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11
Property, Plant, and Equipment
and Intangible Assets: Utilization
and Impairment
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
McGraw-Hill/Irwin
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.
Cost Allocation – An 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
Cost
11 - 2
(Balance Sheet)
Expense
(Income Statement)
Cost Allocation – An Overview
Asset
Category
Debit
Property, Plant, &
Equipment
Depreciation
Natural Resource
Depletion
Intangible
Amortization
Account Credited
Accumulated
Depreciation
Natural Resource
Asset
Intangible Asset
Caution! Depreciation, depletion, and amortization
are processes of cost allocation, not valuation!
Depreciation
on the
Balance
Sheet
11 - 3
Measuring Cost Allocation
Cost allocation requires three pieces
of information for each asset:
Service
Life
Allocation
Base
The estimated expected
use from an asset.
Allocation
Method
The systematic approach
used for allocation.
Total amount of cost to be allocated.
Cost - Residual Value (at end of useful life)
11 - 4
Depreciation
Time-based Methods
Straight-line (SL)
Accelerated Methods
Sum-of-the-years’ digits (SYD)
Declining Balance (DB)
Group and
composite
methods
Tax
depreciation
Activity-based methods
Units-of-production method (UOP).
11 - 5
Straight-Line
The most widely
used and most easily
understood method.
Results in the same
amount of depreciation in
each year of the asset’s
service life.
On January 1, we purchase equipment for $50,000 cash.
The equipment has an estimated service life of 5 years
and estimated residual value of $5,000.
What is the annual straight-line depreciation?
11 - 6
Annual
Straight-line
=
$
50,000
= $
1
2
3
4
5
5,000
9,000
Life in Years
Depreciation
(debit)
Accumulated
Depreciation
(credit)
Accumulated
Depreciation
Balance
$
$
$
$
11 - 7
– $
5
Depreciation
Year
Depreciation
Straight-Line
9,000
9,000
9,000
9,000
9,000
45,000
$
9,000
9,000
9,000
9,000
9,000
45,000
9,000
18,000
27,000
36,000
45,000
BV = Residual Value at the
end of the asset’s useful life.
Undepreciated
Balance
(book value)
$
50,000
41,000
32,000
23,000
14,000
5,000
Residual Value
Accelerated Methods
Accelerated methods result in more depreciation
in the early years of an asset’s useful life and less
depreciation in later years of an asset’s useful life.
Note that total depreciation over the asset’s useful
life is the same as the straight-line method.
Sum-of-the-years’-digits (SYD) depreciation
SYD
= ( Cost
Depreciation
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–
Residual
) ×
Value
Remaining Years
of Useful Life
Sum-of-the-Years
Digits*
Sum-of-the-Years’ Digits (SYD)
Sum-oftheYears'Digits
(SYD)
= (
Useful
Life
× [
Useful
Life
2
+ 1 ] )
On January 1, we purchase equipment for $50,000 cash.
The equipment has a service life of 5 years and an
estimated residual value of $5,000. Using SYD
depreciation, compute depreciation for the first two years.
SYD
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= (
5
× [
=
30
÷
=
15
5
2
+ 1] ) ÷ 2
Sum-of-the-Years’ Digits (SYD)
SYD
Depreciation
= (
Cost
= ( $50,000
=
11 - 10
Residual
Value
–
$ 5,000 )
)
×
×
5
15
$15,000 Depreciation in Year 1
= ( $50,000
=
–
Remaining
Years of
Sum-of-theYears Digits
–
$ 5,000 )
×
$12,000 Depreciation in Year 2
4
15
Sum-of-the-Years’ Digits (SYD)
Fraction
5/15
4/15
3/15
2/15
1/15
Depreciation
(debit)
Accumulated
Depreciation
Balance
$
$
Depreciation
$
15,000
12,000
9,000
6,000
3,000
45,000
15,000
27,000
36,000
42,000
45,000
Undepreciated
Balance
(book value)
$
50,000
35,000
23,000
14,000
8,000
5,000
Residual Value
16000
14000
12000
10000
8000
6000
4000
2000
0
1
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2
3
4
Life in Years
5
Declining-Balance (DB) Methods
DB depreciation
• Based on the straight-line rate
multiplied by an acceleration
factor.
Stop depreciating
when:
BV = Residual Value
• Computations initially ignore
residual value.
