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CHAPTER 11
PROPERTY, PLANT, AND EQUIPMENT AND INTANGIBLE ASSETS:
UTILIZATION AND IMPAIRMENT
Overview
This chapter completes our discussion of accounting for property, plant, and equipment and
intangible assets. We address the allocation of the cost of these assets to the periods benefited by
their use.
The usefulness of most of these assets is consumed as the assets are applied to the production of
goods or services. Cost allocation corresponding to this consumption of usefulness is known as
depreciation for plant and equipment, depletion for natural resources, and amortization for
intangibles.
We also consider impairment of these assets, and the treatment of expenditures incurred
subsequent to acquisition.
Learning Objectives
LO11-1 Explain the concept of cost allocation as it pertains to property, plant, and equipment and
intangible assets.
LO11-2 Determine periodic depreciation using both time-based and activity-based methods.
LO11-3 Calculate the periodic depletion of a natural resource.
LO11-4 Calculate the periodic amortization of an intangible asset.
LO11-5 Explain the appropriate accounting treatment required when a change is made in the service
life or residual value of property, plant, and equipment and intangible assets.
LO11-6 Explain the appropriate accounting treatment required when a change in depreciation,
amortization, or depletion method is made.
LO11-7 Explain the appropriate treatment required when an error in accounting for property, plant,
and equipment and intangible assets is discovered.
LO11-8 Identify situations that involve a significant impairment of the value of property, plant, and
equipment and intangible assets and describe the required accounting procedures.
LO11-9 Discuss the accounting treatment of repairs and maintenance, additions, improvements, and
rearrangements to property, plant, and equipment and intangible assets.
LO11-10 Discuss the primary differences between U.S. GAAP and IFRS with respect to the
utilization and impairment of property, plant, and equipment and intangible assets.
Lecture Outline
Part A: Depreciation, Depletion, and Amortization
I. Cost Allocation—An Overview (T11-1)
A. The matching principle requires that the net cost of a long-lived, revenue-producing asset
(cost less residual value) be allocated to the years of asset use in direct proportion to the
role the asset plays in revenue production.
11-2 Intermediate Accounting, 8/e
II. Measuring Cost Allocation (T11-2)
A. The process of cost allocation for an asset requires that three factors be established at the
time the asset is put into use: (1) service life, (2) allocation base, and (3) allocation
III. Depreciation of Assets (T11-3)
A. Time-based depreciation methods allocate the depreciable base according to the passage of
time.
1. The straight-line depreciation method allocates an equal amount of depreciable base
to each year of the asset's service life.
2. Accelerated depreciation methods allocate more depreciable base to the earlier years of
an asset's life and less to the later years.
a. The sum-of-the-years'-digits method multiplies depreciable base by a declining
fraction whose denominator is the constant sum of the digits from one to n where n
is the number of years in the asset's service life.
b. Declining balance depreciation methods multiply beginning of year book value,
not depreciable base, by an annual rate that is a multiple of the straight-line rate.
B. It is not uncommon for a company to switch from accelerated to straight-line
approximately halfway through an asset's life.
C. Activity-based depreciation methods estimate service life in terms of some measure of
productivity.
1. Productivity could be measured in terms of output (for example, the number of units a
machine will produce) or input (for example, the number of hours a machine will
operate).
Decision Makers’ Perspective—Selecting a Depreciation Method (T11-4)
A. All methods provide the same total depreciation over an asset's life.
B. Activity-based methods are theoretically superior to time-based methods, but often are
infeasible or too costly to use.
C. One possible motivation for the predominant use of straight-line is its positive effect on
reported income.
IV. Group and Composite Depreciation Methods
A. Group and composite depreciation methods aggregate assets in order to reduce the
recordkeeping costs of determining periodic depreciation.
B. The group depreciation method defines the collection of assets as depreciable assets that
share similar service lives and other attributes. (T11-6)
1. The group depreciation rate is determined by dividing the depreciation per year by the
total cost of the group.
3. The depreciation rate is applied to the total cost of the group.
4. No gain or loss is recorded when a group asset is retired or sold.
C. The composite depreciation method is used when assets are physically dissimilar but are
aggregated anyway to gain the convenience of group depreciation.
V. Depletion of Natural Resources (T11-7)
A. Depletion of the cost of natural resources usually is determined using the units-of-
production method.
B. Depletion is a product cost and is included in the cost of inventory.
Valuation of Property, Plant, and Equipment
IFRS allows a company to report property, plant, and equipment at cost less accumulated
depreciation (book value), or, alternatively, at fair value (revaluation). (T11-9)
11-4 Intermediate Accounting, 8/e
VI. Amortization of Intangible Assets (T11-10)
A. The cost of an intangible asset with a finite useful life is amortized.
2. Intangibles typically have no residual value, so the amortization base is simply cost.
3. The cost of an intangible asset usually is amortized by the straight-line method.
B. The cost of an intangible asset with an indefinite useful life is not amortized. Goodwill is
the most common intangible asset with an indefinite useful life.
