Intermediate Accounting: Depreciation, Impairments, Intangibles, and Current Liabilities

Comprehensive Question and Answer flashcards reviewing Intermediate Accounting topics: PPE depreciation methods, depletion, asset impairments, intangible assets, goodwill, R&D costs (ASC 730/IAS 38), current liabilities, and contingencies (ASC 450).

How is depreciation defined in financial accounting for property, plant, and equipment?

Depreciation is defined as 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.

What is the formula used to calculate the depreciable base of a plant asset?

The formula is: $\text{Depreciable Base} = \text{Original Cost} - \text{Salvage Value}$ (where salvage value is also referred to as residual value).

What two primary categories of factors lead to the retirement or disposal of plant assets, and what are examples of each?

1. Physical factors: Wear and tear, damage, decay, and casualty (maintenance can sustain and extend service life).
2. Economic factors: Inadequacy due to technological changes in the industry and obsolescence caused by changing company demands.

What are the four primary depreciation methods covered in accounting for plant assets?

1. Activity method (variable-charge or units of production approach)
2. Straight-line method
3. Decreasing-charge methods (accelerated: sum-of-the-years'-digits and declining-balance)
4. Group and composite methods

What core operational assumption distinguishes the activity method of depreciation from the straight-line method?

The activity method assumes that depreciation is a function of asset usage or productivity rather than the passage of time.

How is annual depreciation expense computed under the sum-of-the-years'-digits (SYD) method?

It multiplies the depreciable base ($\text{Original Cost} - \text{Salvage Value}$) by a fraction where the numerator is the remaining years of estimated useful life at the start of the year and the denominator is the sum of the digits computed as: $\frac{n(n + 1)}{2}$ where $n$ is the service life in years.

What are the three sequential steps for calculating depreciation using the declining-balance method?

Step 1: Determine the declining-balance rate as a multiple of the straight-line rate (e.g., double-declining rate is $\frac{1}{n} \times 2$). Step 2: Multiply the declining-balance rate by the beginning book value ($\text{Cost} - \text{Accumulated Depreciation}$) without initially deducting salvage value. Step 3: Repeat Step 2 until book value equals salvage value; in the final year, adjust depreciation expense to equal book value minus salvage value so that the ending book value equals salvage value.

How are composite life and composite depreciation rate calculated under the composite depreciation method?

Composite life is calculated as: $\text{Composite Life} = \frac{\text{Total Depreciable Base}}{\text{Total Depreciation Expense per Year}}$ Composite rate is calculated as: $\text{Composite Rate} = \frac{\text{Total Depreciation Expense per Year}}{\text{Total Original Cost}}$

When an individual plant asset is retired or sold under the composite or group depreciation method, how is the transaction recorded?

No gain or loss is recognized. Cash is debited for proceeds, the plant asset account is credited for its original cost, and Accumulated Depreciation—Plant Assets is debited or credited for the balancing difference.

How is a revision in an asset's useful life or salvage value (a change in accounting estimate) reported in financial statements?

It is accounted for prospectively from the current period into the future. No correcting entries or restatements are made to prior years' financial statements.

What is the two-step impairment test for property, plant, and equipment under US GAAP?

1. Recoverability Test: Compare the sum of expected future net cash flows (undiscounted) from the asset to its carrying amount. If undiscounted cash flows are less than carrying value, an impairment has occurred.
2. Measurement: Compute the impairment loss as the amount by which the carrying amount of the asset exceeds its fair value.

How does the accounting treatment for an impairment loss differ between assets held for use versus assets held for disposal?

For assets held for use:

1. Impairment loss is the excess of carrying amount over fair value.
2. Depreciate on the new cost basis.
3. Restoration of impairment loss is not permitted.

For assets held for disposal:

1. Impairment loss is the excess of carrying amount over fair value less cost of disposal (reported at lower-of-cost-or-net realizable value).
2. No depreciation is taken.
3. Restoration of impairment loss is permitted up to the carrying amount prior to impairment.

What four cost components comprise the depletion base of a natural resource?

1. Acquisition costs: Price paid to obtain property rights to search for the resource.
2. Exploration costs: Costs incurred to locate the natural resource.
3. Development costs: Intangible development costs only (e.g., drilling costs, tunnels, shafts, wells); tangible equipment is depreciated.
4. Restoration costs: Estimated obligations to restore the property after extraction.

How is depletion expense calculated under the units-of-production method?

Depletion is calculated as: $\text{Depletion} = \text{Number of Units Extracted} \times \text{Depletion Cost per Unit}$ where: $\text{Depletion Cost per Unit} = \frac{\text{Depletion Base}}{\text{Total Estimated Recoverable Units}}$

Why are financial instruments (e.g., accounts receivable, stock investments, bank deposits) excluded from intangible assets?

Although financial instruments lack physical substance, their value is derived from a legal right (claim) to receive cash or cash equivalents in the future, rather than from rights and privileges granted for use in enterprise operations.

What are the five main categories of intangible assets and their typical accounting amortization treatments?

1. Marketing: Trademarks, trade names, domain names (no amortization if indefinite life).
2. Customers: Customer lists, order backlogs, customer relationships (amortize over useful life).
3. Artistic Creations: Copyrights for music, books, photos, films (amortize over useful life, usually shorter than legal life).
4. Contracts: Franchises, licensing agreements, broadcast rights (amortize if definite life; do not amortize if indefinite/perpetual).
5. Technology: Product and process patents (amortize over legal life or useful life, whichever is shorter).

How does the routine journal entry for amortizing an intangible asset differ from depreciating PP&E?

Depreciation credits a contra-asset account (Accumulated Depreciation), whereas intangible amortization is typically credited directly to the intangible asset account, directly reducing its book value.