Double-Declining-Balance (DDB) depreciation
is computed as follows:
DDB =
Book
Value
× ( 2 × Straight-line Rate )
Note that the Book Value will get lower each year.
11 - 12
Declining-Balance (DB) Methods
On January 1, we purchase equipment for $50,000
cash. The equipment has a service life of 5 years
and an estimated residual value of $5,000.
What is depreciation for the first two years using
double-declining-balance?
DDB =
Book
Value
× ( 2 × Straight-line Rate )
= $ 50,000 × ( 2 × 20% )
= $ 20,000 1st Year Depreciation
= ($50,000 - $20,000) × (2 × 20%)
= $ 12,000 2nd Year Depreciation
11 - 13
Declining-Balance (DB) Methods
Year
1
2
3
4
5
Depreciation
(debit)
Accumulated
Depreciation
Balance
$
$
20,000
12,000
7,200
4,320
1,480
45,000
$
20,000
32,000
39,200
43,520
45,000
Undepreciated
Balance
(book value)
$
50,000
30,000
18,000
10,800
6,480
5,000
Depreciation forced so that BV = Residual Value.
Depreciation
20000
15000
10000
5000
0
1
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2
3
4
Life in Years
5
Units-of-Production
Depreciation
rate per unit
of output
=
Acquisition
Cost
Residual
–
Value
Estimated Output in Units
Depreciation
Depreciation =
rate per unit
11 - 15
×
Units of
output
Units-of-Production
On January 1, we purchased equipment for $50,000 cash.
The equipment is expected to produce 100,000 units during
its life and has an estimated residual value of $5,000.
If 22,000 units were produced this year, what is the amount
of depreciation?
Depreciation
rate per unit
Depreciation
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$50,000 – $5,000
=
100,000
=
Depreciation
rate per unit
=
=
$0.45
$9,900
= $0.45
×
Units of
output
×
22,000
Use of Various Depreciation Methods
11 - 17
U.S. GAAP vs. IFRS
Component Depreciation, Depreciable Base,
and Residual Value
• Component depreciation is
allowed but not often used in
practice.
• The depreciable base is
determined by subtracting
estimated residual value from
cost. Annual reviews of
residual values are not
required.
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• Each component of an item of
property, plant, and equipment
is depreciated separately if its
cost is significant to the total
cost of the item.
• Depreciable base is
determined by subtracting
estimated residual value from
cost. IFRS requires a review of
residual values annually.
Group and Composite Methods
• Assets are grouped by common characteristics.
• An average depreciation rate is used.
• Annual depreciation is the average rate × the total
group acquisition cost.
• Accumulated depreciation records are not maintained
for individual assets.


11 - 19
If assets in the group are sold, or new assets
added, the composite rate remains the same.
When an asset in the group is sold or retired,
debit accumulated depreciation for the
difference between the asset’s cost and the
proceeds.
U.S. GAAP vs. IFRS
Valuation of Property, Plant, and Equipment
• Property, plant, and equipment
is reported in the balance
sheet at cost less accumulated
depreciation (book value).
• Revaluation is prohibited.
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• Property, plant, and equipment
may be reported at cost less
accumulated depreciation, or
alternatively, at fair value
(revaluation).
• If revaluation is chosen, all
assets within a class of
property, plant, and equipment
must be revalued on a regular
basis.
Depletion of Natural Resources
As natural resources are “used
up,” or depleted, the cost of the
natural resources must be
allocated to the units extracted.
Cost of Natural
Resource
Depletion rate
=
per unit
Total
Depletion
Cost
11 - 21
The approach is based
on the units-ofproduction method.
–
Residual
Value
Estimated Recoverable Units
=
Unit Depletion
Rate
×
Units
Extracted
Depletion of Natural Resources
ABC Mining acquired a tract of land containing ore
deposits. Total costs of acquisition and development were
$1,100,000. ABC estimated the land contained 40,000
tons of ore, and that the land will be sold for $100,000 after
the coal is mined. What is ABC’s depletion rate?
Depletion rate = 1,000,000 ÷ 40,000 Tons = $25 Per Ton
For the year ABC mined 13,000 tons. What is
the total amount of depletion for the year?
Depletion = 13,000 tons × $25per ton = $325,000
11 - 22
U.S. GAAP vs. IFRS
Valuation of Biological Assets
• Biological assets, such as
timber tracts, are valued at
cost less accumulated
depletion.