Valuation of Intangible Assets
IFRS allows a company to report intangible assets at cost less accumulated amortization (book
value), or, alternatively, at fair value (revaluation). (T11-11)
Part B: Additional Issues
I. Partial Periods (T11-12)
A. Depreciation, depletion, and amortization in the year of acquisition and year of disposal
should be determined only for the part of the year that the asset is actually used. Partial-
year depreciation presents a problem only for time-based methods.
II. Changes in Estimates (T11-13)
A. Changes in estimates are reflected in the financial statements of the current period and
future periods.
B. Prior years' financial statements are not restated.
III. Change in Depreciation, Amortization, or Depletion Method (T11-14)
A. Changes in depreciation, amortization, or depletion method are accounted for the same
way as a change in accounting estimate.
IV. Error Corrections (T11-15)
A. For material errors occurring in a previous year, previous years' financial statements are
retrospectively restated.
B. Any account balances that are incorrect as a result of the error are corrected.
C. If retained earnings requires correction, the correction is reported as a prior period
adjustment.
V. Impairment of Value
A. An asset held for use should be written down if there has been a significant impairment of
value.
B. Property, plant, and equipment and finite-life intangible assets are tested for impairment
only when events or changes in circumstances indicate that book value, sometimes called
carrying value or carrying amount, may not be recoverable.
C. For property, plant, and equipment and finite-life intangible assets, determining whether to
record an impairment loss and actually recording the loss is a two-step process. (T11-16)
1. Step 1 - An impairment loss is required only when the undiscounted sum of future cash
flows is less than book value.
D. There are important differences in accounting for impairment of value of property, plant,
and equipment and finite-life intangible assets between U.S. GAAP and international
financial reporting standards. (T11-17)
E. Intangible assets with indefinite useful lives, other than goodwill, should be tested for
impairment at least annually and more frequently if events or changes in circumstances
indicate that it is more likely than not that the asset is impaired. A company has the option
of first undertaking a qualitative assessment. Companies selecting this option will
F. GAAP provides guidelines for the recognition and measurement of goodwill impairment.
(T11-19)
1. Step 1 – A goodwill impairment loss is indicated when the fair value of the reporting
unit is less than its book value.
3. The implied fair value of goodwill is calculated in the same way that goodwill is
determined in a business combination. That is, it’s a residual amount measured by
subtracting the fair value of all identifiable net assets from the consideration
exchanged (purchase price) using the unit’s previously determined fair value as the
consideration exchanged. Similar to other intangible assets with indefinite useful lives,
G. There are important differences in accounting for impairment of value of goodwill
between U.S. GAAP and international financial reporting standards. (T11-20)
H. For assets held for sale, if book value exceeds fair value, an impairment loss is recognized
for the difference.
I. Impairment Guidelines– A Summary (T11-21)
11-6 Intermediate Accounting, 8/e
Part C: Subsequent Expenditures and Disposition
I. Expenditures Subsequent to Acquisition (T11-22)
A. Expenditures that are expected to produce future benefits beyond the current year are
capitalized. Expenditures that simply maintain a given level of benefits are expensed in
the period they are incurred.
C. Expenditures for repairs and maintenance generally are expensed when incurred.
D. Additions involve adding a new major component to an existing asset and should be
capitalized because future benefits are increased.
E. Improvements involve the replacement of a major component of an asset and usually are
capitalized. (T11-23)
1. By the substitution method, both the disposition of the old component and the
acquisition of the new component are recorded.
3. Another way to record improvements is to reduce accumulated depreciation.
F. The cost of material rearrangements should be capitalized if they clearly increase future
benefits. (T11-24)
G. The costs incurred to successfully defend an intangible right should be capitalized. The
Appendix 11A: Comparison with MACRS (Tax Depreciation) (T11-26)
A. The federal tax code allows taxpayers to compute depreciation for their tax returns on
assets acquired after 1986 using the modified accelerated cost recovery system (MACRS).
B Under MACRS, each asset is placed with a recovery period category, which determines
Appendix 11B: Retirement and Replacement Methods of Depreciation
A. The retirement depreciation method records depreciation when assets are disposed of and
measures depreciation as the difference between the proceeds received and cost. (T11-27)
B. By the replacement method, depreciation is recorded when assets are replaced. (T11-28)
PowerPoint Slides
A PowerPoint presentation of the chapter is available in the Connect library.