How is the impairment test conducted for an indefinite-life intangible asset (other than goodwill)?

Indefinite-life intangibles are not amortized and are tested at least annually using a fair value test only. If the carrying value of the intangible asset exceeds its fair value, an impairment loss is recognized for the difference: $\text{Impairment Loss} = \text{Carrying Value} - \text{Fair Value}$

What is goodwill, and how is it measured when acquiring a business?

Goodwill is an indefinite-life intangible asset measured as the excess of the purchase price of the acquired business over the fair value of the identifiable net assets (tangible and identifiable intangible assets less liabilities) acquired.

Why is internally generated goodwill forbidden from being capitalized under US GAAP?

Internally generated goodwill is not capitalized because measuring it is subjective and complex, and capitalizing it could misrepresent financial statements; therefore, associated costs are expensed as incurred.

How is goodwill tested for impairment, and can a recognized goodwill impairment loss be reversed?

Goodwill is tested at least annually at the reporting unit level. If the fair value of the reporting unit (including goodwill) is less than its carrying value, an impairment loss is recognized. Subsequent reversal of recognized goodwill impairment losses is prohibited.

According to ASC 730, what is the distinction between 'research' and 'development'?

Research is the planned search or critical investigation aimed at discovery of new knowledge. Development is the translation of research findings into a plan or design for a new product/process or for significant improvement to an existing product/process prior to commercial production.

How should equipment purchased for research and development activities be accounted for if it has an alternative future use?

If the equipment has alternative future uses (in other R&D projects or general operations), it is capitalized as a tangible asset and depreciated over its useful life, with the depreciation included in R&D expense. If it has no alternative future use, its entire cost is expensed as R&D immediately.

What are examples of activities that ASC 730 explicitly excludes from research and development costs?

Engineering follow-through during early commercial production, routine quality control testing, troubleshooting during production, routine adjustments or minor periodic changes to existing products, routine design of tools/dies, and legal work for patent applications.

Under IAS 38, under what conditions may development costs for internally generated intangibles be capitalized?

Development costs must be capitalized if the entity can demonstrate all six criteria: technical feasibility, intention to complete, ability to use or sell, how it will generate future economic benefits, availability of adequate resources to complete, and ability to measure expenditures reliably.

How are organization costs (e.g., attorney fees, state incorporation fees, and meetings of incorporators) accounted for under US GAAP?

Organization costs are expensed as incurred in the period of formation and are not capitalized as intangible assets.

What is the definition of a current liability, and what formula defines working capital?

Current liabilities are financial obligations whose liquidation is reasonably expected to occur within one year or the operating cycle using existing current assets or by creating other current liabilities. Working capital is computed as: $\text{Working Capital} = \text{Current Assets} - \text{Current Liabilities}$

How does a zero-interest-bearing note payable function if no interest rate is stated on the face of the note?

The borrower receives the present value of the note in cash (face value minus bank discount fee). The discount represents the interest charge, which is recorded in Discount on Notes Payable (a contra liability) and amortized to Interest Expense over the life of the note.

What journal entries are made when a business receives cash for unearned revenue and when it subsequently performs the service?

Upon receiving cash in advance: Debit Cash, Credit Unearned Revenue (a liability).

Upon satisfying the performance obligation: Debit Unearned Revenue, Credit Revenue (adjusting entries never affect cash).

Under ASC 450, what two conditions must be satisfied to accrue an estimated loss from a loss contingency?

1. Information available prior to issuance of financial statements indicates that it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements.
2. The amount of the loss can be reasonably estimated.

What are the three probability tiers defined in ASC 450 for loss contingencies, and how is each handled when estimable?

1. Probable: The future event is likely to occur; accrue as a loss and a liability in the financial statements.
2. Reasonably possible: The chance is more than remote but less than likely; disclose in the notes to the financial statements (no accrual).
3. Remote: The chance is slight; no accrual and no footnote required (disclosure is permitted).

If a probable loss contingency can only be estimated within a dollar range, what amount is accrued under US GAAP?

If one amount within the range is a better estimate than any other, that amount is accrued. If no amount within the range is better, the minimum amount in the range is accrued, and the additional potential exposure is disclosed in notes.

What is the general accounting rule regarding gain contingencies under US GAAP?

Gain contingencies are not accrued in the financial statements to avoid recognizing revenue before realization. They are disclosed in the notes only if probable or reasonably possible, with care taken to avoid misleading inferences.

How does the accounting treatment for an assurance-type warranty differ from a service-type (extended) warranty?

Assurance-type warranties are quality guarantees included in the sale; warranty expense and estimated warranty liabilities are accrued in the period of sale. Service-type warranties are sold separately; proceeds are recorded as Unearned Warranty Revenue and recognized into revenue on a straight-line basis over the coverage period.

How does a company record sales promotion premiums and coupon liabilities at year-end?

Purchases of premiums are debited to Premium Inventory. Redemptions are recorded by debiting Premium Expense and crediting Premium Inventory. At year-end, an adjusting entry debits Premium Expense and credits Premium Liability for the expected cost of outstanding coupons estimated to be redeemed.

Can an enterprise accrue a reserve liability for potential future losses due to being self-insured or uninsurable?

No. GAAP prohibits accruing liabilities for expected future casualties or lack of insurance because no event has occurred on or before the balance sheet date to impair an asset or incur a liability. The condition of self-insurance may only be disclosed in notes.

Under what criteria may short-term debt due within the year be excluded from current liabilities and classified as long-term debt?

The entity must demonstrate both the intent to refinance on a long-term basis and the ability to do so, shown either by (1) actually issuing long-term debt or equity securities after the balance sheet date but before financial statements are issued, or (2) entering into a financing agreement that clearly permits long-term refinancing.