CHAPTER

11 Depreciation, Impairments,
and Depletion

LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1 Explain the concept of depreciation. 6 Explain the accounting procedures for depletion of
mineral resources.
2 Identify the factors involved in the depreciation process.
7 Explain the accounting for revaluations.
3 Compare activity, straight-line, and diminishing-charge
methods of depreciation. 8 Explain how to report and analyze property, plant,
4 Explain component depreciation. equipment, and mineral resources.

5 Explain the accounting issues related to asset

impairment.

Here Come the Write-Offs

The credit crisis starting in late 2008 affected many financial and non-financial institutions. Many of the statistics related to this
crisis are sobering, as noted below.
• In October 2008, the FTSE 100 in the United Kingdom suffered its biggest one-day fall since October 1987. The index
closed at its lowest level since October 2004.
• The U.S. Dow Jones Industrial Average fell below the 8,000 level for the first time since 2003.
• Germany’s benchmark DAX tumbled after the collapse of the proposed rescue plan for Hypo Real Estate (DEU).
• Tightening credit and less disposable income led to Japanese electronic groups losing value; the Nikkei fell to its lowest
point since February 2004.
• The Hong Kong Hang Seng dropped in line with the rest of Asia, closing below 17,000 points for the first time in two years
in October and below 11,000 by November 2008.
• Governments have spent billions of dollars bailing out financial institutions.
Although some financial rebound has occurred since October 2008, it is clear that most economies of the world are now
in a slower growth pattern. This slowdown raises many questions related to the proper accounting for many non-current as-
sets, such as property, plant, and equipment; intangible assets; and many types of financial assets. One of the most difficult
issues relates to the possibility of higher impairment charges related to these assets and the related disclosures that may be
needed. The following is an example of a recent impairment charge taken by Fujitsu Limited (JPN).

Impairment Losses (in part)

Due to the worsening of the global business environment, Fujitsu recognized consolidated impairment losses of 58.9 billion yen in relation
to property, plant and equipment of businesses with decreased profitability. The main losses are as follows:
(1) Property, Plant, and Equipment of LSI Business
Impairment losses related to the property, plant, and equipment of the LSI business of Fujitsu Microelectronics Limited totaled 49.9 billion
yen. In January, Fujitsu Microelectronics announced business reforms in response to a sharp downturn in customer demand that began
last autumn. Though the company continues to implement these reforms, since the business environment is unlikely to improve quickly,
Fujitsu is taking a cautious approach to evaluating the expected future return from the LSI business assets.
(2) Property, Plant, and Equipment of Optical Transmission Systems and Other Businesses
Consolidated impairment losses of 8.9 billion yen were recognized in relation to the property, plant, and equipment of the optical transmis-
sion systems business, the electronic components business and other businesses due to their decreased profitability.
(3) Property, Plant, and Equipment of HDD Business (included in business restructuring expenses)
Impairment losses of 16.2 billion yen have been recognized in relation to the property, plant, and equipment of the reorganized HDD busi-
ness. These losses are included in business restructuring expenses. The impairment loss includes 5.3 billion yen recognized in the third
quarter for the discontinuation for the HDD head business.
 CONCEPTUAL FOCUS
> See the Underlying Concepts on pages 496,
Here are some of the questions that will need to be 497, and 504.
addressed regarding possible impairments.
INTERNATIONAL FOCUS
1. How often should a company test for impairment?
2. What are key impairment indicators? > Read the Global Accounting Insights on
3. What types of disclosures are necessary for impairments? pages 519–520 for a discussion of non-IFRS
4. What is the process that companies use to match their financial reporting for property, plant, and
cash flows to the asset that is potentially impaired? equipment.
Assessing whether a company has impaired assets is
difficult. For example, in addition to the technical accounting
issues, the environment can change quickly. Reduced spending by consumers, lack of confidence in global economic deci-
sions, and higher volatility in both share and commodity markets are factors to consider. Nevertheless, for investors and
creditors to have assurance that the amounts reported on the statement of financial position for property, plant, and equip-
ment are relevant and representationally faithful, appropriate impairment charges must be reported on a timely basis.

Source: A portion of this discussion is taken from “Top 10 Tips for Impairment Testing,” PricewaterhouseCoopers (December 2008).

As noted in the opening story, many companies like Fujitsu (JPN)

PREVIEW OF CHAPTER 11 are affected by impairment rules. These rules recognize that when
economic conditions deteriorate, companies may need to write off an
asset’s cost to indicate the decline in its usefulness. The purpose of this chapter is to examine the depreciation
process and the methods of writing off the cost of property, plant, and equipment and mineral resources. The
content and organization of the chapter are as follows.

Depreciation, Impairments,
and Depletion

Presentation and
Depreciation Impairments Depletion Revaluations
Analysis

• Factors involved • Recognizing • Establishing a base • Recognition • Presentation

• Methods of impairments • Write-off of • Issues • Analysis
depreciation • Impairment resource cost
• Component illustrations • Estimating reserves
depreciation • Reversal of loss • Liquidating
• Special issues • Cash-generating dividends
units • Presentation
• Assets to be
disposed of

493
494 Chapter 11 Depreciation, Impairments, and Depletion

DEPRECIATION—A METHOD
OF COST ALLOCATION
Most individuals at one time or another purchase and trade in an automobile.
LEARNING OBJECTIVE 1 The automobile dealer and the buyer typically discuss what the trade-in value of
Explain the concept of depreciation. the old car is. Also, they may talk about what the trade-in value of the new car
will be in several years. In both cases, a decline in value is considered to be an
example of depreciation.
To accountants, however, depreciation is not a matter of valuation. Rather, depre-
ciation is a means of cost allocation. Depreciation is the accounting process of allo-
cating the cost of tangible assets to expense in a systematic and rational manner to
those periods expected to benefit from the use of the asset. For example, a company
like Enhance Electronics Co., Ltd. (TWN) does not depreciate assets on the basis of a
decline in their fair value. Instead, it depreciates through systematic charges to expense.
This approach is employed because the value of the asset may fluctuate between the
time the asset is purchased and the time it is sold or junked. Attempts to measure these in-
terim value changes have not been well received because values are difficult to measure
objectively. Therefore, Enhance Electronics charges the asset’s cost to depreciation expense
over its estimated life. It makes no attempt to value the asset at fair value between acquisi-
tion and disposition. Companies use the cost allocation approach because it matches costs
with revenues and because fluctuations in fair value are uncertain and difficult to measure.
When companies write off the cost of long-lived assets over a number of periods,
they typically use the term depreciation. They use the term depletion to describe the
reduction in the cost of mineral resources (such as oil, gas, and coal) over a period of time.
The expiration of intangible assets, such as patents or copyrights, is called amortization.

Factors Involved in the Depreciation Process

Before establishing a pattern of charges to revenue, a company must answer
LEARNING OBJECTIVE 2 three basic questions:
Identify the factors involved
in the depreciation process. 1. What depreciable base is to be used for the asset?
2. What is the asset’s useful life?
3. What method of cost apportionment is best for this asset?

The answers to these questions involve combining several estimates into one single
figure. Note the calculations assume perfect knowledge of the future, which is never
attainable.

Depreciable Base for the Asset

The base established for depreciation is a function of two factors: the original cost and
residual value. We discussed historical cost in Chapter 10. Residual value (often re-
ferred to as salvage value) is the estimated amount that a company will receive when it
sells the asset or removes it from service.1 It is the amount to which a company writes
down or depreciates the asset during its useful life. If an asset has a cost of €10,000 and
a residual value of €1,000, its depreciation base is €9,000.
ILLUSTRATION 11-1
Original cost €10,000
Computation of Less: Residual value 1,000
Depreciation Base
Depreciation base € 9,000

See the Authoritative

Literature section
1
(page 529). Residual value does not include possible future inflation effects. [1]
 Depreciation—A Method of Cost Allocation 495

From a practical standpoint, companies often assign a zero residual value. Some
long-lived assets, however, have substantial residual values.

Estimation of Service Lives

The service life of an asset often differs from its physical life. A piece of machinery may
be physically capable of producing a given product for many years beyond its service
life. But, a company may not use the equipment for all that time because the cost of
producing the product in later years may be too high.
Companies retire assets for two reasons: physical factors (such as casualty or expi-
ration of physical life) and economic factors (obsolescence). Physical factors are the
wear and tear, decay, and casualties that make it difficult for the asset to perform in-
definitely. These physical factors set the outside limit for the service life of an asset.
We can classify the economic or functional factors into three categories:

1. Inadequacy results when an asset ceases to be useful to a company because the

demands of the firm have changed. An example would be the need for a larger
building to handle increased production. Although the old building may still be
sound, it may have become inadequate for the company’s purpose.
2. Supersession is the replacement of one asset with another more efficient and eco-
nomical asset. Examples would be the replacement of the mainframe computer
with a PC network, or the replacement of the Boeing 767 with the Boeing 787.
3. Obsolescence is the catchall for situations not involving inadequacy and supersession.

Because the distinction between these categories appears artificial, it is probably

best to consider economic factors collectively instead of trying to make distinctions that
are not clear-cut.
To illustrate the concepts of physical and economic factors, consider a new nuclear
power plant. Which is more important in determining the useful life of a nuclear power
plant—physical factors or economic factors? The limiting factors seem to be (1) ecologi-
cal considerations, (2) competition from other power sources, and (3) safety concerns.
Physical life does not appear to be the primary factor affecting useful life. Although the
plant’s physical life may be far from over, the plant may become obsolete in 10 years.
For a house, physical factors undoubtedly are more important than the economic or
functional factors relative to useful life. Whenever the physical nature of the asset pri-
marily determines useful life, maintenance plays an extremely vital role. The better the
maintenance, the longer the life of the asset.2
Most companies estimate the useful life of an asset based on their past experiences
with the same or similar assets. Others use sophisticated statistical methods to establish
a useful life for accounting purposes. And, in some cases, companies select arbitrary
service lives. In highly industrial economies, where research and innovation are so
prominent, technological factors have as much effect, if not more, on service lives of
tangible plant assets as physical factors do.

Methods of Depreciation
3 LEARNING OBJECTIVE
The third factor involved in the depreciation process is the method of cost
Compare activity, straight-line, and
apportionment. The profession requires that the depreciation method employed diminishing-charge methods of
be “systematic and rational.” To be systematic and rational, the depreciation depreciation.
2
The airline industry also illustrates the type of problem involved in estimation. In the
past, aircraft were assumed not to wear out—they just became obsolete. However, some
jets have been in service as long as 20 years, and maintenance of these aircraft has become
increasingly expensive. As a result, some airlines now replace aircraft not because of
obsolescence but because of physical deterioration.
496 Chapter 11 Depreciation, Impairments, and Depletion

method should reflect the pattern in which the asset’s future economic benefits are
expected to be consumed by the company. [2] Companies may use a number of depre-
ciation methods, as follows.
Underlying Concepts
1. Activity method (units of use or production).
Depreciation attempts to match 2. Straight-line method.
the cost of an asset to the 3. Diminishing (accelerated)-charge methods:
periods that benefit from (a) Sum-of-the-years’-digits.
the use of that asset.
(b) Declining-balance method.3
To illustrate these depreciation methods, assume that Stanley Coal Mines recently
purchased an additional crane for digging purposes. Illustration 11-2 contains the perti-
nent data concerning this purchase.

