Prepared by Coby Harmon University of California, Santa Barbara 11-1 Westmont College CHAPTER 11 Depreciation, Impairments, and Depletion LEARNING OBJECTIVES After studying this chapter, you should be able to: Describe depreciation concepts and methods of mineral resources depreciation Identify other depreciation issues Explain the accounting issues related to asset impairment 11-2 Discuss the accounting procedures for depletion of Apply the accounting for revaluations Demonstrate how to report and analyze property, plant, equipment, and mineral resources PREVIEW OF CHAPTER 11 Intermediate Accounting IFRS 3rd Edition Kieso ● Weygandt ● Warfield 11-3 LEARNING OBJECTIVE Depreciation—A Method Describe depreciation concepts and methods of depreciation 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: 11-4 Fixed assets = Depreciation expense Intangibles = Amortization expense Mineral resources = Depletion expense LO Depreciation—Method of Cost Allocation Factors Involved in the Depreciation Process Three basic questions: 11-5 What depreciable base is to be used? What is the asset’s useful life? What method of cost apportionment is best? LO Factors Involved in Depreciation Process Depreciable Base for the Asset ILLUSTRATION 11.1 Computation of Depreciation Base 11-6 LO Factors Involved in Depreciation Process Estimation of Service Lives 11-7 Service life often differs from physical life Companies retire assets for two reasons: Physical factors (casualty or expiration of physical life) Economic factors (inadequacy, supersession, and obsolescence) LO Depreciation—Method of Cost Allocation Methods of Depreciation The profession requires the method employed be “systematic and rational.” Methods used include: 11-8 Activity method (units of use or production) Straight-line method Diminishing (accelerated)-charge methods: a Sum-of-the-years’-digits b Declining-balance method LO Methods of Depreciation Activity Method ILLUSTRATION 11.2 Data Used to Illustrate Depreciation Methods Data for Stanley Coal Mines Illustration: If Stanley uses the crane for 4,000 hours the first year, the depreciation charge is: ILLUSTRATION 11.3 Depreciation Calculation, Activity Method—Crane Example 11-9 LO Methods of Depreciation Straight-Line Method ILLUSTRATION 11.2 Data Used to Illustrate Depreciation Methods Data for Stanley Coal Mines Illustration: Stanley computes depreciation as follows: ILLUSTRATION 11.4 Depreciation Calculation, Straight-Line Method—Crane Example 11-10 LO ILLUSTRATION 11A.5 Summary of Revaluation—2020 The carrying amount of the equipment is now €570,000 Nokia reports depreciation expense of €237,500 and an impairment loss of €30,000 in the income statement Nokia reports the reversal of the previously recorded unrealized gain by recording the transfer to retained earnings of €37,500 and the entry to Unrealized Gain on Revaluation—Equipment of €112,500 11-84 LO Revaluation—2021: Recovery of Impairment Loss Assuming no change in the useful life of the equipment, depreciation expense for Nokia in 2021 is €190,000 (€570,000 ÷ 3), and the entry to record depreciation expense on December 31, 2021 as follows Depreciation Expense 190,000 Accumulated Depreciation—Equipment 11-85 190,000 LO Nokia transfers the difference between depreciation based on the revalued carrying amount of the equipment and depreciation based on the asset’s original cost from AOCI to retained earnings Depreciation based on the original cost was €200,000 (€1,000,000 ÷ 5) and on fair value is €190,000 Retained Earnings 10,000 Accumulated Other Comprehensive Income 10,000 Before revaluation in 2021, Nokia has the following amounts related to its equipment 11-86 LO Revaluation—2021: Recovery of Loss Nokia determines through appraisal that the equipment now has a fair value of €450,000 To report the equipment at fair value, Nokia does the following Reduces the Accumulated Depreciation—Equipment account of €190,000 to zero Reduces the Equipment account by €120,000 (€570,000 − €450,000)—it then is reported at its fair value of €450,000 11-87 Records an Unrealized Gain on Revaluation—Equipment for €40,000 Records a Recovery of Loss on Impairment for €30,000 LO Revaluation—2021: Recovery of Loss Nokia determines through appraisal that the equipment now has a fair value of €450,000 To report the equipment at fair value, Nokia does the following The entry to record this transaction is as follows Accumulated Depreciation—Equipment 190,000 Unrealized Gain on Revaluation—Equipment Equipment 120,000 Recovery of Loss on Impairment 11-88 40,000 30,000 LO ILLUSTRATION 11A.6 Summary of Revaluation—2021 On January 2, 2022, Nokia sells the equipment