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• Biological assets are valued at
fair value less estimated costs
to sell.
Amortization of Intangible Assets
The amortization process uses the straight-line
method, but usually assumes residual value = 0.
Amortization period is the shorter of
the asset’s legal or contractual life.
The amortization entry is:
Amortization expense ..................................
Intangible asset ………………........
$$$
$$$
To record amortization expense.
A contra-asset account is generally not used when
recording the amortization of intangible assets.
11 - 24
Amortization of Intangible Assets
Torch, Inc. has developed a new device. Patent
registration costs consisted of $2,000 in attorney fees and
$1,000 in federal registration fees. The device has a
contractual (useful) life of 5 years. The legal life is 20
years.
For year 1, what is Torch’s amortization expense?
Use the shorter of contractual life (5 years) or
legal life (20 years).
Amortization
= Cost
÷ Contractual life
= $3,000 ÷ 5 years
= $ 600 per year
Amortization expense ...................................
Patent ………………........................
To record amortization of patent.
11 - 25
600
600
Intangible Assets not
Subject to Amortization
Goodwill and Trademarks
Not amortized.
11 - 26
Subject to assessment
for impairment of
value and may be
written down.
U.S. GAAP vs. IFRS
Valuation of Intangible Assets
• Intangible assets are reported
at cost less accumulated
amortization.
• U.S.GAAP prohibits
revaluation of any intangible
asset.
11 - 27
• Intangible assets may be
reported at (1) cost less
accumulated amortization or
(2) fair value, if fair value can
be determined in an active
market.
• If revaluation is chosen, all
assets within the class of
intangibles must be revalued
on a regular basis.
• Goodwill cannot be revalued.
Partial-Period Depreciation
Pro-rating the depreciation based on the
date of acquisition is time-consuming
and costly. A commonly used alternative
is the . . .
Half-Year Convention
Take ½ of a year of depreciation in the
year of acquisition, and the other ½ in
the year of disposal.
11 - 28
Changes in Estimates
ESTIMATED
service life
ESTIMATED
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.
On January 1, equipment was purchased that cost $30,000, has
a useful life of 10 years and no salvage value. At the beginning
of the fourth year, it was decided that there were only 5 years
remaining, instead of 7 years.
Calculate depreciation expense for the fourth
year using the straight-line method.
11 - 29
Changes in Estimates
Asset cost
Accumulated depreciation
($3,000 per year × 3 years)
Remaining book value
Divide by remaining life
Revised annual depreciation
$ 30,000
9,000
21,000
÷ 5
$ 4,200
What happens if we change
depreciation methods?
11 - 30
Change in Depreciation Method
A change in depreciation, amortization, or depletion
method is considered a change in accounting estimate
that is achieved by a change in accounting principle.
We account for these changes prospectively,
exactly as we would any other change in estimate.
On January 1, 2009, Matrix, Inc., purchased equipment for $400,000.
Matrix expected a residual value $40,000, and a service life of 5
years. Matrix uses the double-declining-balance method to
depreciate this type of asset. During 2011, the company switched
from double-declining balance to straight-line depreciation. The
residual value remained at $40,000. Let’s determine the amount of
depreciation to be recorded at the end of 2011.
11 - 31
Change in Depreciation Method
Depreciation - 2009 $
Depreciation - 2010
Total Depreciation $
160,000 ($400,000 × 40%)
96,000 [($400,000 - $160,000) × 40%]
256,000
Cost of asset
Undepreciated balance
Less: residual value
New depreciable amount
Remaining service life
Annual depreciation
December 31, 2011:
Depreciation expense ...................................
Accumulated depreciation................
To record depreciation expense.
11 - 32
$
$
÷
$
400,000
144,000
(40,000)
104,000
3
34,667
34,667
34,667
Error Correction
Errors found in a subsequent
accounting period are corrected by . . .
 Entries that
restate the
incorrect account
balances to the
correct amount.
 Restating the
prior period’s
financial
statements.
 Reporting the
correction as a
prior period
adjustment to
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.
11 - 33
Impairment of Value
Accounting treatment differs.
Long-term assets
to be held and used
Tangible and
intangible
with finite
useful lives
Intangible
with
indefinite
useful lives
Test for
impairment
of value when
considered
for sale.
Long-term assets
held for sale
Goodwill
Test for impairment of
value at least annually.
