F2 M5 PP&E: Depreciation, Disposal, and Impairment

long-lived assets

are assets of an entity that are expected to provide value to the entity for a period longer than a year; usually included in PP&E, intangible asset such as patents & copyrights, and natural resources

depreciation

is the systematic and rational allocation of a tangible, long-lived asset’s depreciable cost over its estimated useful life; applied the matching principle by recognizing the asset’s cost as expense during the period it helps generate revenue

depreciable base

amount of an asset’s cost that will be allocated to depreciation expense, will equal accumulated depreciation at the end of the asset’s life

amortization

is the systematic allocation of the cost of a finite-life intangible asset over its estimated useful life

depletion

is the systematic allocation of the cost of a wasting natural resource to the united extracted or produced

physical depreciation

related to an asset’s deterioration and wear over a period of time (tangible asset); could be due to use, age, or exposure to elements

functional depreciation

arises from obsolescence (out of date) or inadequacy of the asset to perform efficiently (ex: asset become obsolete because newer technology performs the same function more efficiently)

salvage value

or residual value, is the estimated amount an entity expects to receive when it disposes of a long-lived asset at end of useful life; long-lived assets usually have little or not value at end of life

estimated useful life

is the period over which a long-lived asset is expected to provide benefits and be depreciated, amortized, or depleted; it may be revised at any time (prospective adjustment); expressed in years, months, or unites of production (or activity)

asset placed into service

the date the long-lived asset is ready and available for its intended use, whether or not it is actually used that day; start depreciation of asset at this point (check date to see if only certain months need to be depreciated)

component depreciation

is the separate depreciation of each part of an item of PP&E (each parts have different useful lives) that is significant to the total cost of the fixed asset; rarely used under GAAP

composite (group) depreciation

is the process of averaging the economic lives of a number of property units and depreciating the entire class of asset over a single life; generally used for a group of similar assets

*total depreciable cost of group/total annual depreciation of group (straight-line, usually)

asset retirement in composite depreciation

when one asset in the group is sold or retired before the group’s average service life ends, no gain or loss is recognized, the difference is absorbed in accumulated depreciation; a debit to cash for the amount sold, a debit to accumulated depreciation for the loss, and a credit to Asset A at historical cost (what it was bought for)

straight-line (SL) depreciation

records the same deprecation expense in each period over an asset’s useful life (a constant depreciation method)

*(cost - salvage value)/estimated useful life

sum-of-the-years’-digits depreciation

is an accelerate depreciation method that provides higher depreciation expense in early years and lower charges in later years (net income is lower in earlier years)

*1 + 2 + 3 + 4 + 5 = 15 (sum-of-the-years’-digits)
*(cost - salvage value) x (remaining life/15)

units-of-production depreciation

relates to depreciation to the estimated production capacity of an asset and is expense in a rate per unit or hour (variable cost); dependent on actual use or output, not the passage of time

*(cost - salvage value)/estimated units or hours = rate per unit
*rate per unit x number of units produced (or hours) = depreciation expense

double-declining balance

is the most common accelerated depreciation method and it records more depreciation in the early years and less in later years (net income is lower in earlier years); no allowance is made for salvage value, but asset still should not be depreciated below salvage value (a limitation)

*(cost - accumulated depreciation to date) x (2/estimated life)

half-year convention

records one-half of the normal depreciation in the first year and the remaining one-half in the final year, regardless of the asset’s actual purchase or disposal date; regular depreciation expense is taken in the in between months

*annual depreciation x ½ = depreciation expense in purchase and disposal year

other variations of depreciation

no depreciation in acquisition year, but a full year depreciation in disposal year and vice versa