ILLUSTRATION 11-2
Cost of crane $500,000
Data Used to Illustrate Estimated useful life 5 years
Depreciation Methods Estimated residual value $ 50,000
Productive life in hours 30,000 hours

Activity Method
The activity method (also called the variable-charge or units-of-production approach)
assumes that depreciation is a function of use or productivity, instead of the passage
of time. A company considers the life of the asset in terms of either the output it pro-
vides (units it produces) or an input measure such as the number of hours it works.
Conceptually, the proper cost association relies on output instead of hours used, but
often the output is not easily measurable. In such cases, an input measure such as ma-
chine hours is a more appropriate method of measuring the dollar amount of deprecia-
tion charges for a given accounting period.
The crane poses no particular depreciation problem. Stanley can measure the usage
(hours) relatively easily. If Stanley uses the crane for 4,000 hours the first year, the depre-
ciation charge is:

ILLUSTRATION 11-3
(Cost 2 Residual Value) 3 Hours this Year
Depreciation Calculation, 5 Depreciation Charge
Activity Method—Crane Total Estimated Hours
Example ($500,000 2 $50,000) 3 4,000
5 $60,000
30,000

The major limitation of this method is that it is inappropriate in situations in which

depreciation is a function of time instead of activity. For example, a building steadily
deteriorates due to the elements (time) regardless of its use. In addition, where eco-
nomic or functional factors affect an asset, independent of its use, the activity method
loses much of its significance. For example, if a company is expanding rapidly, a par-
ticular building may soon become obsolete for its intended purposes. In both cases,
activity is irrelevant. Another problem in using an activity method is the difficulty of
estimating units of output or service hours received.

3
Companies use the straight-line method more than any other method of depreciation. In a
survey of 200 international companies, straight-line depreciation was used 170 times, declining-
balance 11 times, units-of-production (activity method) 18 times, and other (e.g., proportion of
proven reserve) 8 times. In some cases, companies use two or more depreciation methods. See
IFRS Accounting Trends & Techniques, 2012–2013 (AICPA, 2012).
 Depreciation—A Method of Cost Allocation 497

In cases where loss of services results from activity or productivity, the activity
method matches costs and revenues the best. Companies that desire low depreciation
during periods of low productivity, and high depreciation during high productivity,
either adopt or switch to an activity method. In this way, a plant running at 40 percent
of capacity generates 60 percent lower depreciation charges.

Straight-Line Method Underlying Concepts

The straight-line method considers depreciation as a function of time rather If benefits flow on a “straight-
than a function of usage. Companies widely use this method because of its sim- line” basis, then justification
plicity. The straight-line procedure is often the most conceptually appropriate, exists for matching the cost
too. When creeping obsolescence is the primary reason for a limited service life, of the asset on a straight-line
the decline in usefulness may be constant from period to period. Stanley com- basis with these benefits.
putes the depreciation charge for the crane as follows.

ILLUSTRATION 11-4
Cost 2 Residual Value
5 Depreciation Charge Depreciation Calculation,
Estimated Service Life Straight-Line Method—
$500,000 2 $50,000 Crane Example
5 $90,000
5

The major objection to the straight-line method is that it rests on two tenuous as-
sumptions: (1) the asset’s economic usefulness is the same each year, and (2) the main-
tenance and repair expense is essentially the same each period.
One additional problem that occurs in using straight-line—as well as some other
methods—is that distortions in the rate of return analysis (income/assets) develop. Illus-
tration 11-5 indicates how the rate of return increases, given constant revenue flows,
because the asset’s book value decreases.

ILLUSTRATION 11-5
Undepreciated Income (after Rate of Return
Depreciation Asset Balance depreciation (Income 4 Depreciation and Rate of
Year Expense (book value) expense) Assets) Return Analysis—Crane
Example
0 $500,000
1 $90,000 410,000 $100,000 24.4%
2 90,000 320,000 100,000 31.2%
3 90,000 230,000 100,000 43.5%
4 90,000 140,000 100,000 71.4%
5 90,000 50,000 100,000 200.0%

Diminishing-Charge Methods
The diminishing-charge methods provide for a higher depreciation cost in the Underlying Concepts
earlier years and lower charges in later periods. Because these methods allow for
higher early-year charges than in the straight-line method, they are often called The expense recognition con-
accelerated depreciation methods. cept does not justify a constant
charge to income. If the benefits
What is the main justification for this approach? The rationale is that compa-
from the asset decline as the
nies should charge more depreciation in earlier years because the asset is most
asset ages, then a diminishing
productive in its earlier years. Furthermore, the accelerated methods provide a charge to income better
constant cost because the depreciation charge is lower in the later periods, at the matches cost to benefits.
time when the maintenance and repair costs are often higher. Generally, compa-
nies use one of two diminishing-charge methods: the sum-of-the-years’-digits
method or the declining-balance method.
498 Chapter 11 Depreciation, Impairments, and Depletion

Sum-of-the-Years’-Digits. The sum-of-the-years’-digits method results in a decreasing

depreciation charge based on a decreasing fraction of depreciable cost (original cost less
residual value). Each fraction uses the sum of the years as a denominator (5 1 4 1 3 1
2 1 1 5 15). The numerator is the number of years of estimated life remaining as of
the beginning of the year. In this method, the numerator decreases year by year, and the
denominator remains constant (5/15, 4/15, 3/15, 2/15, and 1/15). At the end of the
asset’s useful life, the balance remaining should equal the residual value. Illustration 11-6
shows this method of computation.4

ILLUSTRATION 11-6 Remaining Book

Sum-of-the-Years’-Digits Depreciation Life in Depreciation Depreciation Value, End
Depreciation Schedule— Year Base Years Fraction Expense of Year
Crane Example 1 $450,000 5 5/15 $150,000 $350,000
2 450,000 4 4/15 120,000 230,000
3 450,000 3 3/15 90,000 140,000
4 450,000 2 2/15 60,000 80,000
5 450,000 1 1/15 30,000 50,000a
15 15/15 $450,000

a
Residual value.

Declining-Balance Method. The declining-balance method (often referred to as the

reducing-balance method) utilizes a depreciation rate (expressed as a percentage) that
is some multiple of the straight-line method. For example, the double-declining rate for
a 10-year asset is 20 percent (double the straight-line rate, which is 1/10 or 10 percent).
Companies apply the constant rate to the declining book value each year.
Unlike other methods, the declining-balance method does not deduct the residual
value in computing the depreciation base. The declining-balance rate is multiplied by
the book value of the asset at the beginning of each period. Since the depreciation charge
reduces the book value of the asset each period, applying the constant-declining-
balance rate to a successively lower book value results in lower depreciation charges
each year. This process continues until the book value of the asset equals its estimated
residual value. At that time, the company discontinues depreciation.
Companies use various multiples in practice. For example, the double-declining-
balance method depreciates assets at twice (200 percent) the straight-line rate. Illustra-
tion 11-7 shows Stanley’s depreciation charges if using the double-declining approach.

ILLUSTRATION 11-7
Book Value Rate on Balance Book
Double-Declining of Asset First Declining Depreciation Accumulated Value, End
Depreciation Schedule— Year of Year Balancea Expense Depreciation of Year
Crane Example
1 $500,000 40% $200,000 $200,000 $300,000
2 300,000 40% 120,000 320,000 180,000
3 180,000 40% 72,000 392,000 108,000
4 108,000 40% 43,200 435,200 64,800
5 64,800 40% 14,800b 450,000 50,000
a
Based on twice the straight-line rate of 20% ($90,000/$450,000 5 20%; 20% 3 2 5 40%).
b
Limited to $14,800 because book value should not be less than residual value.

4
What happens if the estimated service life of the asset is, let us say, 51 years? How would we
calculate the sum-of-the-years’-digits? Fortunately, mathematicians have developed the follow-
ing formula that permits easy computation:
n(n 1 1) 51(51 1 1)
5 5 1,326
2 2
 Depreciation—A Method of Cost Allocation 499

Companies often switch from the declining-balance method to the straight-line

method near the end of the asset’s useful life to ensure that they depreciate the asset
only to its residual value.5

Component Depreciation
As indicated in Chapter 10, companies are required to use component deprecia-
4 LEARNING OBJECTIVE
tion. IFRS requires that each part of an item of property, plant, and equipment that
Explain component depreciation.
is significant to the total cost of the asset must be depreciated separately. Compa-
nies therefore have to exercise judgment to determine the proper allocations to the
components. As an example, when a company like Nokia (FIN) purchases a building, it
must determine how the various building components (e.g., the foundation, structure,
roof, heating and cooling system, and elevators) should be segregated and depreciated.
To illustrate the accounting for component depreciation, assume that EuroAsia
Airlines purchases an airplane for €100,000,000 on January 1, 2016. The airplane has a
useful life of 20 years and a residual value of €0. EuroAsia uses the straight-line method
of depreciation for all its airplanes. EuroAsia identifies the following components,
amounts, and useful lives, as shown in Illustration 11-8.

ILLUSTRATION 11-8
Components Component Amount Component Useful Life
Airplane Components
Airframe €60,000,000 20 years
Engine components 32,000,000 8 years
Other components 8,000,000 5 years

Illustration 11-9 shows the computation of depreciation expense for EuroAsia for 2016.

ILLUSTRATION 11-9
Components Component Amount 4 Useful Life 5 Component Depreciation
Computation of
Airframe € 60,000,000 20 €3,000,000 Component Depreciation
Engine components 32,000,000 8 4,000,000
Other components 8,000,000 5 1,600,000
Total €100,000,000 €8,600,000

As indicated, EuroAsia records depreciation expense of €8,600,000 in 2016, as follows.

Depreciation Expense 8,600,000
Accumulated Depreciation—Equipment 8,600,000

On the statement of financial position at the end of 2016, EuroAsia reports the airplane
as a single amount. The presentation is shown in Illustration 11-10.

ILLUSTRATION 11-10
Non-current assets
Airplane €100,000,000 Presentation of Carrying
Less: Accumulated depreciation—airplane 8,600,000 Amount of Airplane
€ 91,400,000

5
A pure form of the declining-balance method (sometimes called the “fixed percentage of book
value method”) has also been suggested as a possibility. This approach uses a rate that depreci-
ates the asset exactly to the residual value at the end of its expected useful life. The formula for
determining the rate is as follows.
n Residual value
Depreciation rate 5 1 2
B Acquisition cost
The life in years is n. After computing the depreciation rate, a company applies it on the
declining book value of the asset from period to period, which means that depreciation expense
will be successively lower. This method is not used extensively in practice, and it is generally
not permitted for tax purposes.
500 Chapter 11 Depreciation, Impairments, and Depletion

In many situations, a company may not have a good understanding of the cost of
the individual components purchased. In that case, the cost of individual components
should be estimated based on reference to current market prices (if available), discus-
sion with experts in valuation, or use of other reasonable approaches.

Special Depreciation Issues

We still need to discuss several special issues related to depreciation:

1. How should companies compute depreciation for partial periods?

2. Does depreciation provide for the replacement of assets?
3. How should companies handle revisions in depreciation rates?

