Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Topic 5 Operating Assets – Utilization and Impairment Depreciation Methods

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.

Topic 5

Operating Assets –

Utilization and ImpairmentDepreciation Methods

11-2

Some of the cost is expensed each period.Some of the cost is expensed each period.

Cost Allocation – An Overview

ExpenseExpenseAcquisitionCost

AcquisitionCost

(Balance Sheet) (Income Statement)

The matching principle requires that part of the acquisition cost of operational assets be

expensed in periods when the future revenues are earned.

The matching principle requires that part of the acquisition cost of operational assets be

expensed in periods when the future revenues are earned.

11-3


Some of the cost is expensed each period.Some of the cost is expensed each period.

ExpenseExpenseAcquisitionCost

AcquisitionCost

(Balance Sheet) (Income Statement)

Depreciation, depletion and amortization are cost allocation processes used to help meet the matching principle requirements.

Depreciation, depletion and amortization are cost allocation processes used to help meet the matching principle requirements.

11-4

Type ofOperational

Asset Debit

Intangible Amortization Intangible Asset

Account Credited

Accumulated Depreciation

Property, Plant, & Equipment

Depreciation

Natural Resource DepletionNatural Resource

Asset

Caution! Depreciation, depletion, and amortization are

processes of cost allocation, not valuation!


11-5

Cost allocation requires developing three estimates for each asset:

The estimated expected use from an asset.

The estimated expected use from an asset.

Total amount of cost to be allocated.

Cost - Residual Value (at end of useful life)

Total amount of cost to be allocated.

Cost - Residual Value (at end of useful life)

The systematic approach used for allocation.

The systematic approach used for allocation.

Allocation Base

Allocation Base

Useful (Service)

Life

Useful (Service)

Life

Allocation Method

Allocation Method

Cost Allocation - Judgments

11-6

Time-based MethodsStraight-line (SL)Accelerated Methods

Sum-of-the-years’ digits (SYD)Declining Balance (DB)

Time-based MethodsStraight-line (SL)Accelerated Methods

Sum-of-the-years’ digits (SYD)Declining Balance (DB)

Activity-based methodsUnits-of-production method (UOP).Activity-based methodsUnits-of-production method (UOP).

Group andcomposite methods

Group andcomposite methods

Taxdepreciation

Taxdepreciation

Depreciation of Operational Assets

11-7

Depreciation on the Balance Sheet

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$

Net property, plant & equipment is the undepreciated cost (book value) of operating assets.

11-8

Straight-Line

The most widely used and most

easily understood method.

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.

Results in the same amount of

depreciation in each year of the asset’s

service life.

Acquisition Cost

–Residual

ValueEstimated Service Life in

Years

Annual Straight-line Depreciation

=

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?

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?

11-9

Straight-Line

SYD depreciation is quickly computed using Excel.

11-10

Accumulated Accumulated UndepreciatedDepreciation Depreciation Depreciation Balance

Year (debit) (credit) Balance (book value)50,000$

1 9,000$ 9,000$ 9,000$ 41,000 2 9,000 9,000 18,000 32,000 3 9,000 9,000 27,000 23,000 4 9,000 9,000 36,000 14,000 5 9,000 9,000 45,000 5,000

45,000$ 45,000$

Residual ValueResidual Value

Note that at the end of the asset’s useful life, BV = Residual Value

Note that at the end of the asset’s useful life, BV = Residual Value

Straight-Line

11-11

0100020003000400050006000700080009000

1 2 3 4 5

Life in Years

De

pre

cia

tio

n

Straight-Line

11-12

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.

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.

Accelerated Methods

Note that total depreciation over the

asset’s useful life is the same as the Straight-

line Method.

Note that total depreciation over the

asset’s useful life is the same as the Straight-

line Method.

11-13

* Sum-of-the-

Years'-Digits

= (Useful

Life × [

Useful Life

+ 1 ] )

2

SYD depreciation is quickly computed using Excel.

The formula is as follows:

Sum-of-the-Years’ Digits (SYD)

=SYD

DepreciationResidual

Value –Cost(

Remaining Years of Useful Life

Sum-of-the-Years Digits*

×)

5+4+3+2+1= 15

11-14

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.

Use Excel’s SYD function to compute depreciation

for the five years.

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.

Use Excel’s SYD function to compute depreciation

for the five years.

