipment’s
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, Acme’s 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 equipment’s
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 ................................... 80,000,000

Accumulated depreciation ................... 150,000,000
Equipment ……………………. 230,000,000
To record impairment loss.
11 - 41
 Indefinite-life Intangibles

Other
Other Indefinite
Indefinite
Goodwill
Goodwill Life
Life Intangibles
Intangibles

Step
Step 11 IfIf BV
BV of
of reporting
reporting
unit
unit >> FV,
FV, impairment
impairment One-step
One-step Process
Process
indicated.
indicated.
IfIf BV
BV of
of asset
asset >>
FV,
FV, recognize
recognize
Step
Step 22 Loss
Loss == BV
BV of
of impairment
impairment loss.
loss.
goodwill
goodwill less
less implied
implied value
value
of
of goodwill.
goodwill.

11 - 42
 U.S. GAAP vs. IFRS
Impairment of Value: Indefinite-life Intangible
Assets Other than Goodwill
• 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.
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 the recoverable amount,
the higher of the asset’s value-
in-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

• Reversals of impairment losses • An impairment loss is reversed

are prohibited.
• caused the impairment is
If certain criteria are met,
indefinite-life intangible assets
are combined for the required
annual impairment test.
if the circumstances that
resolved.
• Indefinite-life intangible assets
may not be combined with
other indefinite-life intangible
assets for the required annual
impairment test.

11 - 44
 U.S. GAAP vs. IFRS
Impairment of Value: Goodwill

• Goodwill is tested for • Goodwill is tested for impairment

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

11 - 45
 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 Blake’s
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 Blake’s
identifiable net assets, excluding goodwill is $350 million. Is goodwill
impaired and if so, by what amount?
Step 2
Determination of implied goodwill
Fair value of Blake $ 400,000,000
Fair value of Blake's net assets excluding goodwill 350,000,000
Implied value of goodwill $ 50,000,000
Measure of impairment loss
Book value of goodwill $ 150,000,000
Implied value of goodwill 50,000,000
Impairment loss $ 100,000,000

11 - 48
 Expenditures Subsequent
to Acquisition
Type of Definition Usual Accounting Treatment
Expenditure
Repairs and Expenditures to maintain Expense in the period incurred
Maintenance a given level of benefits

Additions 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 Capitalize and depreciate over the

a major component useful life of the improved asset

Rearrangements Expenditures to restructure If expenditures are material and

an asset without addition, clearly increase future benefits,
replacement, or improvement capitalize and depreciate over
the future periods benefited

11 - 49
 U.S. GAAP vs. IFRS
Costs of Defending Intangible Rights

• Litigation costs to successfully • Litigation costs are expensed,

defend intangible rights are except in rare situations when
capitalized and amortized over an expenditure increases
the remaining useful life of the future benefits.
asset.

11 - 50
 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 Ignores Rates based

for rapid residual on asset
write-off value “class lives”

11 - 51
 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 • Record initial acquisitions of
of assets at cost in the assets at cost in the asset
asset account. account.
• Record subsequent • Record subsequent
acquisitions of assets at acquisitions with a debit to
cost in the asset account depreciation expense.
Dispositions: Dispositions:
• Credit the asset account • Credit depreciation expense
for cost. for the proceeds received.
• Debit depreciation expense
for cost less the proceeds
received.
11 - 52
End of Chapter 11