PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPA

Property, Plant, and Equipmentand Intangible Assets: Utilization

and Impairment

11

Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

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Major Topics

1) Cost allocation – in general2) Depreciation methods3) Changes: estimates, methods, error corrections4) Impairments

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Some of the cost is expensed each period.

Topic #1: Cost Allocation Overview

ExpenseAcquisitionCost

(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.

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AssetCategory Debit

Intangible Amortization Intangible Asset

Account Credited

Accumulated Depreciation

Property, Plant, & Equipment Depreciation

Natural Resource Depletion Natural Resource Asset

Caution! Depreciation, depletion, and amortizationare processes of cost allocation, not valuation!

Property, plant, and equipment: Land and buildings 150,000$ Machinery and equipment 200,000 Office furniture and equipment 175,000 Land improvements 50,000 Total 575,000$ Less Accumulated depreciation (122,000) Net property, plant and equipment 453,000$

Depreciation on the

Balance Sheet

Cost Allocation – An Overview

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Topic #2: Depreciation Methods

• Text pages 560-564• Example: Exercise 11-1 (page 598)

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Exercise 11-1 (page 598)

Depreciation Methods

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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.

Topic #3a: Changes in Estimates

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Topic # 3b: Change in Write-Off Method

We account for these changes prospectively, exactly as we would any other change in estimate.

A change in depreciation, amortization, or depletion method is considered a change in accounting estimate

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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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Topic #3c: 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.

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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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4a) Impairment Test for 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 (recoverability test)

Itsbookvalue

<

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Impairmentloss =

Bookvalue

Fairvalue–

Market value, price of similar assets,or PV of future net cash inflows.

Reported as partof income from

continuing operations.

Measurement Step 2: Is only taken if Step 1 “signals” impairment

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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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Exercise 11-24 (concluded)

• Journal Entry:– Loss on Impair 7.3 million– Acc Depr 14.2 million – Plant assets 21.5 millionNote: 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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4b) Impairment Testing forAssets 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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Step 2 Loss = BV of goodwill less implied value

of goodwill.

Goodwill

Step 1 If BV of reporting unit is less than its FV, impairment is indicated.

Other IndefiniteLife Intangibles

One-step ProcessIf BV of asset is

less than FV, recognize

impairment loss.

4c) Annual Impairment Testing ForIndefinite-life Intangibles

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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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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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Type of Expenditure Definition Usual Accounting TreatmentRepairs and Maintenance

Expenditures to maintaina 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 ofa 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 overthe future periods benefited

Summary of Accounting Treatments:Expenditures Subsequent

to Acquisition (pages 589-592)

End of Chapter 11