Sum-of-the-Years’-Digits (SYD)

11-15


11-16


Sum-of-the-Years @SYD

Cost 50,000 50,000 50,000 50,000 50,000

Salvage Value 5,000 5,000 5,000 5,000 5,000

Estimated Life 5 5 5 5 5

Period 1 2 3 4 5

Period Depreciation 15,000 12,000 9,000 6,000 3,000 45,000

11-17

0

2000

4000

6000

8000

10000

12000

14000

16000

1 2 3 4 5

Life in Years

De

pre

cia

tio

n


11-18

Declining-Balance (DB) Methods

DB depreciation

Based on the straight-line rate multiplied by an acceleration factor.

Computations initially ignore residual value.

DB depreciation

Based on the straight-line rate multiplied by an acceleration factor.

Computations initially ignore residual value.

Stop depreciating when:

BV=Residual Value

Stop depreciating when:

BV=Residual Value

11-19

DDB depreciation is easy to compute using Excel function =ddb

The formula is as follows:

DDB =Book Value

× ( 2 ÷ Useful Life )

Note that the Book Value will get lower each time

depreciation is computed!

Note that the Book Value will get lower each time

depreciation is computed!

Double-Declining-Balance (DDB)

11-20

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 forthe five two years using

double-declining-balance?

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 forthe five two years using

double-declining-balance?


11-21


11-22


Excel will stop depreciation when the BV = Residual Value.Excel will stop depreciation when the BV = Residual Value.

Double Declining Balance @DDBCost 50,000 50,000 50,000 50,000 50,000

Salvage Value 5,000 5,000 5,000 5,000 5,000 Estimated Life 5 5 5 5 5

Year 1 2 3 4 5 Period Depreciation $20,000 $12,000 $7,200 $4,320 $1,480 $45,000

11-23

02000400060008000

100001200014000160001800020000

1 2 3 4 5

Life in Years

De

pre

cia

tio

n


11-24

Activity-Based Depreciation

Depreciation can also be based on measures of input or output like: Service hours, or

Units-of-Production

Depreciation is not taken for idle assets.

Depreciation can also be based on measures of input or output like: Service hours, or

Units-of-Production

Depreciation is not taken for idle assets.

This approach looks different.

11-25

Acquisition Cost

–Residual

Value

Estimated Output in Units

Depreciation rate per unit

of output =

Depreciation =Depreciation rate per unit

×Units of output

Units-of-Production

11-26

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?

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?

Units-of-Production

11-27

Units-of-Production

Units of ProductionCost 50,000

Salvage Value 5,000 Estimated Life-Units 100,000

Per Unit 0.45 Current Production 22,000

Period Depreciation 9,900$

11-28

Use of Various Depreciation Methods

11-29

Comparison With MACRS (Tax Depreciation)Covered in Income Tax Course & Referred to in Intermediate III

Ignores residual

value

Provides for rapid write-off

Rates based on asset

“class lives”

Most corporations use the Modified Accelerated Cost Recovery System

(MACRS) for tax purposes.

Most corporations use the Modified Accelerated Cost Recovery System

(MACRS) for tax purposes.

11-30

Depreciation Disclosures

Depreciation. Balances of major classes of depreciable

assets. Accumulated depreciation by asset or in

total. General description of

depreciation methods used.

Depreciation. Balances of major classes of depreciable

assets. Accumulated depreciation by asset or in

total. General description of

depreciation methods used.

11-31

I bought an asset on May 19 this year. Do I get a full

year’s depreciation?

May19

Partial-Period Depreciation

11-32

Partial-Period Depreciation

Half-Year ConventionTake ½ of a year of depreciation in the year of acquisition, and the other ½ in

the year of disposal.

Half-Year ConventionTake ½ of a year of depreciation in the year of acquisition, and the other ½ in

the year of disposal.

Pro-rating the depreciation based on the date of acquisition is time-consuming

and costly. A commonly used alternative is the . . .

11-33

Partial Year – Demo Problem

On March 31,2009 Canseco Plumbing Fixtures purchased equipment for $30,000. Residual value at the end of an estimated four-year service life is expected to be $2,000. The company expects the machine to operate for 10,000 hours. Calculate depreciation expense for 2009 and 2010 using straight line depreciation method (a) Partial Year basis(b) Half Year Convention

11-34

Partial Year – Demo Problem

SLM for a full year: [$30,000 - 2,000]/4 = $7,000

a.2009 $7,000 x 9/12 = $5,2502010 $7,000 x 12/12 = $7,000

b.2009 $7,000 x 50% = $3,5002010 $7,000 x 100% = $7,000

11-35

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.

