Chapter 11

Depreciation and Impairment

Sunqian Ren
ACC 3000
 Cost Allocation
• Depreciation, depletion, and amortization are cost
allocation processes used to help meet the
matching principle requirements.
• Depreciation: Tangible Assets
• Depletion: Natural Resources
• Amortization: Intangible Assets
 Depreciation:
• Time-Based Depreciation
– Straight-line Depreciation:
– Accelerated Depreciation:
• Declining Balance Methods
• Sum of the years digits method (SYD)
(The denominator of the fraction remains constant and is
the sum of the digits from one to n, where n is the number
of years in the asset's service life)
– Group and Composite Depreciation Methods:
• Activity-Based Depreciation
 Sum of the years’ digits method
• Equipment has beginning book value of
250,000 and residual value of 40,000. Useful
life is 5 years.
Group and Composite Depreciation
Methods
 Practice (CPA Q1)
Slovac Company purchased a machine that has an estimated
useful life of eight years for $7,500. Its salvage value is estimated
at $500. What is the depreciation for the second year of the
asset's life, assuming Slovac uses the double-declining-balance
method of depreciation?

a. $1,406
b. $1,438
c. $1,875
d. $3,750
 Practice (CPA Q2)
Calculate depreciation for year 2 based on the following
information:

a. $7,000
b. $7,400
c. $8,000
d. $8,600
 LO11-3
Depletion of Natural Resources
• Allocation of costs of natural resources
• Activity-based units-of-production method widely used
to calculate periodic depletion
• Because the usefulness of natural resources is directly
related to the amount of the resources extracted
• Service life is the estimated amount of natural resource
to be extracted

Depletion Base = Cost – Residual Value

Depletion Base
Depletion per unit =
Estimated Extractable Units
Journal entry:
Depletion (Depletion rate × Units extracted) xxx
Natural resource xxx
This way of booking depletion is traditional. The use of a contra account is acceptable
 LO11-3

Depreciation of Equipment used in Extraction

If the asset is movable and useable on future projects

• The asset’s depreciable base should be allocated over its
useful life
If the asset is not movable
• The asset should be depreciated over its useful life or the
life of the natural resource, whichever is shorter
• The units-of-production method often is used to
determine depreciation on assets used in the extraction
of natural resources
Depletion base
Depletion per unit =
Estimated extractable units
 Practice (CPA Q3)
A company pays $20,000 for the rights to a well with 5 million
gallons of water. If the company extracts 250,000 gallons of
water in the first year, what is the total depletion in year 1?

a. $ 400
b. $1,000
c. $1,250
d. $5,000
Exercise (E11-14)
Jackpot Mining Company operates a copper mine. The company paid $1,000,000 in 2016 for
the mining site and spent an additional $600,000 to prepare the mine for extraction of the
copper. After the copper is extracted in approximately four years, the company is required to
restore the land to its original condition. The company has provided the following three cash
flow possibilities for the restoration costs:

To aid extraction, Jackpot purchased some new equipment on July 1, 2016, for $120,000.
After the copper is removed from this mine, the equipment will be sold for an estimated
residual amount of $20,000. There will be no residual value for the copper mine. The credit-
adjusted risk-free rate of interest is 10%.
The company expects to extract 10 million pounds of copper from the mine. Actual
production was 1.6 million pounds in 2016 and 3 million pounds in 2017.
Required: Compute depletion and depreciation on the mine and mining equipment for 2016
and 2017. The units-of-production method is used to calculate depreciation.
 Solution
Cost of copper mine:
Mining site $1,000,000
Development costs 600,000
Restoration costs 303,939 †
$1,903,939
†
$300,000 x 25% = $ 75,000
400,000 x 40% = 160,000
600,000 x 35% = 210,000
$445,000 x .68301* = $303,939
*Present value of $1, n = 4, i = 10% (Table 2)

Depletion:
$1,903,939
Depletion per pound = = $.1904 per pound
10,000,000 pounds

2016 depletion = $.1904 x 1,600,000 pounds = $304,640

2017 depletion = $.1904 x 3,000,000 pounds = $571,200

Depreciation:

$120,000 – 20,000
Depreciation per pound = = $.01 per pound
10,000,000 pounds

2016 depreciation = $.01 x 1,600,000 pounds = $16,000

2017 depreciation = $.01 x 3,000,000 pounds = $30,000
 Amortization
• Intangible Assets that subject to Amortization:
Patent, Franchise, Copy Right

• Intangible Assets that are not subject to

Amortization: Infinite Life time (Trademark,
Goodwill)