*acquisition year = no depreciation
middle years = annual depreciation
disposal year = annual depreciation

sale of an asset during its useful life

a debit to cash (received from sale), a debit to accumulated depreciation (total amount of depreciation expense taken), a credit to sold asset (historical cost), and a debit if a loss OR a credit if a gain

write-off fully depreciation asset

a debit to accumulated depreciation (at 100%) and a credit to old asset at full (historical) cost (at 100%)

total and permanent impairment

a debit to accumulated depreciation per records, a debit to loss due to impairment (plug), and a credit to asset at full (historical) cost

disclosures of depreciable assets and depreciation

depreciation expense for the period, major classes of depreciable assets (by nature and function) such as buildings & equipment, accumulated depreciation by major class or in total, depreciation methods used for each major class, and significant estimates (useful lives, salvage value, etc.) when applicable

purchase of cost depletion

includes the necessary costs to acquire the natural resource and prepare it for extraction or harvest; add purchase price, drilling, tunnels, shafts, & other development costs, estimated restoration costs, and other costs necessary to prepare the property for production

residual value of depletion

is the estimated value of property after all the natural resources have been extracted (similar to salvage value)

depletion base

the total cost assigned to a natural resource over the units expected to be extracted

*purchase cost + development and preparation costs + estimated restoration costs - residual value

cost depletion

is the GAAP method for allocating the cost of a natural resource

*depletion base/estimated recoverable units = unit cost depletion rate
*unit cost depletion rate x units extracted = total depletion

depletion in COGS and ending inventory

*unit cost depletion rate x units sold = COGS
*unit cost depletion rate x units extracted but unsold = ending inventory (allocated as direct materials)

carrying value is not recoverable

fixed assets held for use and to be disposed are reviewed whenever events or changes in circumstances occur, resulting in impairment (ex: a significant decline in asset’s market value, technological changes to make asset obsolete, etc.)

recoverability test

first step in testing for impairment; if undiscounted future cash flow are less than or equal to carrying amount, then impairment loss has occurred and an impairment loss needs to be calculated and recorded

impairment loss for assets held for use

write down asset, depreciate at new cost (use the asset’s new lower carrying amount as the depreciation basis moving forward), and restoration is not permitted

*fair value (or discounted future cash flows, PV) - carry value

impairment loss for assets held for disposal

write down asset, no depreciation taken, and restoration is permitted (but not above the amount of impairment losses previously recognized)

*fair value (or discounted future cash flows, PY) - carry value + costs of disposal

impairment

means an asset’s carrying value us greater than the economic benefits expected to be recorded from it; asset is recorded at more than it is worth or can generate; depreciate recoverable amount (if applicable) by the remaining life, when asset if permanently at a loss

reporting impairment loss

is reported as a component of income from continuing operations before income taxes (income statement) or in statement of activities (nonprofit entities); for assets held for use, report asset by reducing it to fair value; for assets held for disposal, report a loss

long-lived assets held for sale

the long-lived asset must be ready for immediate sale in its present condition, management commits to a plan to sell the assets, an active program to locate a buyer have been initiated, the sale of the asset is probable and expected to be completed within on year, asset is actively marketed at a reasonable sale price relative to its fair value, and significant changes in the plan to sell are not expected; will be reclassified as held and used if one of these is not met

reporting requirements for long-lived assets held for sale

should be presented separately on the face of the balance sheet of the current period (generally as a current asset); recognize the lower of the fair value minus costs to sell or carrying amount (gain/loss to follow if applicable)

loss associated with long-lived asset held for sale

when the fair value minus costs to sell is less than the carrying amount; stop depreciation and amortization since asset is classified as held for sale

*carrying amount - (fair value - costs to sell) = loss

gain associated with a long-lived asset held for sale

only recognized when there is a subsequent increase in fair value minus costs to sell, and only up to the cumulative impairment losses previously recognized; stop depreciation and amortization since asset is classified as held for sale

*(new fair value - costs to sell) - current carrying amount = gain (cap is the prior impairment loss)

costs to sell

are direct costs of the sale transaction; these would not have been incurred by the entity if the sale had not taken place; include items such as commissions, legal fees, title transfer fees, and closing costs