Depreciation and Partial Periods

Companies seldom purchase plant assets on the first day of a fiscal period or dispose of
them on the last day of a fiscal period. A practical question is: How much depreciation
should a company charge for the partial periods involved?
In computing depreciation expense for partial periods, companies must determine the
depreciation expense for the full year and then prorate this depreciation expense between the
two periods involved. This process should continue throughout the useful life of the asset.
Assume, for example, that Steeltex Company purchases an automated drill machine
with a five-year life for £45,000 (no residual value) on June 10, 2015. The company’s fis-
cal year ends December 31. Steeltex therefore charges depreciation for only 62⁄3 months
during that year. The total depreciation for a full year (assuming straight-line deprecia-
tion) is £9,000 (£45,000/5). The depreciation for the first, partial year is therefore:
6 2/3
3 £9,000 5 £5,000
12
The partial-period calculation is relatively simple when Steeltex uses straight-line
depreciation. But how is partial-period depreciation handled when it uses an acceler-
ated method such as sum-of-the-years’-digits or double-declining-balance? As an illus-
tration, assume that Steeltex purchased another machine for £10,000 on July 1, 2015,
with an estimated useful life of five years and no residual value. Illustration 11-11 shows
the depreciation figures for 2015, 2016, and 2017.

ILLUSTRATION 11-11
Sum-of-the-Years’-Digits Double-Declining-Balance
Calculation of Partial-
1st full year (5/15 3 £10,000) 5 £3,333.33 (40% 3 £10,000) 5 £4,000
Period Depreciation,
2nd full year (4/15 3 10,000) 5 2,666.67 (40% 3 6,000) 5 2,400
Two Methods
3rd full year (3/15 3 10,000) 5 2,000.00 (40% 3 3,600) 5 1,440

Depreciation from July 1, 2015, to December 31, 2015

6/12 3 £3,333.33 5 £1,666.67 6/12 3 £4,000 5 £2,000

Depreciation for 2016

6/12 3 £3,333.33 5 £1,666.67 6/12 3 £4,000 5 £2,000

6/12 3 2,666.67 5 1,333.33 6/12 3 2,400 5 1,200
£3,000.00 £3,200

or (£10,000 2 £2,000) 3 40% 5 £3,200

Depreciation for 2017

6/12 3 £2,666.67 5 £1,333.33 6/12 3 £2,400 5 £1,200

6/12 3 2,000.00 5 1,000.00 6/12 3 1,440 5 720
£2,333.33 £1,920

or (£10,000 2 £5,200) 3 40% 5 £1,920

 Depreciation—A Method of Cost Allocation 501

Sometimes a company like Steeltex modifies the process of allocating costs to a par-
tial period to handle acquisitions and disposals of plant assets more simply. One varia-
tion is to take no depreciation in the year of acquisition and a full year’s depreciation in
the year of disposal. Other variations charge one-half year’s depreciation both in the
year of acquisition and in the year of disposal (referred to as the half-year convention),
or charge a full year in the year of acquisition and none in the year of disposal.
In fact, Steeltex may adopt any one of these several fractional-year policies in allo-
cating cost to the first and last years of an asset’s life so long as it applies the method
consistently. However, unless otherwise stipulated, companies normally compute de-
preciation on the basis of the nearest full month.
Illustration 11-12 shows depreciation allocated under five different fractional-year
policies using the straight-line method on the £45,000 automated drill machine pur-
chased by Steeltex Company on June 10, 2015, discussed earlier.

ILLUSTRATION 11-12
Machine Cost 5 £45,000 Depreciation Allocated per Period Over 5-Year Life*
Fractional-Year
Fractional-Year Policy 2015 2016 2017 2018 2019 2020 Depreciation Policies
a
1. Nearest fraction of a year. £5,000 £9,000 £9,000 £9,000 £9,000 £4,000b
2. Nearest full month. 5,250c 9,000 9,000 9,000 9,000 3,750d
3. Half year in period of
acquisition and disposal. 4,500 9,000 9,000 9,000 9,000 4,500
4. Full year in period of acquisition,
none in period of disposal. 9,000 9,000 9,000 9,000 9,000 –0–
5. None in period of acquisition,
full year in period of disposal. –0– 9,000 9,000 9,000 9,000 9,000

a b c d
6.667/12 (£9,000) 5.333/12 (£9,000) 7/12 (£9,000) 5/12 (£9,000)
*Rounded to nearest pound.

Depreciation and Replacement of Property, Plant, and Equipment

A common misconception about depreciation is that it provides funds for the re-
placement of property, plant, and equipment. Depreciation is like other expenses in
that it reduces net income. It differs, though, in that it does not involve a current
cash outflow.
To illustrate why depreciation does not provide funds for replacement of plant as-
sets, assume that a business starts operating with plant assets of $500,000 that have a
useful life of five years. The company’s statement of financial position at the beginning
of the period is:

Plant assets $500,000 Equity $500,000

If we assume that the company earns no revenue over the five years, the income
statements are:

Year 1 Year 2 Year 3 Year 4 Year 5

Revenue $ –0– $ –0– $ –0– $ –0– $ –0–
Depreciation (100,000) (100,000) (100,000) (100,000) (100,000)
Loss $(100,000) $(100,000) $(100,000) $(100,000) $(100,000)

Total depreciation of the plant assets over the five years is $500,000. The statement
of financial position at the end of the five years therefore is:

Plant assets –0– Equity –0–

502 Chapter 11 Depreciation, Impairments, and Depletion

This extreme example illustrates that depreciation in no way provides funds for the
replacement of assets. The funds for the replacement of the assets come from the rev-
enues (generated through use of the asset). Without the revenues, no income material-
izes and no cash inflow results.

Revision of Depreciation Rates

When purchasing a plant asset, companies carefully determine depreciation rates based
on past experience with similar assets and other pertinent information. The provisions
for depreciation are only estimates, however. Companies may need to revise them during
the life of the asset. Unexpected physical deterioration or unforeseen obsolescence
may decrease the estimated useful life of the asset. Improved maintenance procedures,
revision of operating procedures, or similar developments may prolong the life of the
asset beyond the expected period.6
For example, assume that Nestlé (CHE) purchased machinery with an original cost
of CHF90,000. It estimates a 20-year life with no residual value. However, during year
11, Nestlé estimates that it will use the machine for an additional 20 years. Its total life,
therefore, will be 30 years instead of 20. Depreciation has been recorded at the rate
of 1/20 of CHF90,000, or CHF4,500 per year by the straight-line method. On the basis
of a 30-year life, Nestlé should have recorded depreciation as 1/30 of CHF90,000, or
CHF3,000 per year. It has therefore overstated depreciation, and understated net
income, by CHF1,500 for each of the past 10 years, or a total amount of CHF15,000.
Illustration 11-13 shows this computation.

ILLUSTRATION 11-13
Per Year For 10 Years
Computation of
Depreciation charged per books (1/20 3 CHF90,000) CHF4,500 CHF45,000
Accumulated Difference
Depreciation based on a 30-year life (1/30 3 CHF90,000) (3,000) (30,000)
Due to Revisions
Excess depreciation charged CHF1,500 CHF15,000

Nestlé should report this change in estimate in the current and prospective peri-
ods. It should not make any changes in previously reported results. And it does not
adjust opening balances nor attempt to “catch up” for prior periods. The reason?
Changes in estimates are a continual and inherent part of any estimation process. Con-
tinual restatement of prior periods would occur for revisions of estimates unless
handled prospectively. Therefore, no entry is made at the time the change in estimate
occurs. Charges for depreciation in subsequent periods (assuming use of the straight-
line method) are determined by dividing the remaining book value less any residual
value by the remaining estimated life.

ILLUSTRATION 11-14
Machinery CHF90,000
Computing Depreciation Less: Accumulated depreciation 45,000
after Revision of
Book value of machinery at end of 10th year CHF45,000
Estimated Life
Depreciation (future periods) 5 CHF45,000 book value 4 20 years remaining life 5 CHF2,250

6
As an example of a change in operating procedures, General Motors (USA) used to write off its
tools—such as dies and equipment used to manufacture car bodies—over the life of the body
type. Through this procedure, it expensed tools twice as fast as Ford (USA) and three times as
fast as Chrysler (USA). However, it slowed the depreciation process on these tools and length-
ened the lives on its plant and equipment. These revisions reduced depreciation and amortiza-
tion charges by approximately $1.23 billion, or $2.55 per share, in the year of the change. In
Chapter 22, we provide a more complete discussion of changes in estimates.
 Impairments 503

The entry to record depreciation for each of the remaining 20 years is:
Depreciation Expense 2,250
Accumulated Depreciation—Machinery 2,250

What do the numbers mean? DEPRECIATION CHOICES

D

The amount of depreciation expense recorded depends on

1.7 Property, Plant, and Equipment
both the depreciation method used and estimates of service
Property, plant, and equipment are recorded at historical acqui-
lives and residual values of the assets. Differences in these sition cost to the Group, less accumulated depreciation and any
choices and estimates can significantly impact a company’s accumulated impairment losses.
reported results and can make it difficult to compare the Property, plant, and equipment are recorded by compo-
depreciation numbers of different companies. nent, with each component depreciated over its useful life.
Useful lives are as follows:
For example, Veolia Environment (FRA) provided
information regarding useful lives of its assets in the note to Range of Useful Lives in
its financial statements, as shown to the right. Number of Years*
With the information provided, an analyst determines Buildings 20 to 50
Technical systems 7 to 24
the impact of these management choices and judgments on
Vehicles 3 to 25
the amount of depreciation expense for classes of property, Other plant and equipment 3 to 12
plant, and equipment.
*The range of useful lives is due to the diversity of property,
plant and equipment concerned.

IMPAIRMENTS
The general accounting standard of lower-of-cost-or-net realizable value for
5 LEARNING OBJECTIVE
inventories does not apply to property, plant, and equipment. Even when
Explain the accounting issues
property, plant, and equipment has suffered partial obsolescence, accountants
related to asset impairment.
have been reluctant to reduce the asset’s carrying amount. Why? Because, un-
like inventories, it is difficult to arrive at a fair value for property, plant, and
equipment that is not somewhat subjective and arbitrary.
For example, Falconbridge Ltd. Nickel Mines (CAN) had to decide whether to
write off all or a part of its property, plant, and equipment in a nickel-mining operation
in the Dominican Republic. The project had been incurring losses because nickel prices
were low and operating costs were high. Only if nickel prices increased by approxi-
mately 33 percent would the project be reasonably profitable. Whether a write-off was
appropriate depended on the future price of nickel. Even if the company decided to
write off the asset, how much should be written off?

Recognizing Impairments
As discussed in the opening story, the credit crisis starting in late 2008 has affected many
financial and non-financial institutions. As a result of this global slump, many compa-
nies are considering write-offs of some of their long-lived assets. These write-offs are
referred to as impairments.
A long-lived tangible asset is impaired when a company is not able to recover the
asset’s carrying amount either through using it or by selling it. To determine whether an
asset is impaired, on an annual basis, companies review the asset for indicators of
impairments—that is, a decline in the asset’s cash-generating ability through use or sale.
This review should consider internal sources (e.g., adverse changes in performance) and
external sources (e.g., adverse changes in the business or regulatory environment) of
504 Chapter 11 Depreciation, Impairments, and Depletion

Underlying Concepts information. If impairment indicators are present, then an impairment test must
be conducted. This test compares the asset’s recoverable amount with its carrying
IFRS uses the terms carrying amount. If the carrying amount is higher than the recoverable amount, the differ-
value, carrying amount, and ence is an impairment loss. If the recoverable amount is greater than the carrying
book value interchangeably. amount, no impairment is recorded. [3]
Recoverable amount is defined as the higher of fair value less costs to sell or
value-in-use. Fair value less costs to sell means what the asset could be sold for after
deducting costs of disposal. Value-in-use is the present value of cash flows expected
from the future use and eventual sale of the asset at the end of its useful life. Illustra-
tion 11-15 highlights the nature of the impairment test.

