2. Major Topics
1) Cost allocation – in general
2) Depreciation methods
3) Changes: estimates, methods, error corrections
4) Impairments
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3. Topic #1: Cost Allocation Overview
The matching principle requires that part of the
acquisition cost of property, plant, and equipment and
intangible assets be expensed in periods when the
future revenues are earned.
Depreciation, depletion, and amortization are
cost allocation processes used to help meet the
matching principle requirements.
Some of the cost is expensed each period.
Acquisition
Expense
Cost
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(Balance Sheet) (Income Statement)
4. Cost Allocation – An Overview
Asset
Account Credited
Category Debit
Property, Plant, & Accumulated
Depreciation
Equipment Depreciation
Natural Resource
Natural Resource Depletion
Asset
Intangible Amortization Intangible Asset
Caution! Depreciation, depletion, and amortization
are processes of cost allocation, not valuation!
Depreciation
on the
Balance
Sheet
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7. Topic #3a: Changes in Estimates
ESTIMATED ESTIMATED
service life residual value
• Changes in estimates are accounted for prospectively.
• The book value less any residual value at the date of
change is depreciated over the remaining useful life.
•A disclosure note should describe the effect of a
change.
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8. Topic # 3b:
Change in Write-Off Method
A change in depreciation, amortization, or depletion
method is considered a change in accounting estimate
We account for these changes
prospectively, exactly as we would any other
change in estimate.
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9. Example: Exercise 11-20 (page 602)
Exercise 11-20: Change in Depreciation Method
original cost 2,560,000
acc depr to end of 2010 (1,801,000)
sub-total 759,000
residual value (160,000)
remainder to be depreciated 599,000
remaining life 3 years
annual straight-line depr amount 199,667
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10. Topic #3c: Error Correction
Errors found in a subsequent
accounting period are corrected by . . .
Entries that Restating the Reporting the
restate the prior period’s correction as a
incorrect account financial prior period
balances to the statements. adjustment to
correct amount. Beginning R/E.
In addition, a disclosure note is needed to describe the nature
of the error and the impact of its correction on net
income, income before extraordinary items, and earnings per
share.
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11. Topic #4: Testing for “Impairment”
• What is the difference between
“allocation methods” and
“impairment write-offs”??
• When to test for impairment?
–See list on page 581
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12. 4a) Impairment Test for
Finite-life Assets to be Held and Used
Measurement – Step 1
(recoverability test)
An asset is impaired when . . .
The undiscounted Its
sum of its estimated
future cash flows
< book
value
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13. Measurement Step 2:
Is only taken if Step 1 “signals” impairment
Impairment Book Fair
loss = value – value
Reported as part
of income from Market value, price of similar assets,
continuing operations. or PV of future net cash inflows.
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14. Examples of the Two Step Process
Re: Impairment Measurement
• On your own: review Illustr. 11-9 on page 582
• We will do Exercise 11-24 (page 602)
• Step #1:
– Future cash flows compared to book value
– $15 million is less than $18.3 million – yes, there is
impairment
– Go to Step #2
• Step #2:
– Compare market value to book value
– $11 million is less than $18.3 = $7.3 million loss
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15. Exercise 11-24 (concluded)
• Journal Entry:
– Loss on Impair 7.3 million
– Acc Depr 14.2 million
– Plant assets 21.5 million
Note: new book value = $11 million = fair value
• Requirement 5
• Step #1:
– Future cash flows compared to book value
– $19 million is greater than $18.3 million – no, there is
no impairment
– Do not go to Step #2
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16. 4b) Impairment Testing for
Assets Held for Sale (not in use)
• Assets that management intends to sell in their
existing condition
• The two-step process is NOT used
• Impairment loss is measured by comparing:
– Book value, and
– Fair value (less cost to sell, if any)
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17. 4c) Annual Impairment Testing For
Indefinite-life Intangibles
Other Indefinite
Goodwill Life Intangibles
Step 1 If BV of reporting
unit is less than its One-step Process
FV, impairment is indicated.
If BV of asset is
less than
Step 2 Loss = BV of FV, recognize
goodwill less implied value impairment loss.
of goodwill.
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18. Impairment of Goodwill
• Read pages 584-585 to see why impairment
testing for “regular assets” & goodwill is so
different.
• On your own: review Illustr. 11-10 on page 585
• We will do Exercise 11-25 (page 603)
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19. Exercise 11-25 (page 603)
• Step 1:
– Compare book value of the unit to its fair value
– $250 million is greater than $220 (signals possible
loss) - Go to Step 2
• Step 2: Measure the loss by comparing:
– Book value of the Goodwill = $50 million, and
– Implied value of the Goodwill:
• Fair value of the unit $220
• Fair value of net assets without Goodwill -200
• Implied Goodwill $20
– Therefore, Impairment loss = $30 million
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20. Summary of Accounting Treatments:
Expenditures Subsequent
to Acquisition (pages 589-592)
Type of
Expenditure Definition Usual Accounting Treatment
Repairs and Expenditures to maintain Expense in the period incurred
Maintenance a given level of benefits
Additions The addition of a new major Capitalize and depreciate over the
component to an existing asset remaining useful life of the original
asset, or over the useful life of the
addition, whichever is shorter
Improvements The replacement of Capitalize and depreciate over the
a major component useful life of the improved asset
Rearrangements Expenditures to restructure If expenditures are material and
an asset without addition, clearly increase future benefits,
replacement, or improvement capitalize and depreciate over
the future periods benefited
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Chapter 11: Property, Plant, and Equipment and Intangible Assets: Utilization and Impairment.Chapter 11 completes the discussion of accounting for property, plant, and equipment and intangible assets by addressing the allocation of the cost of these assets to the periods benefitted by their use. Expenditures subsequent to acquisition and impairment are also covered in this chapter.
After a plant asset is purchased, the company may incur additional expenditures on that asset. The accounting issue is deciding whether to capitalize these expenditures or to expense them in the period incurred. We normally use the following procedures: expenditures for maintenance and ordinary repairs are normally expensed. These types of expenditures maintain the normal operating condition and do not extend the useful life beyond the original estimate. expenditure for additions usually increase the productive capacity and are capitalized. expenditures for improvements, replacements, and extraordinary repairs either increase the useful life beyond the original estimate, or increase productive output, or both. These expenditures are normally capitalized. rearrangements are changes made in an existing process for improved output or improved efficiency. Normally, the cost of rearrangements are capitalized.