Teaching Transparency Masters
The following can be reproduced on transparency film as they appear here, or
11-8 Intermediate Accounting, 8/e
COST ALLOCATION
➢ Cost allocation for long-lived, revenue producing assets is
known as depreciation for plant and equipment, depletion
Beginning of End of
year 1 year 5
| | | |
Year 1 Year 2 Year 3 Year 4 Year 5
Illustration 11-1
T11-1
MEASURING COST ALLOCATION
➢ The process of cost allocation requires that three factors be
established at the time the asset is put into use:
▶ The service life, or useful life, of an asset is the amount
of use that the company expects to obtain from the asset
before disposing of it.
▶ The allocation base is the difference between the cost of
T11-2
11-10 Intermediate Accounting, 8/e
DEPRECIATION OF ASSETS
➢ Time-based depreciation methods allocate the depreciable
base according to the passage of time.
➢ Accelerated depreciation methods allocate more depreciable
base to the earlier years of an asset's life and less to the later
years.
The Hogan Manufacturing Company purchased a machine for $250,000.
The company expects the service life of the machine to be five years.
During that time, it is expected that the machine will produce 140,000
units. The anticipated residual value is $40,000. The machine was
disposed of after five years of use. Actual production during the five
years of the asset’s life was:
Year Units Produced
Illustration 11-3
Straight-line Depreciation Method
DEPRECIATION OF ASSETS
(continued)
Sum-of-the-Years’-Digits Depreciation Method
Year
Depreciable
Base
X
Depreciation
Rate per Year
=
Depreciation
Book Value
End of Year
1
$210,000
5/15*
$70,000
$180,000
Illustration 11-3a
Double-Declining-Balance Depreciation Method
Year
Book Value
Beginning of
Year
X
Depreciation
Rate per Year
=
Depreciation
Book Value
End of Year
1
$250,000
40%
$100,000
$150,000
Illustration 11-3b
T11-3 (continued)
11-12 Intermediate Accounting, 8/e
DEPRECIATION OF ASSETS
(continued)
Units-of-Production Depreciation Method
Year
Units
Produced
X
Depreciation
Rate per Unit
=
Depreciation
Book Value
End of Year
1
24,000
$1.50*
$ 36,000
$214,000
Illustration 11-3c
11-3 (continued)
DECISION MAKERS' PERSPECTIVE —
SELECTING A DEPRECIATION METHOD
➢ All methods provide the same total depreciation over an
asset's life.
➢ Activity-based methods are theoretically superior to time-
based methods, but often are infeasible or too costly to use.
➢ Most companies use the straight-line method.
A recent survey of 500 large companies:
Depreciation Method
Number of Companies
Straight line
490
Declining balance
9
Illustration 11–4
T11-4
11-14 Intermediate Accounting, 8/e
INTERNATIONAL FINANCIAL REPORTING STANDARDS
Depreciation. IAS No. 16 requires that each component of an item of property, plant,
and equipment must be depreciated separately if its cost is significant in relation to the
total cost of the item. In the U.S., component depreciation is allowed but is not often
used in practice.
Consider the following illustration:
Cavandish LTD. purchased a delivery truck for $62,000. The truck is expected to
have a service life of six years and a residual value of $12,000. At the end of three
years, the over-sized tires, which have a cost of $6,000 (included in the $62,000
purchase price), will be replaced.
Under U.S. GAAP, the typical accounting treatment is to depreciate the $50,000
($62,000 – 12,000) depreciable base of the truck over its six-year useful life. Using
IFRS, the depreciable base of the truck is $44,000 ($62,000 – 12,000 – 6,000) and is
depreciated over the trucks six-year useful life, and the $6,000 cost of the tires is
depreciated separately over a three-year useful life.
U.S. GAAP and IFRS determine depreciable base in the same way, by subtracting
estimated residual value from cost. However, IFRS requires a review of residual
values at least annually.
Sanofi-Aventis, a French pharmaceutical company, prepares its financial statements
using IFRS. In its property, plant, and equipment note, the company discloses its use
of the component–based approach to accounting for depreciation.
Property, plant, and equipment (in part)
The component-based approach to accounting for property, plant, and equipment is
applied. Under this approach, each component of an item of property, plant, and
equipment with a cost which is significant in relation to the total cost of the item and
which has a different useful life from the other components must be depreciated
separately.
Depreciation Methods. IAS No. 16 specifically mentions three depreciation methods:
GROUP AND COMPOSITE DEPRECIATION
➢ Group and composite depreciation methods aggregate assets in order
to reduce the recordkeeping costs of determining periodic
depreciation.