Test for impairment of value when it is suspected
that book value may not be recoverable
11 - 34
Finite-life Assets to be Held and Used
Measurement – Step 1
An asset is impaired when . . .
The undiscounted
sum of its estimated
future cash flows
11 - 35
<
Its
book
value
Finite-life Assets to be Held and Used
Measurement – Step 2
Impairment
loss
=
Reported as part
of income from
continuing operations.
$0
Book
value
Market value, price of similar assets,
or PV of future net cash inflows.
Fair Value
$125
Case 1: $50 book value.
No loss recognized
–
Fair
value
Undiscounted future
cash flows
$250
Case 3: $275 book value.
Loss = $275 - $125
Case 2: $150 book value. No loss recognized
11 - 36
Assets Held for Sale
Assets held for sale
include assets that management
has committed to sell immediately in
their present condition and
for which sale is probable.
Impairment
loss
11 - 37
=
Book
value
Fair value less
– cost to sell
U.S. GAAP vs. IFRS
Impairment of Value: Property, Plant, and
Equipment and Finite-life Intangible Assets
• Assets are tested for
impairment when events or
changes in indicators suggest
that book value may not be
recoverable.
• An impairment loss is required
when an asset’s book value
exceeds the undiscounted
sum of the estimated future
cash flows.
11 - 38
• Assets must be assessed for
circumstances of impairment
at the end of each reporting
period.
• An impairment loss is required
when an asset’s book value
exceeds the higher of the
asset’s value-in-use (present
value of estimated future cash
flow) and fair value less costs
to sell.
U.S. GAAP vs. IFRS
Impairment of Value: Property, Plant, and
Equipment and Finite-life Intangible Assets
• The impairment loss is the
difference between book value
and fair value.
• Reversals of impairment
losses are prohibited.
11 - 39
• The impairment loss is the
difference between book value
and the recoverable amount,
the higher of the asset’s valuein-use and fair value less costs
to sell.
• An impairment loss is reversed
if the circumstances that
caused the impairment is
resolved.
Finite-life Assets to be Held and Used
Because Acme Auto Parts has seen its sales steadily decrease due
to the decline in new car sales, Acme’s management believes that
equipment that originally cost $350 million, with a $200 million book
value may not be recoverable. Management estimates that future
undiscounted cash flows associated with the equipment’s
remaining useful life will be only $140 million, and that the
equipment could be sold now for $120 million. Has Acme suffered
an impairment loss and if so, how should it be recorded?
Step 1
$140 million < $200 million
Impairment loss is indicated.
11 - 40
Finite-life Assets to be Held and Used
Because Acme Auto Parts has seen its sales steadily decrease due
to the decline in new car sales, Acme’s management believes that
equipment that originally cost $350 million, with a $200 million book
value may not be recoverable. Management estimates that future
undiscounted cash flows associated with the equipment’s
remaining useful life will be only $140 million, and that the
equipment could be sold now for $120 million. Has Acme suffered
an impairment loss and if so, how should it be recorded?
Step 2
Impairment loss = $200 million – $120 million = $80 million
Impairment loss ...................................
Accumulated depreciation ...................
Equipment …………………….
To record impairment loss.
11 - 41
80,000,000
150,000,000
230,000,000
Indefinite-life Intangibles
Goodwill
Step 1 If BV of reporting
unit > FV, impairment
indicated.
Step 2 Loss = BV of
goodwill less implied value
of goodwill.
11 - 42
Other Indefinite
Life Intangibles
One-step Process
If BV of asset >
FV, recognize
impairment loss.
U.S. GAAP vs. IFRS
Impairment of Value: Indefinite-life Intangible
Assets Other than Goodwill
• Indefinite-life intangible assets
other than goodwill are tested
for impairment at least annually.
• The impairment loss is the
difference between book value
and fair value.
11 - 43
• Indefinite-life intangible assets
other than goodwill are tested
for impairment at least annually.
• The impairment loss is the
difference between book value
and the recoverable amount,
the higher of the asset’s valuein-use (present value of
estimated future cash flows)
and fair value less costs to sell.
U.S. GAAP vs. IFRS
Impairment of Value: Indefinite-life Intangible
Assets Other than Goodwill
• Reversals of impairment losses
are prohibited.
• If certain criteria are met,
indefinite-life intangible assets
are combined for the required
annual impairment test.
11 - 44
• An impairment loss is reversed
if the circumstances that
caused the impairment is
resolved.