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.

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.

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.

11-36GROUP AND COMPOSITE DEPRECIATION

Page 243.

If there are no changes in the assets contained in the group, depreciation of $52,800 per year (16% x $330,000) will be recorded for 5.15 years.

11-37

BE 11-4

Mondale Winery depreciates its equipment using the group method. The cost of equipment purchased in 2013 totaled $425,000. The estimated residual value of the equipment was $40,000 and the group depreciation rate was determined to be 18%.

What is the annual depreciation for the group? If equipment that cost $42,000 is sold in 2014 for

$35,000, what amount of gain or loss will the company recognize for the sale?

11-38

BE 11-4 Solution

Annual depreciation will equal the group rate multiplied by the depreciable base of the group: ($425,000 – 40,000) x 18% = $69,300

Since depreciation records are not kept on an individual asset basis, dispositions are recorded under the assumption that the book value of the disposed item exactly equals any proceeds received and no gain or loss is recorded. Any actual gain or loss is implicitly included in the accumulated depreciation account.

11-39

BE 11-4 Solution

Journal entry for sale Cash 35,000 Acc. Dep (difference) 7,000

Equipment (cost) 42,000

11-40

The approach is based on the units-

of-production method.

The approach is based on the units-

of-production method.

As natural resources are “used up”, or

depleted, the cost of the natural resources must be allocated to the units extracted.

As natural resources are “used up”, or

depleted, the cost of the natural resources must be allocated to the units extracted.

Depletion of Natural Resources

11-41

Cost of Natural Resource

–Residual

Value

Estimated Recoverable Units

Depletion rate per unit

=

Total Depletion

Cost =

Unit Depletion Rate

×Units

Extracted


11-42

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.


11-43

What is ABC’s unit depletion rate?

a. $40 per ton

b. $50 per ton

c. $25 per ton

d. $20 per ton


a. $40 per ton

b. $50 per ton

c. $25 per ton

d. $20 per ton


11-44


a. $40 per ton

b. $50 per ton

c. $25 per ton

d. $20 per ton


a. $40 per ton

b. $50 per ton

c. $25 per ton

d. $20 per ton

Cost / Units

$1,000,000 / 40,000 Tons

= $25 Per Ton

Cost / Units

$1,000,000 / 40,000 Tons

= $25 Per Ton


11-45

For the year ABC mined 13,000 tons and sold 9,000 tons. What is the total depletion and the depletion expense?

a. $325,000 & $225,000

b. $325,000 & $325,000

c. $225,000 & $225,000

d. $275,000 & $225,000


a. $325,000 & $225,000

b. $325,000 & $325,000

c. $225,000 & $225,000

d. $275,000 & $225,000


11-46


a. $325,000 & $225,000

b. $325,000 & $325,000

c. $225,000 & $225,000

d. $275,000 & $225,000


a. $325,000 & $225,000

b. $325,000 & $325,000

c. $225,000 & $225,000

d. $275,000 & $225,000


Depletion = 13,000 x $25

= $325,000

Expense = 9,000 x $25

= $225,000

Depletion = 13,000 x $25

= $325,000

Expense = 9,000 x $25

= $225,000

11-47

Amortization of Intangible Assets

The amortization process uses the straight-line method, but assumes

residual value = 0.

The amortization process uses the straight-line method, but assumes

residual value = 0.

Amortization period is the shorter of:

Economic Life

Legal Life

or

11-48


The amortization entry is:The amortization entry is:

GENERAL JOURNAL Page 42

Date Description PR Debit Credit

Amortization Expense $$$

Intangible Asset $$$

Note that the amortization process does not use a contra-asset account.

11-49

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 useful life of 5 years. The legal life is 20

years.

At the end of year 1, what is Torch’s amortization expense?

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 useful life of 5 years. The legal life is 20

years.

At the end of year 1, what is Torch’s amortization expense?


11-50

Amortization = Cost ÷ Economic life = $3,000 ÷ 5 years = $ 600 per year

Use the shorter of economic life (5 years) or legal life (20 years).

Record the amortization entry.


11-51

Note that the patent will have a book value of $2,400 after this amortization entry is posted.