ILLUSTRATION 11-15
Impairment Test Carrying Recoverable
Compared to
Amount Amount

Higher of

Fair Value Less

Value-in-Use
Costs to Sell

If either the fair value less costs to sell or value-in-use is higher than the carrying amount,
there is no impairment. If both the fair value less costs to sell and value-in-use are lower
than the carrying amount, a loss on impairment occurs.

Example: No Impairment
Assume that Cruz Company performs an impairment test for its equipment. The carry-
ing amount of Cruz’s equipment is €200,000, its fair value less costs to sell is €180,000,
and its value-in-use is €205,000. In this case, the value-in-use of Cruz’s equipment is
higher than its carrying amount of €200,000. As a result, there is no impairment.7

Example: Impairment
Assume the same information for Cruz Company above except that the value-in-use of
Cruz’s equipment is €175,000 rather than €205,000. Cruz measures the impairment loss
as the difference between the carrying amount of €200,000 and the higher of fair value
less costs to sell (€180,000) or value-in-use (€175,000). Cruz therefore uses the fair value
less cost of disposal to record an impairment loss of €20,000 (€200,000 2 €180,000).
Cruz makes the following entry to record the impairment loss.
Loss on Impairment 20,000
Accumulated Depreciation—Equipment 20,000

The Loss on Impairment is reported in the income statement in the “Other income and
expense” section. The company then either credits Equipment or Accumulated
Depreciation—Equipment to reduce the carrying amount of the equipment for the
impairment. For purposes of homework, credit accumulated depreciation when recording an
impairment for a depreciable asset.

7
If a company can more readily determine value-in-use (or fair value less costs to sell) and it
determines that no impairment is needed, it is not required to compute the other measure. [4]
 Impairments 505

Impairment Illustrations
Presented below are additional examples of impairments.

Case 1
At December 31, 2016, Hanoi Company has equipment with a cost of VND26,000,000,
and accumulated depreciation of VND12,000,000. The equipment has a total useful life
of four years with a residual value of VND2,000,000. The following information relates
to this equipment.
1. The equipment’s carrying amount at December 31, 2016, is VND14,000,000
(VND26,000,000 2 VND12,000,000).
2. Hanoi uses straight-line depreciation. Hanoi’s depreciation was VND6,000,000
[(VND26,000,000 2 VND2,000,000) 4 4] for 2016 and is recorded.
3. Hanoi has determined that the recoverable amount for this asset at December 31,
2016, is VND11,000,000.
4. The remaining useful life of the equipment after December 31, 2016, is two years.
Hanoi records the impairment on its equipment at December 31, 2016, as follows.
Loss on Impairment (VND14,000,000 2 VND11,000,000) 3,000,000
Accumulated Depreciation—Equipment 3,000,000

Following the recognition of the impairment loss in 2016, the carrying amount of
the equipment is now VND11,000,000 (VND14,000,000 2 VND3,000,000). For 2017,
Hanoi Company determines that the equipment’s total useful life has not changed (thus,
the equipment’s remaining useful life is still two years). However, the estimated resid-
ual value of the equipment is now zero. Hanoi continues to use straight-line deprecia-
tion and makes the following journal entry to record depreciation for 2017.
Depreciation Expense (VND11,000,000/2) 5,500,000
Accumulated Depreciation—Equipment 5,500,000

Hanoi records depreciation in the periods following the impairment using the carry-
ing amount of the asset adjusted for the impairment. Hanoi then evaluates whether
the equipment was further impaired at the end of 2017. For example, the carrying
amount of Hanoi’s equipment at December 31, 2017, is VND5,500,000 (VND26,000,000 2
VND12,000,000 2 VND3,000,000 2 VND5,500,000). If Hanoi determines that the recov-
erable amount at December 31, 2017, is lower than VND5,500,000, then an additional
impairment loss is recorded.

Case 2
At the end of 2015, Verma Company tests a machine for impairment. The machine has
a carrying amount of $200,000. It has an estimated remaining useful life of five years.
Because of the unique nature of the machine, there is little market-related information
on which to base a recoverable amount based on fair value. As a result, Verma deter-
mines the machine’s recoverable amount (i.e., the higher of value-in-use and fair value
less costs to sell) should be based on value-in-use.
To determine value-in-use, Verma develops an estimate of future cash flows
based on internal company cash budgets (and reflecting cash inflows from the machine
and estimated costs necessary to maintain the machine in its current condition). [5]
Verma uses a discount rate of 8 percent, which should be a pretax rate that approximates
Verma’s cost of borrowing.8 Verma’s analysis indicates that its future cash flows will be

8
Specifically, the pretax rate is determined taking into account market- and company-specific
borrowing rates, adjusted for any risks the market might attribute to expected cash flows for the
asset. [6]
506 Chapter 11 Depreciation, Impairments, and Depletion

$40,000 each year for five years, and it will receive a residual value of $10,000 at the end
of the five years. It is assumed that all cash flows occur at the end of the year. The com-
putation of the value-in-use for Verma’s machine is shown in Illustration 11-16.

ILLUSTRATION 11-16
Present value of 5 annual payments of $40,000 ($40,000 3 3.99271, Table 6-4) $159,708.40
Value-in-Use Present value of residual value of $10,000 ($10,000 3 .68058, Table 6-1) 6,805.80
Computation
Value-in-use related to machine $166,514.20

The computation of the impairment loss on the machine at the end of 2015 is shown
in Illustration 11-17.

ILLUSTRATION 11-17
Carrying amount of machine before impairment loss $200,000.00
Impairment Loss Recoverable amount of machine 166,514.20
Calculation Based on
Loss on impairment $ 33,485.80
Value-in-Use

The company therefore records an impairment loss at December 31, 2015, as follows.
Loss on Impairment 33,485.80
Accumulated Depreciation—Machinery 33,485.80

The carrying amount of the machine after recording the loss is $166,514.20.

Reversal of Impairment Loss

After recording the impairment loss, the recoverable amount becomes the basis of the
impaired asset. What happens if a review in a future year indicates that the asset is no
longer impaired because the recoverable amount of the asset is higher than the carrying
amount? In that case, the impairment loss may be reversed.
To illustrate, assume that Tan Company purchases equipment on January 1, 2015,
for HK$300,000, with a useful life of three years and no residual value. Its depreciation
and related carrying amount over the three years is as follows.

Year Depreciation Expense Carrying Amount

2015 HK$100,000 (HK$300,000/3) HK$200,000
2016 HK$100,000 (HK$300,000/3) HK$100,000
2017 HK$100,000 (HK$300,000/3) 0

At December 31, 2015, Tan determines it has an impairment loss of HK$20,000 and
therefore makes the following entry.
Loss on Impairment 20,000
Accumulated Depreciation—Equipment 20,000

Tan’s depreciation expense and related carrying amount after the impairment is as indi-
cated below.

Year Depreciation Expense Carrying Amount

2016 HK$90,000 (HK$180,000/2) HK$90,000
2017 HK$90,000 (HK$180,000/2) 0
 Impairments 507

At the end of 2016, Tan determines that the recoverable amount of the equipment is
HK$96,000, which is greater than its carrying amount of HK$90,000. In this case, Tan
reverses the previously recognized impairment loss with the following entry.
Accumulated Depreciation—Equipment 6,000
Recovery of Impairment Loss 6,000

The recovery of the impairment loss is reported in the “Other income and expense”
section of the income statement. The carrying amount of Tan’s equipment is now
HK$96,000 (HK$90,000 1 HK$6,000) at December 31, 2016.
The general rule related to reversals of impairments is as follows. The amount of the
recovery of the loss is limited to the carrying amount that would result if the impairment
had not occurred. For example, the carrying amount of Tan’s equipment at the end of
2016 would be HK$100,000, assuming no impairment. The HK$6,000 recovery is there-
fore permitted because Tan’s carrying amount on the equipment is now only HK$96,000.
However, any recovery above HK$10,000 is not permitted. The reason is that any recovery
above HK$10,000 results in Tan carrying the asset at a value above its historical cost.

Cash-Generating Units
In some cases, it may not be possible to assess a single asset for impairment because the
single asset generates cash flows only in combination with other assets. In that case,
companies should identify the smallest group of assets that can be identified that gener-
ates cash flows independently of the cash flows from other assets. Such a group is called
a cash-generating unit (CGU).
For example, Santos Company is reviewing its plant assets for indicators of impairment.
However, it is finding that identifying cash flows for individual assets is very cumbersome
and inaccurate because the cash flows related to a group of assets are interdependent. This
situation can arise if Santos has one operating unit (machining division) that manufactures
products that are transferred to another Santos business unit (packing division), which then
markets the products to end customers. Because the cash flows to the assets in the machin-
ing division are dependent on the cash flows in the packing division, Santos should evaluate
both divisions together as a cash-generating unit in its impairment assessments.

Impairment of Assets to Be Disposed Of

What happens if a company intends to dispose of the impaired asset, instead of holding
it for use? Recently, Kroger (USA) recorded an impairment loss of $54 million on prop-
erty, plant, and equipment it no longer needed due to store closures. In this case, Kroger
reports the impaired asset at the lower-of-cost-or-net realizable value (fair value less
costs to sell). Because Kroger intends to dispose of the assets in a short period of time, it
uses net realizable value in order to provide a better measure of the net cash flows that
it will receive from these assets.
Kroger does not depreciate or amortize assets held for disposal during the period it
holds them. The rationale is that depreciation is inconsistent with the notion of assets to
be disposed of and with the use of the lower-of-cost-or-net realizable value. In other
words, assets held for disposal are like inventory; companies should report them at
the lower-of-cost-or-net realizable value.
Because Kroger will recover assets held for disposal through sale rather than
through operations, it continually revalues them. Each period, the assets are reported at
the lower-of-cost-or-net realizable value. Thus, Kroger can write up or down an asset
held for disposal in future periods, as long as the carrying amount after the write-up
never exceeds the carrying amount of the asset before the impairment. Companies
should report losses or gains related to these impaired assets as part of operating income
in “Other income and expense.”
508 Chapter 11 Depreciation, Impairments, and Depletion

Illustration 11-18 summarizes the key concepts in accounting for impairments.

ILLUSTRATION 11-18
Graphic of Accounting Measurement of
Impairment Test
for Impairments Impairment Loss
Recoverable amount* less Yes
Impairment
than carrying amount?

No

Assets held Assets held for

for use sale or disposal
No impairment

1. Impairment loss: excess 1. Lower-of-cost or fair value

of carrying amount over less costs to sell (net
recoverable amount. realizable value).

2. Depreciate on new 2. No depreciation taken.

cost basis.

3. Reversal of impairment
loss permitted.

*The higher of fair value less costs to sell or value-in-use.

DEPLETION
Natural resources, often called wasting assets, include petroleum, minerals, and
LEARNING OBJECTIVE 6 timberlands. Natural resources can be further subdivided into two categories:
Explain the accounting procedures (1) biological assets such as timberlands, and (2) mineral resources such as oil,
for depletion of mineral resources.
gas, and mineral mining. The accounting and reporting requirements for bio-
logical assets such as timberlands use a fair value approach and are discussed in
Chapter 9. Here, we focus on mineral resources, which have two main features: (1) the
complete removal (consumption) of the asset, and (2) replacement of the asset only by
an act of nature.
Unlike plant and equipment, mineral resources are consumed physically over the
period of use and do not maintain their physical characteristics. Still, the accounting
problems associated with these resources are similar to those encountered with prop-
erty, plant, and equipment. The questions to be answered are:

1. How do companies establish the cost basis for write-off?

2. What pattern of allocation should companies employ?

Recall that the accounting profession uses the term depletion for the process of
allocating the cost of mineral resources.

