Depreciation- accounting process of allocating the cost of the tangible asset to expense in a systematic and rational manner- to those

e periods expected to benefit from the use of the asset. Why done? Value of asset may fluctuate between time bought and sold or junked. Measuring these interim period values wont give objective results. Hence cos. do not attempt to value asset at fair value between acquisition and disposition. Accounting principle that it fulfillsThe cost allocation approach fulfills- Matching principle as costs are matched with the revenues Cos use this because uncertainties in fair value are diff to measure. Terms used:Depreciation- writing off the costs of long-lived assets Depletion- reduction in the cost of natural resources Amortization- Expiration of the intangible assets like Patents and copyrights DEPRECIATION PROCESS Imp to know: 1) depreciable base 2) useful life 3) method of deprn. Deprn. base function of 2 factors a) original cost b) salvage value = cost- salvage value

Salvage value is the estimated amount that will be received at the time the asset is sold or removed from service. There is a diff between ECONOMIC life and PHYSICAL life of an asset. These two factors affect the determination of useful life of an asset . Economic factors - inadequacy, supersession or obsolescence Phy factors- wear and tear, decay and casualties that make it difficult for the asset to perform indefinitely. *Whenever physical factor of the asset primarily determine useful life, maintenance plays a very imp role. Other ways to determine useful life: 1) based on past experience with same /similar asset 2) sophisticated statistical methods 3) arbitrary selection 4) technological factors- where research and innovation are prominent What does GAAP require in regard to deprn method a co. uses? It should be rational and systematic

DEPRECIATION METHODS: 1) Straight line 2) Activity method Accelerated methods: 3) Sum of digits 4) Double declining Special methods: 5) Group & composite methods 6) Hybrid & combination methods

Straight line method Considers deprn as a function of time rather than usage. Used because of its simplicity, most often conceptually appropriate too Major objection: It assumes that the assets economic usefulness remains same each year. AND repair & Maint. Exp is the same each period. Other objection: Distortion occurs in determining the rate of return analysis Cost - salvage value depreciable base ( we want to depreciate that portion of cost) Useful life @ end of assets useful life, Book value = Salvage value We estimated what the asset would fetch at the time of disposaland hence the remaining part of the cost is being depreciated. Salvage value also called: Scrap value, residual value, recycle value or end of life sales value Activity method Also called variable charge or units of production method Considers deprn as a function of usage or productivity and NOT of time. Co considers the useful life in terms of Either output or input measure Major limitation: method is inappropriate where deprn is a function of time Also difficult in estimating the output /input units Best used when: loss of service results from the activity or productivity- this method best matched the expenses with the revenues of the period Cos that desire low deprn during period of low productivity either adopt of switch to activity method 2 steps- first calculate deprn rate (cost-salvage)/units next rate X units in this period

Decreasing charge methods Provides for higher deprn in the earlier years and lower later Why this method? Rationale is that cos should charge more deprn in the earlier years because the asset is more productive in its earlier years. Also his method provides a CONSTANT COST because the deprn charge is lower in the later periods, when the repair & Maint. Cost goes higher. Two methods: sum of years digits: no. of yrs. of useful life remaining at beginning of yeardecreases Sum of digits of year constant n(n+1)/2use formula !!! At end of useful life, balance remaining = salvage value. Declining balance: Utilizes percentage that is some multiple of SL method. Unlike other methods, DDB method does not deduct salvage value in computing the depreciation base. The DDB rate is multiplied by BV @ beginning of each period. This fetches lower deprn charge towards the end Cos switch from DDB to SL method towards end of assets useful life- to ensure that they depreciate only up to the salvage value, and not more.

Special depreciation methods May be used when cos assets have unique characteristics or depends on nature of industry. 2 methods: group & composite method---used when assets have similar nature of have similar useful lives Composite approach - when assets have dissimilar nature & diff useful lives

Change in estimate No retrospective changes Changes only in current period an future Get V as on date and then calculate new deprn exp. If no method is mentioned, use SL.

IMPAIREMENTS When the carrying value of the asset is not recoverable, the company writes down its asset to its fair value. This write off Impairment Situations in which impairment occurs: a) When there is decrease in market value of asset b) There is significant change in the way the asset is going to be used c) There are legal factors affecting the way the business functions d) When more cost is accumulated than originally expected e) When continuing future losses are forecasted form the use of the asset To see if impairment has occurred, 2 steps: 1) Recoverability test: determine whether impairment or not Co. will estimate future C/f undiscounted. Compare that with CV If CV> future c/f impairment YES 2) FV test: determine how much impairment Compare CV with FV If CV> FV then CV-FV= impairment los Journal entry: Loss due to impairment DR Accu. Deprn . CR GAAP versus IFRS: Reversal of impairment not allowed under IFRS allows reversal sometimes when the US GAAP underlying economic conditions have GAAP appears more conservative here changed US GAAP follows 2 step process IFRS follows FV comparison step 1) comparing CV to future undiscounted onlyCV compared to lesser amount. C/f which can still be high IFRS appears more conservative here GAAP more conservative in AFTERFACT IFRS more conservative in TESTING reversal It only appears that one may be more conservative than the other. But it differs in context.

Example: Cost 9000k Accu deprn 1000k Exepected future C/f 7000k Fair value 4400k As of Dec 2012 the remaining useful lie was 4 years 1) Journal for impairment in 2012 if any 2) Journal for depreciation exp 2013 3) FV of asset revised to 5100k on Dec 31 2013. Journal entry to record increase in FV Carrying value = cost- accu deprn = 9000k-1000k=8000k Test 1: recoverability test CV versus future C/F 8000k versus 7000k CV> future C/f Therefore Impairment has occurred. . .How much is the impairment loss? . Test 2: FV test: CV versus fair value 9000k-1000k=8000k versus 4400k CV-FV= 8000-4400k = 3600 Impairment loss: 3600 1) Journal for impairment in 2012 if any Loss due to impairmentDR..3600k Accu. Deprn. CR 3600k 2) Journal for depreciation exp 2013 Accumulated deprn at end of 2013= 1000k + 3600K =4600k BV at the end of 2013: 9000k-4600k=4400k Deprn for 2013: by SL method (4400-0)/4= 1100k Deprn expense..DR..1100k Accu deprn CR1100k 3) Revision in Fair value Not allowed under US GAAPno journal!

DEPLETION Use activity approach/ unit of production method Depletion is a function of the no. of units extracted during the period

Depletion for natural resources (also called wasting resources) They have 2 featuresa) They can be completely exhausted b) They can be replaced only by act of nature Establishing a Depletion base difficult. Includes: Acquisition cost Cost to acquire right to search undiscovered/already discovered resource Includes lease paid for property containing the resource Includes royalty paid to owner of property Exploration cost After acquiring right to search, actual process to search the resource If costs are substantial some companies capitalize the cost If cost to find resource is high and risk is uncertain most large co. expense it Development costs Includes tangible equipment cost and intangible development cost. Tangible costs include cost of all transportation and other heavy equipment needed to extract the resource and get it ready for market Because co can move equip from one place to another co normally do not include equipment costs in depletion base. Intangible development costs are considered part of depletion base. Restoration costs Costs to bring the land back to natural state after extraction has occurred.==> part of depletion base.