• Amortization Method are similar to

Depreciation
 LO11-4

Intangible Assets Subject to Amortization

Useful life
• Legal, regulatory, or contractual provisions often limit
the useful life of an intangible asset
• Useful life might sometimes be less than the asset’s
legal or contractual life
Residual value
• Expected residual value of an intangible asset usually
is zero
• The residual value is not zero if at the end of the
asset’s useful life to the reporting entity the asset will
benefit another entity
Allocation method
• The method of amortization should reflect the
pattern of use of the asset in generating benefits
 Practice (CPA Q4)
Black, Inc., acquired another company for $5,000,000. The fair
value of all identifiable tangible and intangible assets was
$4,500,000. Black will amortize any goodwill over the maximum
number of years allowed. What is the annual amortization of
goodwill for this acquisition?
a. $12,500
b. $20,000
c. $25,000
d. 0
 Practice (CPA Q5)
On January 2, 2016, Rafa Company purchased a franchise with a
useful life of 10 years for $50,000. An additional franchise fee of
3% of franchise operating revenues also must be paid each year
to the franchisor. Revenues during 2016 totaled $400,000. In its
December 31, 2016, balance sheet, what net amount should
Rafa report as an intangible asset-franchise?
a. $33,000
b. $43,800
c. $45,000
d. $50,000
 Exercise (E11-6)
On April 29, 2016, Quality Appliances purchased
equipment for $260,000. The estimated service life of the
equipment is six years and the estimated residual value is
$20,000. Quality's fiscal year ends on December 31.
• Required: Calculate depreciation for 2016 and 2017
using each of the three methods listed. Quality
calculates partial year depreciation based on the
number of months the asset is in service. Round all
computations to the nearest dollar.
• Straight-line.
• Sum-of-the-years'-digits.
• Double-declining balance.
1. Straight-line:
Solution
$260,000 – 20,000
= $40,000 per year
6 years

2016 $40,000 x 8/12 = $26,667

2017 $40,000 x 12/12 = $40,000

2. Sum-of-the-years’ digits:

Sum-of-the-years’ digits is ([6 (6 + 1)] ÷ 2) = 21

2016 $240,000 x 6/21 x 8/12 = $45,714

2017 $240,000 x 6/21 x 4/12 = $22,857

+ $240,000 x 5/21 x 8/12 = 38,095
$60,952

3. Double-declining balance:

1/6 (the straight-line rate) x 2 = 1/3 DDB rate

2016 $260,000 x 1/3 x 8/12 = $57,778

2017 $260,000 x 1/3 x 4/12 = $28,889

+ ($260,000 – 86,667) x 1/3 x 8/12 = 38,518
$67,407
or,
2017 ($260,000 – 57,778) x 1/3 = $67,407
 Exercise (E11-10)
Highsmith Rental Company purchased an apartment building early in 2016.
There are 20 apartments in the building and each is furnished with major
kitchen appliances. The company has decided to use the group depreciation
method for the appliances. The following data are available:

In 2016, three new refrigerators costing $2,700 were purchased for cash. The
old refrigerators, which originally cost $1,500, were sold for $200.
Required:
• Calculate the group depreciation rate, group life, and depreciation for
2016.
• Prepare the journal entries to record the purchase of the new refrigerators
and the sale of the old refrigerators
Requirement 1 Solution
Depreciation
Residual Depreciable Estimated per Year
Asset Cost Value Base Life(yrs.) (straight line)
Stoves $15,000 $3,000 $12,000 6 $2,000
Refrigerators 10,000 1,000 9,000 5 1,800
Dishwashers 8,000 500 7,500 4 1,875
Totals $33,000 $4,500 $28,500 $5,675

$5,675
Group depreciation rate = = 17.2% (rounded)
$33,000

Group life = $28,500

= 5.02 years (rounded)
$5,675
Requirement 2
To record the purchase of new refrigerators.

Refrigerators ................................................................... 2,700

Cash ............................................................................ 2,700

To record the sale of old refrigerators.