Establishing a Depletion Base

How do we determine the depletion base for mineral resources? For example, a com-
pany like Total S.A. (FRA) makes sizable expenditures to find mineral resources. And,
for every successful discovery, there are many failures. Furthermore, the company often
 Depletion 509

encounters long delays between the time it incurs costs and the time it obtains the ben-
efits from the extracted resources. As a result, a company in the extractive industries,
like Total S.A., frequently adopts a conservative policy in accounting for the expendi-
tures related to finding and extracting mineral resources.
Computation of the depletion base involves properly accounting for three types of
expenditures:

1. Pre-exploratory costs.
2. Exploratory and evaluation costs.
3. Development costs.

Pre-Exploratory Costs
Pre-exploratory expenditures are costs incurred before the company has obtained the
legal rights to explore a specific area. For example, Royal Dutch Shell (GBR and NLD)
may perform seismic testing of possible oil-drilling sites before incurring any substan-
tial costs of exploration. These costs (often referred to as prospecting costs) are generally
considered speculative in nature and are expensed as incurred.

Exploratory and Evaluation (E&E) Costs

Examples of some types of exploratory and evaluation (E&E) costs are as follows.

• Acquisition of rights to explore.

• Topographical, geological, geochemical, and geophysical studies.
• Exploratory drilling.
• Sampling.
• Activities in relation to evaluating the technical feasibility and commercial viability
of extracting a mineral resource.

Companies have a choice regarding E&E costs. They can either write off these costs
as incurred or capitalize these costs pending evaluation. IFRS therefore provides com-
panies with flexibility as how to account for E&E costs at inception. [7]
The reason for the flexibility is that the accounting for these types of expenditures is
controversial. To illustrate, assume that Royal Dutch Shell is exploring for oil and deter-
mines that the area of exploration has oil reserves. It therefore drills a well to determine
the amount of the reserves. Unfortunately, the well drilled results in a dry hole; that is,
no reserves are found. Shell then drills more wells and finds some oil reserves, but some
others are dry holes. The question is: Should the cost of the dry holes be capitalized? Or
should only the cost of the wells that find reserves be capitalized?
Those who hold the full-cost concept (full capitalization) argue that the cost of
drilling a dry hole is a cost needed to find the commercially profitable wells. Others
believe that companies should capitalize only the costs of the successful wells. This is
the successful-efforts concept. Its proponents believe that the only relevant measure for
a project is the cost directly related to that project, and that companies should report any
remaining costs as period charges. In addition, they argue that an unsuccessful com-
pany will end up capitalizing many costs that will make it, over a short period of time,
show no less income than does one that is successful.

Development Costs
Once technical feasibility and commercial viability of production are demonstrated, E&E
assets are reclassified as development costs. Generally, the development phase occurs
when the company has determined that it has a reasonable level of mineral resources in
510 Chapter 11 Depreciation, Impairments, and Depletion

the ground so that production will be profitable. At this time, any E&E assets recognized
as assets are subsequently tested for impairment, to ensure that these assets are not car-
ried at an amount above their recoverable amount.
Companies divide development costs into two parts: (1) tangible equipment costs
and (2) intangible development costs. Tangible equipment costs include all of the trans-
portation and other heavy equipment needed to extract the resource and get it ready for
market. Because companies can move the heavy equipment from one extracting site to
another, companies do not normally include tangible equipment costs in the deple-
tion base. Instead, they use separate depreciation charges to allocate the costs of such
equipment. However, some tangible assets (e.g., a drilling rig foundation) cannot be
moved. Companies depreciate these assets over their useful life or the life of the re-
source, whichever is shorter.
Intangible development costs, on the other hand, are such items as drilling costs,
tunnels, shafts, and wells. These costs have no tangible characteristics but are needed
for the production of the mineral resource. Intangible development costs are consid-
ered part of the depletion base.
Companies sometimes incur substantial costs to restore property to its natural state
after extraction has occurred. These are restoration costs. Companies consider restora-
tion costs part of the depletion base. The amount included in the depletion base is the
fair value of the obligation to restore the property after extraction. A more complete
discussion of the accounting for restoration costs and related liabilities (sometimes re-
ferred to as environmental liability provisions) is provided in Chapter 13. Similar to
other long-lived assets, companies deduct from the depletion base any residual value to
be received on the property.

Write-Off of Resource Cost

Once the company establishes the depletion base, the next problem is determining how
to allocate the cost of the mineral resource to accounting periods.
Normally, companies compute depletion (often referred to as cost depletion) on a
units-of-production method (an activity approach). Thus, depletion is a function of the
number of units extracted during the period. In this approach, the total cost of the min-
eral resource less residual value is divided by the number of units estimated to be in the
resource deposit, to obtain a cost per unit of product. To compute depletion, the cost per
unit is then multiplied by the number of units extracted.
For example, MaClede Co. acquired the right to use 1,000 acres of land in South
Africa to mine for silver. The lease cost is €50,000, and the related exploration costs on
the property are €100,000. Intangible development costs incurred in opening the mine
are €850,000. Total costs related to the mine before the first ounce of silver is extracted
are, therefore, €1,000,000. MaClede estimates that the mine will provide approximately
100,000 ounces of silver. Illustration 11-19 shows computation of the depletion cost per
unit (depletion rate).

ILLUSTRATION 11-19
Total Cost 2 Residual Value
Computation of 5 Depletion Cost per Unit
Total Estimated Units Available
Depletion Rate
€1,000,000
5 €10 per ounce
100,000

If MaClede extracts 25,000 ounces in the first year, then the depletion for the year is
€250,000 (25,000 ounces 3 €10). It records the depletion as follows.
Inventory 250,000
Accumulated Depletion 250,000
 Depletion 511

MaClede debits Inventory for the total depletion for the year and credits Accumu-
lated Depletion to reduce the carrying amount of the mineral resource. MaClede credits
Inventory when it sells the inventory. The amount not sold remains in inventory and is
reported in the current assets section of the statement of financial position.
Sometimes companies do not use an Accumulated Depletion account. In that case,
the credit goes directly to the mineral resources asset account. MaClede’s statement of
financial position would present the cost of the mineral resource and the amount of
accumulated depletion entered to date as follows.

ILLUSTRATION 11-20
Silver mine (at cost) €1,000,000 Statement of Financial
Less: Accumulated depletion 250,000 €750,000
Position Presentation of
Mineral Resource
In the income statement, the depletion cost related to the inventory sold is part of the
cost of goods sold.
MaClede may also depreciate on a units-of-production basis the tangible equipment
used in extracting the silver. This approach is appropriate if it can directly assign the
estimated lives of the equipment to one given resource deposit. If MaClede uses the
equipment on more than one job, other cost allocation methods such as straight-line or
accelerated depreciation methods would be more appropriate.

Estimating Recoverable Reserves

Sometimes companies need to change the estimate of recoverable reserves. They do so
either because they have new information or because more sophisticated production
processes are available. Mineral resources such as oil and gas deposits and some rare
metals have recently provided the greatest challenges. Estimates of these reserves are in
large measure merely “knowledgeable guesses.”9
This problem is the same as accounting for changes in estimates for the useful lives
of plant and equipment. The procedure is to revise the depletion rate on a prospective
basis: A company divides the remaining cost by the new estimate of the recoverable re-
serves. This approach has much merit because the required estimates are so uncertain.

Liquidating Dividends
A company often owns as its only major asset a property from which it intends to
extract mineral resources. If the company does not expect to purchase additional prop-
erties, it may gradually distribute to shareholders their capital investments by paying
liquidating dividends, which are dividends greater than the amount of accumulated
net income.
The major accounting problem is to distinguish between dividends that are a return
of capital and those that are not. Because the dividend is a return of the investor’s
original contribution, the company issuing a liquidating dividend should debit Share
Premium—Ordinary for that portion related to the original investment, instead of debiting
Retained Earnings.
To illustrate, at year-end, Callahan Mining had a retained earnings balance of
£1,650,000, accumulated depletion on mineral properties of £2,100,000, and share premium
of £5,435,493. Callahan’s board declared a dividend of £3 per share on the 1,000,000 shares
outstanding. It records the £3,000,000 cash dividend as follows.

9
The IASB has conducted a research project on the extractive industry. The primary focus are the
financial reporting issues associated with mineral and other natural resource reserves. The key
question is whether and how to define, recognize, measure, and disclose reserves in the financial
statements. At present, the Board is contemplating an agenda decision for a future standard. See
http://www.ifrs.org/Current-Projects/IASB-Projects/Extractive-Activities/DPA p10/Pages/DP.aspx.
512 Chapter 11 Depreciation, Impairments, and Depletion

Retained Earnings 1,650,000

Share Premium—Ordinary 1,350,000
Cash 3,000,000

Callahan must inform shareholders that the £3 dividend per share represents a £1.65
(£1,650,000 4 1,000,000 shares) per share return on investment and a £1.35 (£1,350,000 4
1,000,000 shares) per share liquidating dividend.

Presentation on the Financial Statements

Companies should disclose the following related to E&E expenditures.

1. The accounting policies for exploration and evaluation expenditures, including the
recognition of E&E assets.
2. The amounts of assets, liabilities, income and expense, and operating cash flow aris-
ing from the exploration for and evaluation of mineral resources.

The financial statement excerpts for Tullow Oil plc (GBR) in Illustration 11-21 highlight
the nature of these disclosures.

ILLUSTRATION 11-21
Reporting of Tullow Oil plc
(in thousands)
Exploration Costs
Income Statement
Exploration costs written off £ 226,701

Statement of Financial Position

Intangible exploration and evaluation assets £1,417,777

Statement of Cash Flows

Purchase of intangible exploration and evaluation of assets £ 323,569

Accounting Policies
Exploration, evaluation, and production assets
The Group adopts the successful efforts method of accounting for exploration and appraisal costs. All
license acquisition, exploration, and evaluation costs are initially capitalized in cost centers by well, field,
or exploration area, as appropriate. Directly attributable administration costs and interest payable are
capitalized insofar as they relate to specific development activities. Pre-license costs are expensed in the
period in which they are incurred. These costs are then written off as exploration costs in the Income
Statement unless commercial reserves have been established or the determination process has not been
completed and there are no indications of impairment. All field development costs are capitalized as
property, plant, and equipment. Property, plant, and equipment related to production activities are
amortized in accordance with the Group’s depletion and amortization accounting policy.

