Chapter 10: Depreciation, Impairments, and Depletion

Vocabulary flashcards covering methods of depreciation, estimate revisions, composite depreciation, asset impairments, depletion of natural resources, and financial statement ratios from Chapter 10.

Depreciation

A means of cost allocation—not a method of valuation—that allocates the cost of tangible fixed assets to expense over the periods benefited to match costs with revenues.

Asset Turnover Ratio

Net sales/ Average Total Assets

Return On Asset (ROA)

Net Income / Average Total Assets

Depreciable Base

The total dollar amount of an asset subject to depreciation, calculated as the original acquisition cost of the asset minus its estimated salvage or disposal value.

Service Life

The period of time an enterprise intends to use an asset in business operations, which often differs from the asset's total physical life.

Physical Factors of Retirement

Wear and tear, decay, casualty, or the natural expiration of an asset's physical life that eventually necessitates its retirement.

Economic Factors of Retirement

Conditions such as inadequacy, supersession, and obsolescence that lead an enterprise to retire an asset before its physical life ends.

Activity Method

A depreciation method (also called units-of-use or units-of-production) that allocates cost based on actual usage rather than the passage of time, computed as

$\frac{\text{Cost} - \text{Salvage Value}}{\text{Total Estimated Activity}} \times \text{Actual Activity}$ .

Write-off of Resource Cost

Total cost – Salvage value

Total estimated units available = Depletion cost per unit

Units extracted × Cost per unit = Depletion

What accounts are affected when writing off resources?

Debit Inventory

Credit the asset itself or a depletion account

Straight-Line Method

A depreciation method that focuses on the passage of time rather than usage, allocating an equal amount of depreciation expense to each period, computed as

$\frac{\text{Cost} - \text{Salvage Value}}{\text{Estimated Life}}$.

Decreasing Charge Methods

Accelerated depreciation methods that yield higher depreciation expense in the early years of an asset's life and lower depreciation expense in later years, including the declining-balance and sum-of-the-years'-digits methods.

Declining-Balance Method

An accelerated depreciation method applying a constant rate (a multiple of the straight-line rate) to the asset's beginning book value without deducting salvage value to determine the base, provided the book value is not reduced below estimated salvage value.

Sum-of-the-Years'-Digits Method

An accelerated depreciation method where depreciation expense is calculated by multiplying the depreciable base by a fraction whose numerator is the remaining years of service life and whose denominator is the sum of the digits of the total service life

($\frac{n(n + 1)}{2}$ ).

Revision of Depreciation Estimates

An accounting adjustment handled prospectively in current and future periods by dividing the remaining book value less revised salvage value by the remaining estimated life, with no retrospective adjustment to prior periods.

Remaining Book Value – Est. Salvage Value

Remaining Estimated Life

Group Depreciation Method

A depreciation approach applied to a collection of assets that are similar in nature and have approximately the same useful lives.

Composite Depreciation Method

A depreciation approach applied to a collection of assets that are dissimilar in nature and have differing useful lives.

Composite Depreciation Rate

The overall rate determined by dividing the total annual straight-line depreciation of all assets in a composite group by their total combined acquisition cost:

$\frac{\text{Total Annual Depreciation}}{\text{Total Cost}}$.

Composite Life

The estimated operational life of a composite group of assets, computed by dividing the total depreciable base

($\text{Cost} - \text{Salvage Value}$) of all assets by total annual depreciation:

$\frac{\text{Total Depreciable Base}}{\text{Total Annual Depreciation}}$.

Impairment

A condition in which an asset's carrying amount (book value) is not recoverable, requiring a write-off down to fair value.

Recoverability Test

The initial test for impairment where an asset is deemed impaired if the undiscounted sum of expected future net cash flows from its use and ultimate disposal is less than its carrying amount.

Impairment Loss Measurement

The loss recognized when an asset fails the recoverability test, calculated as the excess of the carrying amount over market value (fair value), or over the present value of expected future net cash flows discounted at the market rate if no active market exists.

Impaired Assets Held for Use

Impaired assets that continue in service; their carrying value is reduced to fair value, they are depreciated on the new cost basis over remaining life, and restoration of previously recognized impairment loss is not permitted.

Impaired Assets Held for Disposal

Impaired assets to be abandoned or sold; they are written down to fair value less cost of disposal, no depreciation is recorded, and restoration of impairment loss is permitted up to the carrying amount prior to impairment.

Depletion

The process of allocating the cost of natural resources (wasting assets such as petroleum, timber, and minerals) to expense in proportion to the units extracted during a period.

Depletion Base

The total capitalized costs of a natural resource minus residual salvage value, consisting of acquisition costs, capitalized exploration costs, intangible development costs (e.g., drilling and tunnels), and restoration costs.

Asset Turnover Ratio

An efficiency metric measuring how effectively a company uses its assets to generate revenue, calculated as

$\frac{\text{Net Sales}}{\text{Average Total Assets}}$.

Return on Assets (ROA)

A profitability metric evaluating how successfully an enterprise deploys its asset base to generate profit, calculated as

$\frac{\text{Net Income}}{\text{Average Total Assets}}$ .