GENERAL JOURNAL Page 42

Date Description PR Debit Credit

Amortization Expense 600

Patent 600

11-52

Intangible Assets Not Subjectto Amortization

Not amortized.Not amortized.

Subject to assessment for impairment

value and may bewritten down.

Subject to assessment for impairment

value and may bewritten down.

Goodwill

11-53

ESTIMATED service lifeESTIMATED service life

ESTIMATED residual valueESTIMATED

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 residual

value. At the beginning of the fourth year, it was decided that there were only 5 years remaining,

instead of 7 years. Calculate depreciation for the fourthyear using the straight-line method.

Changes in Estimates

11-54

Asset cost 30,000$ Accumulated depreciation ($3,000 per year × 3 years) 9,000 Remaining book value 21,000 Divide by remaining life ÷ 5Revised annual depreciation 4,200$

What happens if we change depreciation methods?

Changes in Estimates

11-55

Change in Depreciation Method

We account for these changes prospectively, exactly as we would any

other change in estimate.

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 that is achieved by a

change in accounting principle.

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

change in accounting principle.

On January 1, 2011, Matrix Inc. purchased office 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

2013, 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 for 2013.

11-56

Depreciation - 2011 160,000$ ($400,000 × 40%)Depreciation - 2012 96,000 [($400,000 - $160,000) × 40%]Total Depreciation 256,000$

Cost of asset 400,000$ Less: Accumulated depreciation 256,000 Undepreciated balance 144,000$ Less: residual value (40,000) New depreciable amount 104,000 Remaining service life ÷ 3 Annual depreciation 34,667$

Change in Depreciation Method

December 31, 2013:Depreciation expense ................................... 34,667

Accumulated depreciation................ 34,667To record depreciation expense.

11-57

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.

11-58

Brief Exercise 11-7

At the beginning of 2011, Robotics, Inc. acquired a manufacturing facility for $12 million. $9 million of the purchase price was allocated to the building. Depreciation for 2011 and 2012 was calculated using the straight-line method, a 25-year useful life, and a $1 million residual value.

In 2013, the estimates of useful life and residual value were changed to 20 years and $500,000, respectively.

What is depreciation on the building for 2013?

11-59

Brief Exercise 11-7

Original calculation of annual depreciationCost 9,000,000$

Residual value 1,000,000$ useful 25

annual depreciation $320,000accumulated depreciation $640,000

Recalculation of annual depreciationUndepreciated cost $8,360,000

Revised residual value $500,000remaining useful life 18

revised annual depreciation 436,667$

Work this using Excel function =SLN

11-60

Brief Exercise 11-8

Refer to the situation described in BE 11-7. Assume that instead of changing the useful life and residual value, in 2013 the company switched to the double-declining-balance depreciation method. How should Robotics account for the change? What is depreciation on the building for 2013?

11-61

Brief Exercise 11-8

a change in the depreciation method reflects:estimated future benefits from the asset,

the pattern of receiving those benefits, or

the company’s knowledge about those benefits

Voluntary changes in accounting principles are reported retrospectively

11-62

Brief Exercise 11-8

A disclosure note should justify that the change is preferable and describe the effect of the change on any financial statement

line items and per share amounts affected for all periods reported.

Original calculation of annual depreciation using SLNCost 9,000,000$

Residual value 1,000,000$ useful 25

annual depreciation $320,000accumulated depreciation $640,000

Recalculation of annual depreciation using DDBUndepreciated cost $8,360,000

residual value $1,000,000remaining useful life 23

revised annual depreciation 726,957$

11-63

Brief Exercise 11-9

Refer to the situation described in BE 11-7. Assume that 2011 depreciation was incorrectly recorded as $32,000. This error was discovered in 2013. How should Robotics account for the error? What is depreciation on the building for 2013 assuming the error was judged material, no change in estimate of useful life or residual value? (ignore income tax)

11-64

Brief Exercise 11-9 Errors are retrospectively restated to reflect the

correction. If retained earnings is one of the incorrect accounts, the correction is reported as a prior period adjustment to the beginning balance in the statement of shareholders’ equity.

Depreciation of $32,000 should have been recorded. ($8,000,000 25 years). Therefore, 2011 retained earnings tax is overstated by $288,000 ($320,000 – 32,000) and accumulated depreciation is understated by the same amount. The following journal entry is needed to record the error correction (ignoring income tax):

11-65

Brief Exercise 11-9

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 item, and

earnings per share.