for €450,000 Nokia makes the following entry to record this transaction Cash 450,000 Equipment 450,000 Nokia does not record a gain or loss because the carrying amount of the equipment is the same as its fair value 11-89 LO ILLUSTRATION 11A.6 Summary of Revaluation—2021 Nokia transfers the remaining balance in Accumulated Other Comprehensive Income to Retained Earnings Accumulated Other Comprehensive Income Retained Earnings 50,000 50,000 Even though the equipment has appreciated in value by €50,000, the company does not recognize this gain in net income 11-90 LO GLOBAL ACCOUNTING INSIGHTS LEARNING OBJECTIVE Compare accounting procedures for property, plant, and equipment under IFRS and U.S GAAP U.S GAAP adheres to many of the same principles as IFRS in the accounting for property, plant, and equipment Major differences relate to use of component depreciation, impairments, and revaluations 11-91 LO GLOBAL ACCOUNTING INSIGHTS Relevant Facts Following are the key similarities and differences between U.S GAAP and IFRS related to property, plant, and equipment Similarities • The definition of property, plant, and equipment is essentially the same under U.S GAAP and IFRS • Under both U.S GAAP and IFRS, changes in depreciation method and changes in useful life are treated in the current and future periods Prior periods are not affected • 11-92 The accounting for plant asset disposals is the same under U.S GAAP and IFRS LO GLOBAL ACCOUNTING INSIGHTS Relevant Facts Similarities • The accounting for the initial costs to acquire natural resources is similar under U.S GAAP and IFRS • Under both U.S GAAP and IFRS, interest costs incurred during construction must be capitalized Recently, IFRS converged to U.S GAAP • The accounting for exchanges of non-monetary assets is essentially the same between U.S GAAP and IFRS U.S GAAP requires that gains on exchanges of non-monetary assets be recognized if the exchange has commercial substance This is the same framework used in IFRS • U.S GAAP and IFRS both view depreciation as allocation of cost over an asset’s life U.S GAAP and IFRS permit the same depreciation methods (straight-line, diminishing-balance, units-of-production) 11-93 LO GLOBAL ACCOUNTING INSIGHTS Relevant Facts Differences • Under U.S GAAP, component depreciation is permitted but is rarely used IFRS requires component depreciation • U.S GAAP does not permit revaluations of property, plant, equipment, and mineral resources Under IFRS, companies can use either the historical cost model or the revaluation model • In testing for impairments of long-lived assets, U.S GAAP uses a different model than IFRS Under U.S GAAP, as long as future undiscounted cash flows exceed the carrying amount of the asset, no impairment is recorded The IFRS impairment test is stricter However, unlike U.S GAAP, reversals of impairment losses are permitted under IFRS 11-94 LO GLOBAL ACCOUNTING INSIGHTS Relevant Facts Differences • 11-95 Under U.S GAAP, all losses on non-monetary asset exchanges are recognized immediately LO GLOBAL ACCOUNTING INSIGHTS About The Numbers As indicated, impairment testing under U.S GAAP is a two-step process Illustration 11.18, in the text, summarizes impairment measurement under U.S GAAP The key distinctions relative to IFRS relate to the use of a cash flow recovery test to determine if an impairment test should be performed Also, U.S GAAP does not permit reversal of impairment losses for assets held for use 11-96 LO GLOBAL ACCOUNTING INSIGHTS On the Horizon With respect to revaluations, as part of the conceptual framework project, the Boards will examine the measurement bases used in accounting It is too early to say whether a converged conceptual framework will recommend fair value measurement (and revaluation accounting) for property, plant, and equipment However, this is likely to be one of the more contentious issues, given the longstanding use of historical cost as a measurement basis in U.S GAAP 11-97 LO Copyright Copyright © 2018 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein 11-98 ... analyze property, plant, equipment, and mineral resources PREVIEW OF CHAPTER 11 Intermediate Accounting IFRS 3rd Edition Kieso ● Weygandt ● Warfield 11-3 LEARNING OBJECTIVE Depreciation—A Method... Identify other depreciation issues Explain the accounting issues related to asset impairment 11-2 Discuss the accounting procedures for depletion of Apply the accounting for revaluations Demonstrate... Describe depreciation concepts and methods of depreciation of Cost Allocation Depreciation is the accounting process of allocating the cost of tangible assets to expense in a systematic and rational