(k) Depletion and amortization—discovery fields

All expenditure carried within each field is amortized from the commencement of production on a
unit of production basis, which is the ratio of oil and gas production in the period to the estimated quanti-
ties of commercial reserves at the end of the period plus the production in the period, generally on a field-
by-field basis. Costs used in the unit of production calculation comprise the net book value of capitalized
costs plus the estimated future field development costs. Changes in the estimates of commercial reserves
or future field development costs are dealt with prospectively.
Where there has been a change in economic conditions that indicates a possible impairment in a
discovery field, the recoverability of the net book value relating to that field is assessed by comparison with
the estimated discounted future cash flows based on management’s expectations of future oil and gas
prices and future costs. Where there is evidence of economic interdependency between fields, such as
common infrastructure, the fields are grouped as a single cash-generating unit for impairment purposes.
Any impairment identified is charged to the Income Statement as additional depletion and amorti-
zation. Where conditions giving rise to impairment subsequently reverse, the effect of the impairment
charge is also reversed as a credit to the Income Statement, net of any depreciation that would have
been charged since the impairment.
 Revaluations 513

REVALUATIONS
Up to this point, we have assumed that companies use the historical cost prin-
ciple to value long-lived tangible assets after acquisition. However, companies
7 LEARNING OBJECTIVE
Explain the accounting for revaluations.
have a choice: They may value these assets at cost or at fair value. [8]

Recognizing Revaluations
Network Rail (GBR) is an example of a company that elected to use fair values to ac-
count for its railroad network. Its use of fair value led to an increase of £4,289 million to
its long-lived tangible assets. When companies choose to fair value their long-lived
tangible assets subsequent to acquisition, they account for the change in the fair value
by adjusting the appropriate asset account and establishing an unrealized gain on the
revalued long-lived tangible asset. This unrealized gain is often referred to as revaluation
surplus.

Revaluation—Land
To illustrate revaluation of land, assume that Siemens Group (DEU) purchased land for
€1,000,000 on January 5, 2015. The company elects to use revaluation accounting for the
land in subsequent periods. At December 31, 2015, the land’s fair value is €1,200,000.
The entry to record the land at fair value is as follows.
Land 200,000
Unrealized Gain on Revaluation—Land 200,000

The land is reported on the statement of financial position at €1,200,000, and the Unre-
alized Gain on Revaluation—Land increases other comprehensive income in the state-
ment of comprehensive income. In addition, if this is the only revaluation adjustment
to date, the statement of financial position reports accumulated other comprehensive
income of €200,000.

Revaluation—Depreciable Assets
To illustrate the accounting for revaluations of depreciable assets, assume that Lenovo
Group (CHN) purchases equipment for ¥500,000 on January 2, 2015. The equipment
has a useful life of five years, is depreciated using the straight-line method of deprecia-
tion, and its residual value is zero. Lenovo chooses to revalue its equipment to fair
value over the life of the equipment. Lenovo records depreciation expense of ¥100,000
(¥500,000 4 5) at December 31, 2015, as follows.
December 31, 2015
Depreciation Expense 100,000
Accumulated Depreciation—Equipment 100,000
(To record depreciation expense in 2015)

After this entry, Lenovo’s equipment has a carrying amount of ¥400,000 (¥500,000 2
¥100,000). Lenovo receives an independent appraisal for the fair value of equipment at
December 31, 2015, which is ¥460,000. To report the equipment at fair value, Lenovo
does the following.

1. Reduces the Accumulated Depreciation—Equipment account to zero.

2. Reduces the Equipment account by ¥40,000—it then is reported at its fair value of
¥460,000.
3. Records Unrealized Gain on Revaluation—Equipment for the difference between the
fair value and carrying amount of the equipment, or ¥60,000 (¥460,000 2 ¥400,000).
The entry to record this revaluation at December 31, 2015, is as follows.
514 Chapter 11 Depreciation, Impairments, and Depletion

December 31, 2015

Accumulated Depreciation—Equipment 100,000
Equipment 40,000
Unrealized Gain on Revaluation—Equipment 60,000
(To adjust the equipment to fair value and record revaluation increase)

The equipment is now reported at its fair value of ¥460,000 (¥500,000 2 ¥40,000).10
The increase in the fair value of ¥60,000 is reported on the statement of comprehensive
income as other comprehensive income. In addition, the ending balance is reported in
accumulated other comprehensive income on the statement of financial position in the
equity section.
Illustration 11-22 shows the presentation of revaluation elements.

ILLUSTRATION 11-22
Statement of Comprehensive Income
Financial Statement
Other comprehensive income
Presentation—
Unrealized gain on revaluation—equipment ¥ 60,000
Revaluations
Statement of Financial Position
Non-current assets
Equipment (¥500,000 2 ¥40,000) ¥460,000
Accumulated depreciation—equipment (¥100,000 2 ¥100,000) 202
Carrying amount ¥460,000
Equity
Accumulated other comprehensive income ¥ 60,000

As indicated, at December 31, 2015, the carrying amount of the equipment is now
¥460,000. Lenovo reports depreciation expense of ¥100,000 in the income statement and
an Unrealized Gain on Revaluation—Equipment of ¥60,000 in “Other comprehensive
income.” Assuming no change in the useful life of the equipment, depreciation in 2016
is ¥115,000 (¥460,000 4 4).
In summary, a revaluation increase generally goes to equity. A revaluation decrease
is reported as an expense (as an impairment loss), unless it offsets previously recorded
revaluation increases. If the revaluation increase offsets a revaluation decrease that went
to expense, then the increase is reported in income. Under no circumstances can the
Accumulated Other Comprehensive Income account related to revaluations have a
negative balance.

Revaluation Issues
The use of revaluation accounting is not an “all or nothing” proposition. That is, a com-
pany can select to value only one class of assets, say buildings, and not revalue other
assets such as land or equipment. However, if a company selects only buildings, revalu-
ation applies to all assets in that class of assets. A class of assets is a grouping of items that
have a similar nature and use in a company’s operations. For example, a company like
Siemens (DEU) may have the following classes of assets: land, equipment, and build-
ings. If Siemens chooses to fair value its land class, it must fair value all land. It cannot
selectively apply revaluation accounting to certain parcels of land within the class and
report them at fair value and keep the remainder at historical cost. To permit such

10
When a depreciable asset is revalued, companies use one of two approaches to record the
revaluation. As an alternative to the one shown here, companies restate on a proportionate basis
the cost and accumulated depreciation of the asset, such that the carrying amount of the asset
after revaluation equals its revalued amount.
 Presentation and Analysis 515

“cherry-picking” not only leads to a misleading mixture of historical cost and fair value,
but also permits a company to maximize its fair value through selective revaluation.
Companies using revaluation accounting must also make every effort to keep the
assets’ values up to date. Assets that are experiencing rapid price changes must be reval-
ued on an annual basis. Otherwise, less frequent revaluation is acceptable. The fair
value of items of property, plant, and equipment is usually determined by appraisal.
Appendix 11A illustrates the accounting for revaluations in more detail both for land
and depreciable assets.

What do the numbers mean? TO REVALUE OR NOT

Most companies do not use revaluation accounting. A major below historical cost decrease net income. In addition, for
reason is the substantial and continuing costs associated depreciable assets, the higher depreciation charges related
with appraisals to determine fair value. In addition, the to the revalued assets also reduce net income. The following
gains associated with revaluations above historical cost table indicates the widespread use of the cost method over
are not reported in net income but instead go directly to eq- the revaluation method, based on a survey of 175 interna-
uity. On the other hand, losses associated with revaluations tional companies.

2011 2010 2009

Cost 172 163 155
Revaluation
Land 1 2 3
Buildings 1 1 1
Property (land and buildings) 6 4 4
Other asset class 1 1 1
More than one asset class 1 0 0
All asset classes 3 3 1
Total companies using revaluation
for at least one asset class 13 11 10
Companies not disclosing a model 0 3 3
Companies using more than one model (10) (7) (8)

Total companies surveyed 175 170 160

Source: IFRS Accounting Trends & Techniques, 2012–2013 (AICPA, 2012).

Companies that choose revaluation accounting often increase their equity base. Increases in its equity base may
are in highly inflationary environments where the historical help a company meet covenant requirements or provide
cost numbers are badly out of date. In addition, some com- additional assurances to investors and creditors that the
panies select the revaluation approach because they wish to company is solvent.

PRESENTATION AND ANALYSIS

Presentation of Property, Plant, Equipment,
and Mineral Resources
A company should disclose the basis of valuation—usually historical cost—for
8 LEARNING OBJECTIVE
property, plant, equipment, and mineral resources along with pledges, liens,
Explain how to report and analyze
and other commitments related to these assets. It should not offset any liability
property, plant, equipment, and mineral
secured by property, plant, equipment, and mineral resources against these as- resources.
sets. Instead, this obligation should be reported in the liabilities section. The
516 Chapter 11 Depreciation, Impairments, and Depletion

company should segregate property, plant, and equipment not currently employed as
producing assets in the business (such as idle facilities or land held as an investment)
from assets used in operations.
When depreciating assets, a company credits a valuation account, normally called
Accumulated Depreciation. Using an accumulated depreciation account permits the
user of the financial statements to see the original cost of the asset and the amount of
depreciation that the company charged to expense in past years.
When depleting mineral resources, some companies use an accumulated depletion
account. Many, however, simply credit the mineral resource account directly. The ratio-
nale for this approach is that the mineral resources are physically consumed, making
direct reduction of the cost of the mineral resources appropriate.
Illustration 11-23 provides the reporting of property, plant, and equipment by
Nestlé Group (CHE) in a recent annual report. Nestlé presents condensed statement
of financial position data, supplemented with detail amounts and accounting policies
provided in the notes to the financial statements.

ILLUSTRATION 11-23
Disclosures for Property, Nestlé Group
(in millions of CHF)
Plant, and Equipment
Non-current assets
Property, plant, and equipment 26,903 23,971
Investments in associates 9,846 8,629
Deferred tax assets 2,903 2,476
Current income tax assets 27 39
Financial assets 5,003 7,161
Employee benefits assets 84 127
Goodwill 32,615 29,008
Intangible assets 13,643 9,356
Total non-current assets 91,024 80,767

Note 1 Accounting Policies

Property, plant, and equipment
Property, plant, and equipment are shown in the balance sheet at their historical cost. Depreciation
is provided on components that have homogenous useful lives by using the straight-line method
so as to depreciate the initial cost down to the residual value over the estimated useful lives. The
residual values are 30% on head offices and nil for all other asset types. The useful lives are as
follows:

Buildings 20–40 years

Machinery and equipment 10–25 years
Tools, furniture, information technology, and sundry equipment 3–10 years
Vehicles 3–8 years
Land is not depreciated.

Useful lives, components, and residual amounts are reviewed annually. Such a review takes into
consideration the nature of the assets, their intended use including but not limited to the closure of
facilities, and the evolution of the technology and competitive pressures that may lead to technical
obsolescence.
Depreciation of property, plant, and equipment is allocated to the appropriate headings of
expenses by function in the income statement.
Borrowing costs incurred during the course of construction are capitalised if the assets under
construction are significant and if their construction requires a substantial period to complete (typically
more than one year). The capitalisation rate is determined on the basis of the short-term borrowing rate
for the period of construction. Premiums capitalised for leasehold land or buildings are amortised over
the length of the lease. Government grants are recognised in accordance with the deferral method,
whereby the grant is set up as deferred income which is released to the income statement over the
useful life of the related assets. Grants that are not related to assets are credited to the income state-
ment when they are received.
 Presentation and Analysis 517

Tools,
Machinery furniture,
Land and and and other
buildings equipment equipment Vehicles Total
Gross value
At 1 January 14,109 26,472 7,728 961 49,270
Currency retranslations (156) (622) (34) (29) (841)
Capital expenditure 1,419 2,863 957 129 5,368
Disposals (169) (548) (610) (95) (1,422)
Reclassified as held for sale (17) (14) (1) — (32)
Modification of the scope of consolidation 484 342 (29) (4) 793
At 31 December 15,670 28,493 8,011 962 53,136

Accumulated depreciation and impairments

At 1 January (5,068) (14,449) (5,278) (504) (25,299)
Currency retranslations 70 259 66 11 406
Depreciation (393) (1,434) (782) (102) (2,711)
Impairments 4 (58) (21) — (75)
Disposals 120 490 552 79 1,241
Reclassified as held for sale 12 11 1 — 24
Modification of the scope of consolidation 26 105 44 6 181
At 31 December (5,229) (15,076) (5,418) (510) (26,233)

Net at 31 December 10,441 13,417 2,593 452 26,903

At 31 December, property, plant and equipment include CHF1,332 million of assets under
construction. Net property, plant and equipment held under finance leases amount to CHF154 million.
Net property, plant and equipment of CHF294 million are pledged as security for financial liabilities. Fire
risks, reasonably estimated, are insured in accordance with domestic requirements.
Impairment
Impairment of property, plant, and equipment arises mainly from the plans to optimise industrial manu-
facturing capacities by closing or selling inefficient production facilities.
Commitments for expenditure
At 31 December, the Group was committed to expenditure amounting to CHF650 million.

