CHAPTER 11

Property, Plant, and Equipment

and Intangible Assets:
Utilization and Impairment
11-2
Some of the cost is allocated to each
period.
Expense*
Acquisition
Cost
(Balance Sheet) (Income Statement)
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.
Cost Allocation An Overview
*Depreciation of an asset used to produce a product is a
product cost that does not become an expense until the product
is sold.
11-3
Asset
Category Debit
Intangible Amortization Intangible Asset
Account Credited
Accumulated
Depreciation
Property, Plant, &
Equipment
Depreciation
Natural Resource Depletion
Natural Resource
Asset
Caution! Depreciation, depletion, and amortization
are processes of cost allocation, not valuation!
Depreciation
on the
Balance
Sheet
Cost Allocation An Overview
11-4
Cost allocation requires three pieces
of information for each asset:
The estimated expected
use from an asset.
Total amount of cost to be allocated.
Cost Residual Value (at end of useful
life)
The systematic approach
used for allocation.
Allocation
Base
Service
Life
Allocation
Method
Measuring Cost Allocation
11-5
Time-based Methods
Straight-line (SL)
Accelerated Methods
Sum-of-the-years'-digits (SYD)
Declining Balance (DB)
Activity-based methods
Units-of-production method (UOP).
Group and
composite
methods
Tax
depreciation
Depreciation
The following information for a piece of machinery will
be used to illustrate some of the depreciation
methods discussed in the following paragraphs.

Cost of machine $260,000
Estimated useful life 10 years
Estimated salvage value $20,000
Productive life in hours 60,000 hours
Depreciation
11-7
Straight-Line
The most widely
used and most easily
understood method.
Results in the same
amount of depreciation in
each year of the assets
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?
Cost less salvage
Estimated service life
Depreciation Charge
($260,000 $20,000)
10
$24,000
Use of the straight-line method results in a uniform charge to
depreciation expense during each year of an assets service life.
This method is based upon the assumption that the decline in an
assets usefulness is the same each year.
Although the straight-line method is easy to use, it rests on an
assumption that, in most situations, is not realistic.

Straight-Line
11-9
Accelerated Methods
Note that total depreciation over the assets useful
life is the same as the straight-line method.
Accelerated methods result in more depreciation
in the early years of an assets useful life and less
depreciation in later years of an assets useful life.
Sum-of-the-years-digits (SYD) method (Not Covered)
Double-Declining-Balance (DDB) method (Covered)
11-10
Declining-Balance (DB) Methods
DB depreciation
Based on the straight-line rate
multiplied by an acceleration
factor.
Computations initially ignore
residual value.
Stop depreciating
when:
BV = Residual Value
Double-Declining-Balance (DDB) depreciation
is computed as follows:
DDB =
Book
Value
( 2 Straight-line Rate )
Note that the book value declines each year.
11-11
Declining-Balance (DB) Methods
The declining-balance method utilizes a depreciation rate that is some multiple of
the straight-line method. One popular method is twice the straight-line rate.

Thus, in our example the 10-year asset life would translate into a 20% declining
rate.

Beginning Rate on
of the Year Declining Depreciation
Book Value X Balance = Charge
Year 1 $260,000 X 20% = $52,000
Year 2 $208,000 X 20% = $41,600
11-12
Acquisition
cost

Residual
value
Estimated life in units
of activity
Depreciation
rate per unit
of activity
=
Depreciation =
Depreciation
rate per unit
of activity

Units of
activity
Units-of-Production
(Cost less salvage)X hours this year
Total estimated hours
Depreciation Charge
($260, 000 $20, 000 X 6, 800)
60, 000
$27, 200
When the activity method (units of production) is used,
depreciation is assumed to be a function of productivity
rather than the passage of time.

This method is most appropriate for assets such as
machinery or automobiles where depreciation can be
based on units produced or miles driven.

Illustration: Assume the machine was used for 6,800
hours in the first year of its useful life.
11-14
The approach is based
on the units-of-
production method.
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

Residual
Value
Estimated Recoverable Units
Depletion Rate
per Unit
=
Total
Depletion
Cost
=
Unit Depletion
Rate

Units
Extracted
11-15
Amortization of Intangible Assets
For an intangible asset with a finite useful life, we allocate
capitalized costs over the assets useful life using the
straight-line method, normally with a zero residual value.
An intangible assets useful life may be limited by
legal, regulatory, or contractual provisions. In other
cases, the useful life may be less than the legal or
contractual life.
The amortization entry is:
A contra-asset account is generally not used when
recording the amortization of intangible assets.
Amortization expense .................................. $$$
Intangible asset ........ $$$
To record amortization expense.
11-16
Not amortized.
Subject to assessment
for impairment of
value and may be
written down.
Goodwill and Trademarks
Intangible Assets not Subject to
Amortization
11-17
Group and composite methods
Involve averaging the service life of many assets and applying depreciation
as though a single unit existed.

The composite approach refers to a collection of dissimilar assets, whereas the
group approach refers to a collection of assets with similar characteristics.

The method of computation for group or composite is essentially the same:
find an average and depreciate on that basis.

For example, the following assets would have the following composite rate
and life.

