19th Edition Chapter 11 Investments in Noncurrent Operating Assets—Utilization and Retirement Intermediate Accounting James D Stice Earl K Stice PowerPoint presented by Douglas Cloud Professor Emeritus of Accounting, Pepperdine University © 2014 Cengage Learning 11-1 What is depreciation? • Depreciation is not a process through which a company accumulates a cash fund to replace its long-lived fixed assets • Depreciation is not a way to compute the current value of long-lived assets • Depreciation is the systematic allocation of the cost of an asset over the different periods benefited by the use of the asset 11-2 Factors Affecting the Periodic Depreciation Charge Four factors are taken into consideration in determining the appropriate amount of annual depreciation expense • Asset cost • Residual or salvage value • Useful life • Pattern of use 11-3 Depreciation Vocabulary • • • Asset cost is the purchase cost plus any capitalized expenditures Residual (salvage) value of property is an estimate of the amount for which the asset can be sold when it is retired Useful life is the expected life of the asset in years, hours of service, or per unit of output (continued) 11-4 Useful Life The physical factors that limit the service life of an asset are— 1) wear and tear, 2) deterioration and decay, and 3) damage or destruction The primary functional factor limiting the useful life of assets is obsolescence 11-5 Depreciation Formula Symbols The examples that follow assume the acquisition of a polyurethane plastic-molding machine at the beginning of 2013 by Schuss Boom Ski Manufacturing, Inc., at a cost of $100,000 with an estimated residual value of $5,000 C = Asset cost R = Estimated residual value n = Estimated life in years, hours of service, or units of output r = Depreciation rate per period, per hour of service, or per unit of output D = Periodic depreciation charge 11-6 Time-Factor Methods Straight-Line Straight-Line • • • Of the time-factor methods, straight-line depreciation is by far the most popular Straight-line depreciation relates to the passage of time and recognizes equal depreciation in each year of the life of the asset This method assumes the asset is equally useful during each time period (continued) 11-7 Straight-Line Depreciation Using data for the machine acquired by Schuss Boom Ski Manufacturing and assuming a 5-year life, annual depreciation is computed as follows: D= C–R N = $100,000 – $5,000 years = $19,000 per year (continued) 11-8 Sum-of-the-Years’ Digits Method The sum-of-the-years’-digits depreciation method yields decreasing depreciation in each successive year To determine the denominator, use the following formula (assuming years): [n (n + 1)] SYD = [5 (5 + 1)] SYD = Or, simple add 1+2+3+4+5 SYD = 15 (continued) 11-9 Sum-of-the-Years’ Digits Method Now that we know the denominator, we can determine the depreciation for the year using the following formula, where “t” equals years remaining at the beginning of the period t × (C – R) D= SYD × ($100,000 – $5,000) D= 15 D = $31,667 (continued) 11-10 Nonmonetary Exchange without Commercial Substance Example Example1—No 1—No Cash CashInvolved Involved Republic Manufacturing Company owns a molding machine that it decided to exchange for a machine owned by Logan Square Company The following cost and market data relate to the two machines: (continued) 11-63 Nonmonetary Exchange without Commercial Substance The entry on Republic’s books to record the exchange will be: Machinery (new) Accumulated Depreciation—Machinery (old) Machinery 46,000 14,000 32,000 Machinery (new) Accumulated Depreciation—Machinery (old) Loss on Exchange of Machinery Machinery (old) 54,000 16,000 37,700 300 The entry on Logan’s books to record the exchange will be: 11-64 Nonmonetary Exchange without Commercial Substance Example Example2—Small 2—SmallAmount Amountof ofCash CashInvolved Involved Assume the same facts as Example 1, except that it is agreed that Republic’s machine has a market value of $16,000 and Logan’s machine is worth $17,000 Republic pays Logan $1,000 cash 17,000 (continued) 11-65 Nonmonetary Exchange without Commercial Substance The entry on Republic’s books to record the exchange will be: Machinery (new) Accumulated Depreciation—Machinery (old) Machinery (old) 46,000 Cash The 1,000 book value of Logan’s machine 15,000 32,000 is less than the fair value, indicating a $700 gain ($17,000 – $16,300) A portion of the gain should be recognized as having been earned (continued) 11-66 Nonmonetary Exchange without Commercial Substance The amount to be recognized is computed using the following formula: Recognized = gain Cash received Cash received + Fair value of acquired asset Total x indicated gain For Logan: Recognized = gain $1,000 x $700 = $41 $1,000 + $16,000 (continued) 11-67 Nonmonetary Exchange without Commercial Substance The entry on Logan’s books to record the exchange is as follows: Cash Machinery (new) Accumulated Depreciation—Machinery (old) Machinery (old) 54,000 Gain on Exchange of Machinery 41 1,000 15,341 37,700 11-68 Nonmonetary Exchange without Commercial Substance Example Example3—Large 3—LargeAmount Amountof ofCash CashInvolved Involved Assume the same facts as in Example 2, except that it is agreed that Republic’s machine has a fair value of $12,750 and Logan’s machine has a fair value of $17,000 Republic pays Logan $4,250 cash (continued) 11-69 Nonmonetary Exchange without Commercial Substance The entry on Republic’s books to record the exchange will be: Machinery (new) Accumulated Depreciation—Machinery (old) Loss on Exchange of Machinery Machinery (old) 46,000 Cash The entry on Logan’s books: 4,250 Cash Machinery (new) Accumulated Depreciation—Machinery (old) Machinery (old) 54,000 Gain on Exchange of Machinery 700 17,000 32,000 1,250 4,250 12,750 37,700 11-70 Depreciation for Partial Periods Makes the Nearest whole month most intuitive Nearest whole year sense Half-year convention No depreciation in year of acquisition; full year depreciation in year of retirement Full year depreciation in year of acquisition; no depreciation in year of retirement (continued) 11-71 Depreciation for Partial Periods Sum-of-the-Years’-Digits Sum-of-the-Years’-DigitsMethod Method 11-72 Depreciation for Partial Periods Declining-Balance Declining-BalanceMethod Method 11-73 Income Tax Depreciation • • • The term cost recovery was used in the tax regulations to emphasize that ACRS is not a standard depreciation method because the system is not based strictly on asset life or pattern of use Salvage values are ignored Depreciate over three to five years (continued) 11-74 Income Tax Depreciation The MACRS method for personal property also incorporates a halfyear convention, meaning that onehalf of a year’s depreciation is recognized on all assets purchased or sold during the year 11-75 Chapter 11 ₵ The The End End $ 11-76 11-77 ... $31,667 (continued) 11- 10 Sum-of-the-Years’ Digits Method For the second year, we reduce the numerator by one t × (C – R) D= SYD × ($100,000 – $5,000) D= 15 D = $25,333 (continued) 11- 11 Declining-Balance... assets is obsolescence 11- 5 Depreciation Formula Symbols The examples that follow assume the acquisition of a polyurethane plastic-molding machine at the beginning of 2013 by Schuss Boom Ski Manufacturing,... output D = Periodic depreciation charge 11- 6 Time-Factor Methods Straight-Line Straight-Line • • • Of the time-factor methods, straight-line depreciation is by far the most popular Straight-line