Cash ................................................................................ 200

Accumulated depreciation (difference) ............................. 1,300
Refrigerators ............................................................... 1,500
 Additional Issues
• 1. Partial Periods
• 2. Changes in Estimates
• 3. Change in depreciation method
• 4. Error Correction (Will be covered in chapter
20)
• 5. Impairment of value
 Alternative method:
1. Partial Periods ($250,000 -75,000) × 40% = $70,000

On April 1, 2016, the Hogan Manufacturing Company purchased a machine for

$250,000. The company expects the service life of the machine to be five years and
the anticipated residual value is $40,000. The machine was disposed of after five
years of use. The company’s fiscal year-end is December 31. Partial-year
depreciation is recorded based on the number of months the asset is in service.
Year Straight Line Sum-of-the-Years’-Digits Double-Declining Balance

2016 $42,000 × 3 / 4 = $31,500 $70,000 × 3 / 4 = $ 52,500 $100,000 × 3 / 4 = $75,000

2017 $42,000 $70,000 × 1 / 4 = $ 17,500 $100,000 × 1 / 4 = $ 25,000

+56,000 × 3 / 4 = 42,000 +60,000 × 3 / 4 = 45,000
$ 59,500 $ 70,000
2018 $42,000 $56,000 × 1 / 4 = $ 14,000 $60,000 × 1 / 4 = $ 15,000
+42,000 × 3 / 4 = 31,500 +36,000 × 3 / 4 = 27,000
$ 45,500 $ 42,000
2019 $42,000 $42,000 × 1 / 4 = $ 10,500 $36,000 × 1 / 4 = $ 9,000
+28,000 × 3 / 4 = 21,000 +14,000 × 3 / 4 = 10,500
$ 31,500 $ 19,500
2020 $42,000 $28,000 × 1 / 4 = $ 7,000 $14,000 × 1 / 4 = $ 3,500
+14,000 × 3 / 4 = 10,500
$ 17,500
2021 $42,000 × 1 / 4 = $10,500 $14,000 × 1 / 4 = $ 3,500

Totals $210,000 $210,000 $210,000

2. Changes in Estimates
3. Change in Depreciation, Amortization or
Depletion Method
 Practice (CPA Q6)
JME acquired a depreciable asset on January 1, 2014, for
$60,000 cash. At that time JME estimated the asset would last 10
years and have no salvage value. During 2016, JME estimated the
remaining life of the asset to be only three more years with a
salvage value of $3,000. If JME uses straight-line depreciation,
what is the depreciation for 2016?
a. $ 6,000
b. $12,000
c. $15,000
d. $16,000
 Exercise (P11-10)
Described below are three independent and unrelated situations involving
accounting changes. Each change occurs during 2016 before any adjusting entries or
closing entries are prepared.
• On December 30, 2012, Rival Industries acquired its office building at a cost of
$10,000,000. It has been depreciated on a straight-line basis assuming a useful
life of 40 years and no residual value. Early in 2016, the estimate of useful life was
revised to 28 years in total with no change in residual value.
• At the beginning of 2012, the Hoffman Group purchased office equipment at a
cost of $330,000. Its useful life was estimated to be 10 years with no residual
value. The equipment has been depreciated by the sum-ofthe-years'-digits
method. On January 1, 2016, the company changed to the straight-line method.
• At the beginning of 2016, Jantzen Specialties, which uses the sum-of-the-years'-
digits method, changed to the straight-line method for newly acquired buildings
and equipment. The change increased current year net income by $445,000.
Required:For each situation:
• Identify the type of change.
• Prepare any journal entry necessary as a direct result of the change as well as any
adjusting entry for 2016 related to the situation described. (Ignore income tax
effects.)
• Briefly describe any other steps that should be taken to appropriately report the
situation.
 Solution

a. This is a change in estimate.

No entry is needed to record the change.

2016 adjusting entry:

Depreciation expense (determined below) ........................ 370,000
Accumulated depreciation ......................................... 370,000

Calculation of annual depreciation after the estimate change:

$10,000,000
Cost
$250,000 Previous depreciation ($10,000,000 ÷ 40 years)
x 3 yrs (750,000) Depreciation to date (2013–2015)
9,250,000 Undepreciated cost
÷ 25 yrs. Estimated remaining life (25 years: 2016–2040)
$ 370,000 New annual depreciation

A disclosure note should describe the effect of a change in estimate on income

before extraordinary items, net income, and related per-share amounts for the current
period.
 Solution
b. This is a change in accounting principle that is accounted for as a change in estimate.

Depreciation expense (below) 21,000

Accumulated depreciation 21,000

SYD
2012 depreciation $ 60,000 ($330,000 x 10/55)
2013 depreciation 54,000 ($330,000 x 9/55)
2014 depreciation 48,000 ($330,000 x 8/55)
2015 depreciation 42,000 ($330,000 x 7/55)
Accumulated depreciation $204,000

$330,000 Cost
204,000 Depreciation to date, SYD (above)
126,000 Undepreciated cost as of 1/1/16
0 Less residual value
126,000 Depreciable base
÷ 6 yrs. Remaining life (10 years – 4 years)
$ 21,000 New annual depreciation

A disclosure note reports the effect of the change on net income and earnings per share along with clear
justification for changing depreciation methods.

c. This is a change in accounting principle accounted for as a change in estimate.