• Indefinite-life intangible assets
may not be combined with
other indefinite-life intangible
assets for the required annual
impairment test.
U.S. GAAP vs. IFRS
Impairment of Value: Goodwill
• Goodwill is tested for
impairment at least annually.
• Reversals of impairment
losses are prohibited.
• The level of testing (reporting
unit) is a segment or a
component of an operating
segment for which discrete
financial information is
available.
11 - 45
• Goodwill is tested for
impairment at least annually.
• Reversals of impairment
losses are prohibited.
• The level of testing (cashgenerating unit) is the smallest
identifiable group of assets
that generates cash flows that
are largely independent of the
cash flows from other assets.
U.S. GAAP vs. IFRS
Impairment of Value: Goodwill
• Measurement of an
impairment loss is a two-step
process. In step one the fair
value of the reporting unit is
compared to its book value. A
loss is indicated if the fair
value is less than the book
value. In step two, the
impairment loss is calculated
as the excess of book value of
goodwill over the implied fair
value of goodwill.
11 - 46
• Measurement of an
impairment loss is a one-step
process. The recoverable
amount of the cash-generating
unit is compared to its book
value. If the recoverable
amount is less, goodwill is
reduced before other assets
are reduced.
Impairment of Goodwill
Simmons Company recorded $150 million of goodwill when it
acquired Blake Company. Blake continues to operate as a separate
company and is considered to be a reporting unit. At the end of the
current year Simmons noted the following related to Blake: (1) book
value of net assets, including $150 million of goodwill is $500 million;
(2) fair value of Blake is $400 million; and (3) fair value of Blake’s
identifiable net assets, excluding goodwill is $350 million. Is goodwill
impaired and if so, by what amount?
Step 1
$500 million > $400 million
Impairment loss is indicated.
11 - 47
Impairment of Goodwill
Simmons Company recorded $150 million of goodwill when it
acquired Blake Company. Blake continues to operate as a separate
company and is considered to be a reporting unit. At the end of the
current year Simmons noted the following related to Blake: (1) book
value of net assets, including $150 million of goodwill is $500 million;
(2) fair value of Blake is $400 million; and (3) fair value of Blake’s
identifiable net assets, excluding goodwill is $350 million. Is goodwill
impaired and if so, by what amount?
Step 2
Determination of implied goodwill
Fair value of Blake
Fair value of Blake's net assets excluding goodwill
Implied value of goodwill
Measure of impairment loss
Book value of goodwill
Implied value of goodwill
Impairment loss
11 - 48
$ 400,000,000
350,000,000
$ 50,000,000
$ 150,000,000
50,000,000
$ 100,000,000
Expenditures Subsequent
to Acquisition
Type of
Expenditure
Repairs and
Maintenance
Additions
Definition
Expenditures to maintain
a given level of benefits
Usual Accounting Treatment
Expense in the period incurred
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
a major component
Capitalize and depreciate over the
useful life of the improved asset
Rearrangements
Expenditures to restructure
an asset without addition,
replacement, or improvement
If expenditures are material and
clearly increase future benefits,
capitalize and depreciate over
the future periods benefited
11 - 49
U.S. GAAP vs. IFRS
Costs of Defending Intangible Rights
• Litigation costs to successfully
defend intangible rights are
capitalized and amortized over
the remaining useful life of the
asset.
11 - 50
• Litigation costs are expensed,
except in rare situations when
an expenditure increases
future benefits.
Appendix 11A – Comparison with
MACRS (Tax Depreciation)
Most corporations use the Modified
Accelerated Cost Recovery System
(MACRS) for tax purposes.
Provides
for rapid
write-off
11 - 51
Ignores
residual
value
Rates based
on asset
“class lives”
Appendix 11B – Retirement and
Replacement Methods of Depreciation
Used for groups of similar, low-valued
assets with short service lives.
Retirement Method
Replacement Method
Acquisitions:
Acquisitions:
• Record initial acquisitions
of assets at cost in the
asset account.
• Record subsequent
acquisitions of assets at
cost in the asset account
Dispositions:
• Credit the asset account
for cost.
• Debit depreciation expense
for cost less the proceeds
received.
11 - 52
• Record initial acquisitions of
assets at cost in the asset
account.
• Record subsequent
acquisitions with a debit to
depreciation expense.
Dispositions:
• Credit depreciation expense
for the proceeds received.
End of Chapter 11