Analysis of Property, Plant, and Equipment

Analysts evaluate assets relative to activity (turnover) and profitability.

Asset Turnover
How efficiently a company uses its assets to generate sales is measured by the asset
turnover. This ratio divides net sales by average total assets for the period. The resulting
number is the dollars of sales produced by each dollar invested in assets. To illustrate,
we use the following data from adidas AG’s (DEU) 2012 annual report.

adidas AG
Net sales €14,883
Total assets, 12/31/12 11,651
Total assets, 12/31/11 11,237
Net income 524

Illustration 11-24 (on page 518) shows computation of the asset turnover.
518 Chapter 11 Depreciation, Impairments, and Depletion

ILLUSTRATION 11-24
Net Sales
Asset Turnover Asset Turnover 5
Average Total Assets

€14,883
5
(€11,651 1 €11,237)/2
5 1.30

The asset turnover shows that adidas generated sales of €1.30 per euro of assets in the
year ended December 31, 2012.
Asset turnovers vary considerably among industries. For example, a large utility
like Ameren (USA) has a ratio of 0.32 times. A large grocery chain like Morrisons (GBR)
has a ratio of 1.86 times. Thus, in comparing performance among companies based on
the asset turnover, you need to consider the ratio within the context of the industry in
which a company operates.

Profit Margin on Sales

Another measure for analyzing the use of property, plant, and equipment is the profit
margin on sales (return on sales). Calculated as net income divided by net sales, this
profitability ratio does not, by itself, answer the question of how profitably a company
uses its assets. But by relating the profit margin on sales to the asset turnover during a
period of time, we can ascertain how profitably the company used assets during that
period of time in a measure of the return on assets. Using the adidas data shown on
page 517, we compute the profit margin on sales and the return on assets as follows.

ILLUSTRATION 11-25
Net Income
Profit Margin on Sales Profit Margin on Sales 5
Net Sales

€524
5
€14,883
5 3.5%

Return on Assets 5 Profit Margin on Sales 3 Asset Turnover

5 3.5% 3 1.30
5 4.6%

Return on Assets
The rate of return a company achieves through use of its assets is the return on assets
(ROA). Rather than using the profit margin on sales, we can compute it directly by di-
viding net income by average total assets. Using adidas’ data, we compute the ratio as
follows.

ILLUSTRATION 11-26
Net Income
Return on Assets Return on Assets 5
Average Total Assets

€524
5
(€11,651 1 €11,237)/2
5 4.6%
 Global Accounting Insights 519

The 4.6 percent rate of return computed in this manner equals the 4.6 percent rate
computed by multiplying the profit margin on sales by the asset turnover. The return on
assets measures profitability well because it combines the effects of profit margin and
asset turnover.

GLOBAL ACCOUNTING INSIGHTS

PROPERTY, PLANT, AND EQUIPMENT
U.S. GAAP adheres to many of the same principles as IFRS differences relate to use of component depreciation, impair-
in the accounting for property, plant, and equipment. Major ments, and revaluations.

Relevant Facts
Following are the key similarities and differences be- • U.S. GAAP and IFRS both view depreciation as allocation
tween U.S. GAAP and IFRS related to property, plant, and of cost over an asset’s life. U.S. GAAP and IFRS permit the
equipment. same depreciation methods (straight-line, diminishing-
balance, units-of-production).
Similarities
• The definition of property, plant, and equipment is essen- Differences
tially the same under U.S. GAAP and IFRS. • Under U.S. GAAP, component depreciation is permitted
• Under both U.S. GAAP and IFRS, changes in depreciation but is rarely used. IFRS requires component depreciation.
method and changes in useful life are treated in the current • U.S. GAAP does not permit revaluations of property, plant,
and future periods. Prior periods are not affected. equipment, and mineral resources. Under IFRS, companies
• The accounting for plant asset disposals is the same under can use either the historical cost model or the revaluation
U.S. GAAP and IFRS. model.
• The accounting for the initial costs to acquire natural re- • In testing for impairments of long-lived assets, U.S. GAAP
sources is similar under U.S. GAAP and IFRS. uses a different model than IFRS (details of the U.S. GAAP
• Under both U.S. GAAP and IFRS, interest costs incurred impairment test is presented in the About the Numbers
during construction must be capitalized. Recently, IFRS discussion). Under U.S. GAAP, as long as future undis-
converged to U.S. GAAP. counted cash flows exceed the carrying amount of the
asset, no impairment is recorded. The IFRS impairment test
• The accounting for exchanges of non-monetary assets is
is stricter. However, unlike U.S. GAAP, reversals of impair-
essentially the same between U.S. GAAP and IFRS. U.S.
ment losses are permitted under IFRS.
GAAP requires that gains on exchanges of non-monetary
assets be recognized if the exchange has commercial sub-
stance. This is the same framework used in IFRS.

About the Numbers

As indicated, impairment testing under U.S. GAAP is a two- to determine if an impairment test should be performed.
step process. The graphic on page 520 summarizes impair- Also, U.S. GAAP does not permit reversal of impairment
ment measurement under U.S. GAAP. The key distinctions losses for assets held for use.
relative to IFRS relate to the use of a cash flow recovery test
520 Chapter 11 Depreciation, Impairments, and Depletion

Measurement of
Recoverability Test
Impairment Loss
Expected future undiscounted
Yes
net cash flows less Impairment
than carrying amount?

No

Assets held Assets held

for use for disposal
No impairment

1. Impairment loss: excess 1. Impairment loss: excess of

of carrying amount over carrying amount over fair
fair value. value less cost of disposal.

2. Depreciate on new 2. No depreciation taken.

cost basis.

3. Reversal of impairment 3. Reversal of impairment

loss not permitted. loss permitted.

On the Horizon
With respect to revaluations, as part of the conceptual frame- measurement (and revaluation accounting) for property,
work project, the Boards will examine the measurement plant, and equipment. However, this is likely to be one of
bases used in accounting. It is too early to say whether a the more contentious issues, given the long-standing use of
converged conceptual framework will recommend fair value historical cost as a measurement basis in U.S. GAAP.

KEY TERMS
SUMMARY OF LEARNING OBJECTIVES
accelerated depreciation
methods, 497
activity method, 496 1 Explain the concept of depreciation. Depreciation allocates the cost of tan-
amortization, 494 gible assets to expense in a systematic and rational manner to those periods expected to
asset turnover, 517 benefit from the use of the asset.
cash-generating unit
(CGU), 507 2 Identify the factors involved in the depreciation process. Three factors
component depreciation, involved in the depreciation process are (1) determining the depreciation base for the
499 asset, (2) estimating service lives, and (3) selecting a method of cost apportionment
cost depletion, 510 (depreciation).
declining (reducing)-
balance method, 498 3 Compare activity, straight-line, and diminishing-charge methods of
depletion, 494, 508 depreciation. (1) Activity method: Assumes that depreciation is a function of use or
productivity instead of the passage of time. The life of the asset is considered in terms of
 Summary of Learning Objectives 521

either the output it provides, or an input measure such as the number of hours it works. depreciation, 494
(2) Straight-line method: Considers depreciation a function of time instead of a function depreciation base, 494
of usage. The straight-line procedure is often the most conceptually appropriate when development costs, 510
the decline in usefulness is constant from period to period. (3) Diminishing-charge diminishing (accelerated)-
methods: Provides for a higher depreciation cost in the earlier years and lower charges charge methods, 497
in later periods. The main justification for this approach is that the asset is the most double-declining-balance
productive in its early years. method, 498
exploratory and
4 Explain component depreciation. IFRS requires that each part of an item of evaluation (E&E) costs,
property, plant, and equipment that is significant to the total cost of the asset must be 509
depreciated separately. fair value less costs
to sell, 504
5 Explain the accounting issues related to asset impairment. The process full-cost concept, 509
to determine an impairment loss is as follows. (1) Review events and changes in circum- impairment, 503
stances for indicators of impairment. (2) If impairment indicators are present, an impair- impairment test, 504
ment test must be conducted. The impairment test compares the asset’s recoverable inadequacy, 495
amount (the higher of fair value less costs to sell and value-in-use) with its carrying liquidating dividends, 511
amount. If the carrying amount is higher than the recoverable amount, the difference is mineral resources, 508
an impairment loss. If the recoverable amount is greater than the carrying amount, no natural resources, 508
impairment is recorded. obsolescence, 495
After a company records an impairment loss, the reduced carrying amount of the pre-exploratory
long-lived asset is its new cost basis. Impairment losses may be reversed as long as expenditures, 509
the write-up is never to an amount greater than the carrying amount before impair- profit margin on
ment. If the company expects to dispose of the asset, it should report the impaired sales, 518
asset at the lower-of-cost-or-net realizable value. Assets held for disposal are not recoverable amount, 504
depreciated. residual (salvage)
value, 494
6 Explain the accounting procedures for depletion of mineral resources. restoration costs, 510
To account for depletion of mineral resources, companies (1) establish the depletion return on assets (ROA),
base and (2) write off resource cost. Three types of costs are considered in establishing 518
the depletion base: (a) pre-exploratory costs, (b) exploration and evaluation costs, and revaluation surplus, 513
(c) development costs. To write off resource cost, companies normally compute deple- straight-line method, 497
tion on the units-of-production method. Thus, depletion is a function of the number of successful-efforts
units withdrawn during the period. To obtain a cost per unit of product, the total cost of concept, 509
the mineral resource less residual value is divided by the number of units estimated to sum-of-the-years’-digits
be in the resource deposit. To compute depletion, this cost per unit is multiplied by the method, 498
number of units withdrawn. supersession, 495
value-in-use, 504
7 Explain the accounting for revaluations. Under IFRS, companies may
choose to value long-lived assets at cost or at fair value. When companies choose to fair
value their long-lived tangible assets subsequent to acquisition, they account for the
change in the fair value by adjusting the appropriate asset account and recording an
unrealized gain on the revalued long-lived tangible asset, which is recorded in other
comprehensive income.