Retained Earnings 288,000Accumulated Depreciation 288,000

Only the annual depreciation is reported in 2013.

11-66

Impairment of Value

Long-term assetsto be held and usedLong-term assets

to be held and usedLong-term assets

held for saleLong-term assets

held for sale

Tangible andintangible with finiteuseful lives

Tangible andintangible with finiteuseful lives

Intangibleswith

indefiniteuseful lives

Intangibleswith

indefiniteuseful lives

GoodwillGoodwill

Test for impairment

of value when

consideredfor 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.Accounting treatment differs.

Operating assets

11-67

Operating Assets to be Held and Used

An asset is impaired when . . .

The undiscounted sum of its

estimated future cash flows

Measurement – Step 1Measurement – Step 1

Itsbookvalue

<

11-68

Impairmentloss =

Bookvalue

Fairvalue–

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 valueUndiscounted future

cash flows

Market value, price of similar assets,

or PV of future net cash inflows.

Reported in the incomestatement as a separate component of operating

expenses


11-69


Step 1 $140 million < $200 million

Impairment loss is indicated.

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?

11-70

Step 2 Impairment loss = $200 million – $120 million = $80

million

Impairment loss ................................... 80,000,000Accumulated depreciation ................... 150,000,000

Equipment ……………………. 230,000,000To record impairment loss.

Operating Assets to be Held and UsedBecause 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?

11-71

Step 2 Loss = BV of goodwill less implied

value of goodwill.

Step 2 Loss = BV of goodwill less implied

value of goodwill.

GoodwillGoodwill

Step 1 If BV of reporting unit > FV, impairment

indicated.

Step 1 If BV of reporting unit > FV, impairment

indicated.

Other Indefinite-life intangibles

Other Indefinite-life intangibles

One-Step Process

If BV of asset > FV, recognize

impairment loss.

One-Step Process

If BV of asset > FV, recognize

impairment loss.

Indefinite-Life IntangiblesThis item covered in Advanced Accounting

11-72

Brief Exercise 11-10

Collison and Ryder Company (C&R) has been experiencing declining market conditions for its sportswear division. Management decided to test the operational assets of the division for possible impairment. The test revealed the following: book value of division’s assets, $26.5 million;

fair value of division’s assets, $21 million;

sum of estimated future cash flows generated from the division’s assets, $24 million.

What amount of impairment loss should C&R recognize?

11-73


Because the undiscounted sum of future cash flows of $24 million is less than book value of $26.5 million, there is an impairment loss. The impairment loss is calculated as follows:

11-74

Expenditures Subsequent to Acquisition

Maintenance and

ordinary repairs.

Maintenance and

ordinary repairs.

Additions.Additions.

Improvements (betterments), replacements,

and extraordinary repairs.

Improvements (betterments), replacements,

and extraordinary repairs.

Rearrangements and other

adjustments.

Rearrangements and other

adjustments.

11-75

Normally we debit an expense account for amounts spent on:


11-76

Normally we debit the asset account for amounts spent on:


11-77

Normally we debit the asset account for amounts spent on:


11-78

Normally, we debit an asset account for amounts spent on

Rearrangements : changes made in an existing process for improved output or improved efficiency. Normally, the cost of rearrangements are

capitalized


11-79


Demmert Manufacturing incurred the following expenditures during the current fiscal year:

- annual maintenance on its machinery, $5,400; remodeling of offices, $22,000;

rearrangement of the shipping and receiving area resulting in an increase in productivity, $35,000;

addition of a security system to the manufacturing facility, $25,000.

How should Demmert account for each of these expenditures?

11-80


Annual maintenance on machinery, $5,400 - This is an example of normal repairs and maintenance. Future benefits are not increased; therefore the expenditure should be expensed in the period incurred.

Remodeling of offices, $22,000 - This is an example of an improvement. The cost of the remodeling should be capitalized and depreciated, either by direct capitalization of the cost, or a reduction of accumulated depreciation.

11-81


Rearrangement of the shipping and receiving area, $35,000 - This is an example of a rearrangement. Because the rearrangement increased productivity, the cost should be capitalized and depreciated.

Addition of a security system, $25,000 - This is an example of an addition. The cost of the security system should be capitalized and depreciated.

Documents

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Topic 5 Operating Assets – Utilization and Impairment Depreciation Methods