The Express Delivery Company began operations in 2016. It will depreciate its fleet
of delivery vehicles using the group method. The cost of vehicles purchased early in
2016, along with residual values, estimated lives, and straight-line depreciation per
year by type of vehicle are as follows:
Depreciation
Residual Depreciable Estimated per Year
Asset Cost Value Base Life(yrs.) (straight line)
Vans $150,000 $30,000 $120,000 6 $20,000
Illustration 11-7
T11-6
11-16 Intermediate Accounting, 8/e
DEPLETION OF NATURAL RESOURCES
The Jackson Mining Company paid $1,000,000 for the right to explore for
a coal deposit on 500 acres of land in Pennsylvania. Costs of exploring
for the coal deposit totaled $800,000 and intangible development costs
incurred in digging and erecting the mine shaft were $500,000. In
addition, the Jackson purchased new excavation equipment for the project
at a cost of $600,000. After the coal is removed from the site, the
equipment will be sold for its anticipated residual value of $60,000.
The company geologist estimates that 1 million tons of coal will be
extracted over the three-year period. During 2016, 300,000 tons were
extracted. Jackson is required by its contract to restore the land to a
condition suitable for recreational use after it extracts the coal.
➢ In Chapter 10, we determined that the capitalized cost of the natural
resource, coal deposit, including restoration costs, is $2,768,360.
➢ The depletion rate per ton is calculated as follows:
➢ In 2016, the following journal entry records depletion.
Illustration 11-9
INTERNATIONAL FINANCIAL REPORTING STANDARDS
Biological Assets. Living animals and plants, including the trees
in a timber tract or in a fruit orchard, are referred to as biological
assets. Under U.S. GAAP, a timber tract is valued at cost less
accumulated depletion and a fruit orchard at cost less accumulated
depreciation. Under IFRS, biological assets are valued at their fair
value less estimated costs to sell, with changes in fair value
included in the calculation of net income.
Mondi Limited, an international paper and packing group headquartered in
Johannesburg, South Africa, prepares its financial statements according to
IFRS. The following disclosure note included in a recent annual report
discusses the company’s policy for valuing its forestry assets.
T11-8
11-18 Intermediate Accounting, 8/e
INTERNATIONAL FINANCIAL REPORTING STANDARDS
Valuation of Property, Plant, and Equipment. As we’ve discussed, under U.S. GAAP a company reports
property, plant, and equipment (PP&E) in the balance sheet at cost less accumulated depreciation (book
value). IAS No. 16 allows a company to report property, plant, and equipment at that amount or, alternatively,
at its fair value (revaluation). If a company chooses revaluation, all assets within a class of PP&E must be
revalued on a regular basis. U.S. GAAP prohibits revaluation.
Consider the following illustration:
Candless Corporation prepares its financial statements according to IFRS. At the beginning of its 2016 fiscal
year, the company purchased equipment for $100,000. The equipment is expected to have a five-year useful
life with no residual value, so depreciation for 2016 is $20,000. At the end of the year, Candless chooses to
revalue the equipment as permitted by IAS No. 16. Assuming that the fair value of the equipment at year-end
is $84,000, Candless records depreciation and the revaluation using the following journal entries:
After this entry, the book value of the equipment is $80,000; the fair value is $84,000. We use the ratio of
the two amounts to adjust both the equipment and the accumulated depreciation accounts (and thus the book
value) to fair value ($ in thousands):
December 31, 2016 Before After
Revaluation Revaluation
Equipment $100 x 84/80 = $105
The entries to revalue the equipment and the accumulated depreciation accounts (and thus the book value)
are:
(b) Equipment ($105,000 – 100,000) 5,000
December 31, 2017 Before After
Revaluation Revaluation
Equipment $105 x 57/63 = $95
The entries to revalue the equipment and the accumulated depreciation accounts (and thus the book value)
are:
(b) Revaluation surplus–OCI ($57,000 – 63,000 = $6,000; limit: $4,000 balance) 4,000
Revaluation expense (to balance) 2,000
Investcorp, a provider and manager of alternative investment products headquartered in London, prepares
its financial statements according to IFRS. The following disclosure note included in a recent annual report
discusses the company’s method of valuing its building and certain operating assets.
Premises and equipment (in part)
The Bank carries its building on freehold land and certain operating assets at revalued amounts, being the fair
value of the assets at the date of revaluation amount less any subsequent accumulated depreciation and
T11-9
11-20 Intermediate Accounting, 8/e
AMORTIZATION OF INTANGIBLE ASSETS
➢ The cost of an intangible asset with a finite useful life is amortized.
▶ Intangibles typically have no residual value, so the amortization base is
simply cost.
➢ The cost of an intangible asset with an indefinite useful life is not
amortized.
▶ Goodwill is the most common intangible asset with an indefinite useful
life.
Hollins Corporation began operations in 2016. Early in January, the company
purchased a franchise from the Ajax Corporation for $200,000. The franchise
The journal entries to record a full year of amortization for these intangibles are as
follows:
Amortization expense ($200,000 ÷ 10 years) ............... 20,000
Illustration 11-12
T11-10