Original Salvage Depreciable Useful Depreciation
Asset Cost Value Cost Life (Straight-Line)
A $ 65,000 $ 5,000 $ 60,000 5 yrs. $12,000
B 148,000 18,000 130,000 10 yrs. 13,000
C 95,000 11,000 84,000 12 yrs. 7,000
$308,000 $34,000 $274,000 $32,000

Composite Rate: $32,000/308,000 = 10.39%
Composite Life: $274,000/32,000 = 8.56 years

These assets will be depreciated at $32,000 per year for 8.56 years (Ex 9)
11-18
Partial Year Depreciation
In general, depreciation should be based on the number of
months an asset is used during an accounting period.

If a decreasing charge depreciation method is used for assets
purchased during an accounting period, a slight modification is
appropriate.

When this situation occurs, determine depreciation expense for
the full year and prorate the expense between the two periods
involved. This process continues throughout the service life of the
asset.

Exercise 6 (1 & 3)
11-19
Change in Accounting Estimates
The estimates involved in the depreciation
process are sometimes subject to revision
as a result of unanticipated occurrences.

Such revisions are classified as changes
in accounting estimates and should be
handled in the current and prospective
periods.

Exercise 16
11-20
Error Correction (Not Covered)
Errors found in a subsequent
accounting period are corrected by . . .
Entries that
restate the
incorrect account
balances to the
correct amount.
Restating the
prior periods
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.
11-21
Impairment of Value
Long-term assets
to be held and used
Long-term assets
held for sale
Tangible and
intangible
with finite
useful lives
Intangibles
with
indefinite
useful lives
Goodwill
Test for
impairment
of value when
considered
for sale.
Test for
impairment
of value at
least
annually.
Test for impairment of value
when it is suspected that
book
value may not be
recoverable.
Test for
impairment of
value when it
is likely that
the fair value
of a reporting
unit is less
than its book
value.
Accounting treatment differs.
11-22
Finite-Life Assets to be Held and Used
An asset is impaired when . . .
The undiscounted
sum of its estimated
future cash flows
Measurement Step 1
Its
book
value
<
11-23
Impairment
loss
=
Book
value
Fair
value

Measurement Step 2
$0 $250 $125
Case 1: $50 book value.
No loss recognized
Case 2: $150 book value. No loss recognized
Case 3: $275 book value.
Loss = $275 $125
Fair value
Undiscounted future
cash flows
Market value, price of similar assets,
or PV of future net cash inflows.
Reported in the income
statement as a separate
component of operating
expenses
Finite-Life Assets to be Held and Used
Exercise 22, 23, 25, 26
Important differences in accounting for impairment of value for property, plant,
and equipment and finite-life intangible assets between U.S. GAAP and I AS No. 36.

U.S. GAAP IFRS
When to Test When events or changes in Assets must be assessed for indicators of
circumstances indicate that impairment at the end of each reporting
book value may not be period. Indicators of impairment are similar
recoverable. to U.S. GAAP.

Recoverability An impairment loss is There is no equivalent recoverability test.
required when an assets An impairment loss is required when an assets
book value exceeds book value exceeds the higher of the assets
the undiscounted sum of value-in- use (present value of estimated
the assets estimated future future cash flows) and fair value less costs to
cash flows. sell.

Measurement The impairment loss is the The impairment loss is the difference between
difference between book book value and the recoverable amount (the
value and fair value. higher of the assets value-in-use and fair value
less costs to sell).

Subsequent Prohibited. Required if the circumstances that caused the
Reversal of Loss impairment are resolved.
Lets look at an illustration highlighting the important differences between GAAP
and IFRS:

The Jasmine Tea Company has a factory that has significantly decreased in
value due to technological innovations in the industry. Below are data related
to the factorys assets:

($ in millions)
Book value $18.5
Undiscounted sum of estimated future cash flows 19.0
Present value of future cash flows 16.0
Fair value less cost to sell (determined by appraisal) 15.5

What amount of impairment loss should Jasmine Tea recognize, if any,
under U.S. GAAP? Under IFRS?
U.S. GAAP
There is no impairment loss.
The sum of undiscounted estimated future cash flows exceeds the book value.

IFRS
Jasmine should recognize an impairment loss of $2.5 million.
Indicators of impairment are present:

Book value exceeds both:
-Value-in-use (present value of cash flows) and
-Fair value less costs to sell.

The recoverable amount is $16 million calculated as the higher of
-Value-in-use ($16 million) and
-Fair value less costs to sell ($15.5million).

The impairment loss is the difference between:
Book value and Recoverable amount = $18.5 million - $16 million =$2.5M
11-27
Impairment
loss
=
Book
value
Fair value less
cost to sell

Assets held for sale
include assets that management
has committed to sell immediately in
their present condition and
for which sale is probable.
Assets Held for Sale
11-28
Step 2 Loss = BV of
goodwill less implied value
of goodwill.
Goodwill
Step 1 If BV of reporting
unit > FV, impairment
indicated.
Other Indefinite-
life intangibles
One-Step Process
If BV of asset >
FV, recognize
impairment loss.
Indefinite-Life Intangibles (Ex 26)
11-29
Type of
Expenditure Definition Usual Accounting Treatment
Repairs and
Maintenance
Expenditures to maintain
a given level of benefits
Expense in the period incurred
Additions The addition of a new major
component to an existing asset
Capitalize and depreciate over the
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
Expenditures Subsequent
to Acquisition
11-30
End of Chapter 11