Because the change will be effective only for assets placed in service after the date of change, depreciation
schedules do not require revision because the change does not affect assets depreciated in prior periods. A disclosure
note still is required to provide justification for the change and to report the effect of the change on current year’s
income.
 Test for
5. Impairment of Value impairment
of value when
Accounting treatment differs. considered
for sale.

Long-term assets Long-term assets

to be held and used held for sale

Tangible and Intangibles Goodwill Test for

intangible with impairment of
with finite indefinite value when it is
useful lives useful lives likely that the
fair value of a
Test for
Test for impairment of value impairment of
reporting unit is
when it is suspected that book value at least less than its
value may not be recoverable. annually. book value.
 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 Book Fair value less

loss = value – cost to sell
Finite-Life Assets to be Held and Used

Measurement – Step 1

An asset is impaired when . . .

The undiscounted sum of Its

its estimated future cash
flows
< book
value
 Finite-Life Assets to be Held and Used
Measurement – Step 2
Impairment Book Fair
loss = value – value

Reported in the income

statement as a separate Market value, price of similar assets,
component of operating or PV of future net cash inflows.
expenses

Undiscounted future
Fair value cash flows
$0 $125 $250

Case 1: $50 book value. Case 3: $275 book value.

No loss recognized Loss = $275 – $125
Case 2: $150 book value. No loss recognized
Impairment Loss-PPE
 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’s fair value is $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.
 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’s fair value is $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 ................................... 80,000,000

Accumulated depreciation ................... 150,000,000
Equipment ……………………. 230,000,000
To record impairment loss.
 Indefinite-Life Intangibles

Other Indefinite-
Goodwill life intangibles

Step 1 If BV of reporting unit >

FV, impairment indicated. One-Step Process
If BV of asset > FV,
recognize
Step 2 Loss = BV of goodwill impairment loss.
less implied value of goodwill.
 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.
 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 $ 400,000,000
Fair value of Blake's net assets excluding goodwill 350,000,000
Implied value of goodwill $ 50,000,000

Measure of impairment loss

Book value of goodwill $ 150,000,000
Implied value of goodwill 50,000,000
Impairment loss $ 100,000,000
Impairment Loss-Goodwill
 Practice (CPA Q7)
The following information concerns Franklin Inc.'s stamping machine:
Acquired: January 1, 2010
Cost: $22 million
Depreciation: straight-line method
Estimated useful life: 12 years
Salvage value: $4 million
As of December 31, 2016, the stamping machine is expected to generate
$1,500,000 per year for five more years and will then be sold for $1,000,000. The
stamping machine is
a. Impaired because expected salvage value has declined.
b. Not impaired because annual expected revenue exceeds annual depreciation.
c. Not impaired because it continues to produce revenue.
d. Impaired because its book value exceeds expected future cash flows
 Exercise (E11-29)
On May 28, 2016, Pesky Corporation acquired all of the outstanding common stock of
Harman, Inc., for $420 million. The fair value of Harman's identifiable tangible and
intangible assets totaled $512 million, and the fair value of liabilities assumed by Pesky
was $150 million.
Pesky performed a goodwill impairment test at the end of its fiscal year ended
December 31, 2016. Management has provided the following information:
Fair value of Harman, Inc. $400 million
Fair value of Harman's net assets 370 million
(excluding goodwill)
Book value of Harman's net assets 410 million
(including goodwill)

Required:
• Determine the amount of goodwill that resulted from the Harman acquisition.
• Determine the amount of goodwill impairment loss that Pesky should recognize at
the end of 2016, if any.
• If an impairment loss is required, prepare the journal entry to record the loss.
Requirement 1
Solution
Calculation of goodwill:

Consideration exchanged $420 million

Less fair value of net assets:
Assets $512 million
Less: Liabilities assumed (150) million (362) million
Goodwill $ 58 million

Requirement 2

Because the book value of the net assets ($410 million) exceeds fair value ($400
million), an impairment loss is indicated.

Determination of implied fair value of goodwill:

Fair value of Harman, Inc. $400 million
Fair value of Harman’s net assets (excluding goodwill) 370 million
Implied fair value of goodwill $ 30 million

Measurement of impairment loss:

Book value of goodwill (determined in requirement 1) $ 58 million
Implied fair value of goodwill 30 million
Impairment loss $ 28 million

Requirement 3

Entry to record the impairment loss:

($ in millions)
Loss on impairment of goodwill 28
Goodwill 28