Intermediate Accounting

Seventeenth Edition

Kieso ● Weygandt ● Warfield

Lecture 2
Depreciation, Impairments,
and Depletion
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Learning Objectives
After studying this lecture, 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.
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 Learning Objective 1
Describe Depreciation Concepts and
Methods of Depreciation

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 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
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 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?

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 Factors Involved in Depreciation
Depreciable Base for the Asset

Original cost $10,000

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

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 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).

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 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. 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.
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 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:

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 Straight-Line 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: Stanley computes depreciation as follows:

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 Decreasing-Charge Methods
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

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

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 Decreasing-Charge Methods
Declining-Balance 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

• 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.

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 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

a
Salvage value.

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 Declining-Balance Method
Depreciation Schedule

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% 43,200 435,200 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.

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 Methods of Depreciation
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.

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 Straight-Line Method
Depreciation Schedule
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

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 (Assume 800 hours used in 2017)
Activity Method ($126,000/21,000 hours = $6 per hour)
Depreciation Schedule
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:
2017 Depreciation Expense 4,800
Accumultated Depreciation 4,800

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 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 × 4.5833/15 = 38,500 ×   = 38,500 56,000
2019 126,000 × 3.5833/15 = 30,100 ×   = 30,100 86,100
2020 126,000 × 2.5833/15 = 21,700 ×   = 21,700 107,800
2021 126,000 × 1.5833/15 = 13,300 ×   = 13,300 121,100
2022 126,000 × .5833/15 = 4,900 × = 4,900 126,000
$126,000

Journal entry:
2017 Depreciation Expense 17,500
Accumultated Depreciation 17,500

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 Double-Declining Balance Method
Depreciation Schedule
Depreciable Rate Per Annual Partial Current Year Accum.
Year Base Year Expense Year Expense Deprec.
2017 $150,000 × 40% = $60,000 × 5/12 = $ 25,000 $ 25,000
2018 125,000 × 40% = 50,000 ×   = 50,000 75,000
2019 75,000 × 40% = 30,000 ×   = 30,000 105,000
2020 45,000 × 40% = 18,000 ×   = 18,000 123,000
2021 27,000 × 40% = 10,800 × Plug = 3,000 126,000
$126,000

Journal entry:
2017 Depreciation Expense 25,000
Accumultated Depreciation 25,000

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 Learning Objective 2
Identify the Accounting Issues Related
to Asset Impairment

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 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.
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 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.

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 Accounting for Impairments

Loss reported as part of

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

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 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
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 Impairment—Example 2
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
Carrying value of asset:
Cost $800,000
Accumulated depreciation − 200,000 600,000
− $ 20,000

Impairment
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 Impairment—Example 2
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
Carrying value of asset:
Cost $800,000
Accumulated depreciation − 200,000 600,000
− $ 75,000

Impairment Loss
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 Impairment—Example 2
Loss Journal Entry
Fair value of equipment $525,000
Carrying value of asset:
Cost $800,000
Accumulated depreciation − 200,000 600,000
− $ 75,000

M. Alou records the impairment loss as follows:

Loss on Impairment 75,000
Accumulated Depreciation 75,000

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 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

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 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

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 Learning Objective 3
Explain the Accounting Procedures for
Depletion of Natural Resources

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 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.

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 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.

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 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:

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 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.

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 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.

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 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.

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 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
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Exercise
Q11: 1-29
BE 11.10
E 11.1
E 11.2
E 11.4

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