8 Explain how to report and analyze property, plant, equipment, and

mineral resources. The basis of valuation for property, plant, and equipment and for
mineral resources should be disclosed along with pledges, liens, and other commit-
ments related to these assets. Companies should not offset any liability secured by prop-
erty, plant, and equipment or by mineral resources against these assets, but should
report it in the liabilities section. When depreciating assets, credit a valuation account
normally called Accumulated Depreciation. When depleting assets, use an accumulated
depletion account, or credit the depletion directly to the mineral resource account. Anal-
ysis may be performed to evaluate the asset turnover, profit margin on sales, and return
on assets.
522 Chapter 11 Depreciation, Impairments, and Depletion

APPENDIX 11A REVALUATION OF PROPERTY, PLANT, AND EQUIPMENT

As indicated in Chapter 11, companies can use revaluation accounting subse-

LEARNING OBJECTIVE 9 quent to acquisition. When companies choose to fair value their long-lived tan-
Explain revaluation accounting
gible assets subsequent to acquisition, they account for the change in the fair
procedures.
value by adjusting the appropriate asset account and recording an unrealized
gain on the revalued long-lived tangible asset. This unrealized gain is often
referred to as revaluation surplus.
The general rules for revaluation accounting are as follows.

1. When a company revalues its long-lived tangible assets above historical cost, it
reports an unrealized gain that increases other comprehensive income. Thus, the
unrealized gain bypasses net income, increases other comprehensive income, and
increases accumulated other comprehensive income.
2. If a company experiences a loss on impairment (decrease of value below historical
cost), the loss reduces income and retained earnings. Thus, gains on revaluation
increase equity but not net income, whereas losses decrease income and retained
earnings (and therefore equity).
3. If a revaluation increase reverses a decrease that was previously reported as an
impairment loss, a company credits the revaluation increase to income using the
account Recovery of Impairment Loss up to the amount of the prior loss. Any
additional valuation increase above historical cost increases other comprehensive
income and is credited to Unrealized Gain on Revaluation.
4. If a revaluation decrease reverses an increase that was reported as an unrealized
gain, a company first reduces other comprehensive income by eliminating the unre-
alized gain. Any additional valuation decrease reduces net income and is reported
as a loss on impairment.

In the following two sections, we explain revaluation procedures for land and de-
preciable assets in a multiple-year setting.

REVALUATION OF LAND
Revaluation—2015: Valuation Increase
To illustrate the accounting for a revaluation, assume that Unilever Group (GBR and
NLD) purchased land on January 1, 2015, that cost €400,000. Unilever decides to report
the land at fair value in subsequent periods. At December 31, 2015, an appraisal of the
land indicates that its fair value is €520,000. Unilever makes the following entry to
record the increase in fair value.
December 31, 2015
Land 120,000
Unrealized Gain on Revaluation—Land (€520,000 2 €400,000) 120,000
(To recognize increase in land value)

Illustration 11A-1 provides a summary of the revaluation adjustments for Unilever in 2015.

ILLUSTRATION 11A-1
Accumulated
Summary of Retained Other Comprehensive
Revaluation—2015 Date Item Land Fair Value Earnings Income (AOCI)
Jan. 1, 2015 Beginning balance €400,000 €0 € 0
Dec. 31, 2015 Revaluation 120,000 0 120,000
Dec. 31, 2015 Ending balance 520,000 0 120,000
 Appendix 11A: Revaluation of Property, Plant, and Equipment 523

The land is now reported at its fair value of €520,000. The increase in the fair value of
€120,000 is reported on the statement of comprehensive income as other comprehensive
income. In addition, the ending balance in Unrealized Gain on Revaluation—Land is
reported as accumulated other comprehensive income in the statement of financial posi-
tion in the equity section.

Revaluation—2016: Decrease below Historical Cost

What happens if the land’s fair value at December 31, 2016, is €380,000, a decrease of
€140,000 (€520,000 2 €380,000)? In this case, the land’s fair value is below its historical
cost. Therefore, Unilever debits Unrealized Gain on Revaluation—Land for €120,000 to
eliminate its balance. In addition, Unilever reports a Loss on Impairment of €20,000
(€400,000 2 €380,000), reducing net income. Unilever makes the following entry to re-
cord the decrease in fair value of the land.

December 31, 2016

Unrealized Gain on Revaluation—Land 120,000
Loss on Impairment 20,000
Land (€520,000 2 €380,000) 140,000
(To record decrease in value of land below historical cost)

Illustration 11A-2 provides a summary of the revaluation adjustments for Unilever in

2016.

ILLUSTRATION 11A-2
Accumulated
Retained Other Comprehensive
Summary of
Date Item Land Fair Value Earnings Income (AOCI) Revaluation—2016
Jan. 1, 2015 Beginning balance €400,000 € 0 € 0
Dec. 31, 2015 Revaluation 120,000 0 120,000
Dec. 31, 2015 Ending balance 520,000 0 120,000

Jan. 1, 2016 Beginning balance €520,000 € 0 € 120,000

Dec. 31, 2016 Revaluation (140,000) (20,000) (120,000)
Dec. 31, 2016 Ending balance 380,000 (20,000) 0

The decrease to Unrealized Gain on Revaluation—Land of €120,000 reduces other com-

prehensive income, which then reduces the balance in accumulated other comprehensive
income. The Loss on Impairment of €20,000 reduces net income and retained earnings.
In this case, Unilever had a revaluation decrease which first reverses any increases that
Unilever reported in prior periods as an unrealized gain. Any additional amount is re-
ported as an impairment loss. Under no circumstances can the revaluation decrease
reduce accumulated other comprehensive income below zero.

Revaluation—2017: Recovery of Impairment Loss

At December 31, 2017, Unilever’s land value increases to €415,000, an increase of €35,000
(€415,000 2 €380,000). In this case, the Loss on Impairment of €20,000 is reversed and
the remaining increase of €15,000 is reported in other comprehensive income. Unilever
makes the following entry to record this transaction.

December 31, 2017

Land 35,000
Unrealized Gain on Revaluation—Land 15,000
Recovery of Impairment Loss 20,000
(Revaluation of land, recovery of impairment loss)
524 Chapter 11 Depreciation, Impairments, and Depletion

Illustration 11A-3 provides a summary of the revaluation adjustments for Unilever in

2017.

ILLUSTRATION 11A-3
Accumulated
Summary of Retained Other Comprehensive
Revaluation—2017 Date Item Land Fair Value Earnings Income (AOCI)
Jan. 1, 2015 Beginning balance € 400,000 € 0 € 0
Dec. 31, 2015 Revaluation 120,000 0 120,000
Dec. 31, 2015 Ending balance 520,000 0 120,000

Jan. 1, 2016 Beginning balance € 520,000 € 0 €120,000

Dec. 31, 2016 Revaluation (140,000) (20,000) (120,000)
Dec. 31, 2016 Ending balance 380,000 (20,000) 0

Jan. 1, 2017 Beginning balance € 380,000 €(20,000) € 0

Dec. 31, 2017 Revaluation 35,000 20,000 15,000
Dec. 31, 2017 Ending balance 415,000 0 15,000

The recovery of the impairment loss of €20,000 increases income (and retained earnings)
only to the extent that it reverses previously recorded impairment losses.
On January 2, 2018, Unilever sells the land for €415,000. Unilever makes the follow-
ing entry to record this transaction.
January 2, 2018
Cash 415,000
Land 415,000
(To record sale of land)

In this case, Unilever does not record a gain or loss because the carrying amount of the
land is the same as its fair value. At this time, since the land is sold, Unilever has the
option to transfer Accumulated Other Comprehensive Income (AOCI) to Retained
Earnings. The entry to record the transfer is as follows.
January 2, 2018
Accumulated Other Comprehensive Income 15,000
Retained Earnings 15,000
(To eliminate the remaining balance in AOCI)

The purpose of this transfer is to eliminate the unrealized gain on the land that was sold.
It should be noted that transfers from Accumulated Other Comprehensive Income can-
not increase net income. This last entry illustrates why revaluation accounting is not
popular. Even though the land has appreciated in value by €15,000, Unilever is not able
to recognize this gain in net income over the periods that it held the land.

REVALUATION OF DEPRECIABLE ASSETS

To illustrate the accounting for revaluations using depreciable assets, assume that Nokia
(FIN) purchases equipment for €1,000,000 on January 2, 2015. The equipment has a use-
ful life of five years, is depreciated using the straight-line method of depreciation, and
its residual value is zero.

Revaluation—2015: Valuation Increase

Nokia chooses to revalue its equipment to fair value over the life of equipment. Nokia
records depreciation expense of €200,000 (€1,000,000 4 5) as follows.
 Appendix 11A: Revaluation of Property, Plant, and Equipment 525

December 31, 2015

Depreciation Expense 200,000
Accumulated Depreciation—Equipment 200,000
(To record depreciation expense at December 31, 2015)

After this entry, Nokia’s equipment has a carrying amount of €800,000 (€1,000,000 2
€200,000). Nokia employs an independent appraiser, who determines that the fair value
of equipment at December 31, 2015, is €950,000. To report the equipment at fair value,
Nokia does the following.

1. Reduces the Accumulated Depreciation—Equipment account to zero.

2. Reduces the Equipment account by €50,000—it then is reported at its fair value of
€950,000.
3. Records an Unrealized Gain on Revaluation—Equipment for the difference between
the fair value and carrying amount of the equipment, or €150,000 (€950,000 2
€800,000). The entry to record this revaluation at December 31, 2015, is as follows.

December 31, 2015

Accumulated Depreciation—Equipment 200,000
Equipment 50,000
Unrealized Gain of Revaluation—Equipment 150,000
(To adjust the equipment to fair value and record unrealized gain)

Illustration 11A-4 provides a summary of the revaluation adjustments for Nokia in 2015.

ILLUSTRATION 11A-4
Accumulated
Equipment Accumulated Retained Other Comprehensive
Revaluation
Date Item Fair Value Depreciation Earnings Income (AOCI) Summary—2015
Jan. 1, 2015 Beginning balance €1,000,000 € 0
Dec. 31, 2015 Depreciation € 200,000 €(200,000)
Dec. 31, 2015 Revaluation (50,000) (200,000) 150,000
Dec. 31, 2015 Ending balance 950,000 0 (200,000) 150,000

Following these revaluation adjustments, the carrying amount of the asset is now
€950,000. Nokia reports depreciation expense of €200,000 in the income statement and
Unrealized Gain on Revaluation—Equipment of €150,000 in other comprehensive
income. This unrealized gain increases accumulated other comprehensive income
(reported on the statement of financial position in the equity section).

Revaluation—2016: Decrease below Historical Cost

Assuming no change in the useful life of the equipment, depreciation expense for Nokia
in 2016 is €237,500 (€950,000 4 4), and the entry to record depreciation expense is as
follows.
December 31, 2016
Depreciation Expense 237,500
Accumulated Depreciation—Equipment 237,500
(To record depreciation expense at December 31, 2016)

Under IFRS, Nokia may transfer from AOCI the difference between depreciation based
on the revalued carrying amount of the equipment and depreciation based on the asset’s
original cost to retained earnings. Depreciation based on the original cost was €200,000
(€1,000,000 4 5) and on fair value is €237,500, or a difference of €37,500 (€237,500 2
€200,000). The entry to record this transfer is as follows.
526 Chapter 11 Depreciation, Impairments, and Depletion

December 31, 2016

Accumulated Other Comprehensive Income 37,500
Retained Earnings 37,500
(To record transfer from AOCI to Retained Earnings)

At this point, before revaluation in 2016, Nokia has the following amounts related
to its equipment.

Equipment €950,000
Less: Accumulated depreciation—equipment 237,500
Carrying amount €712,500

Accumulated other comprehensive income €112,500 (€150,000 2 €37,500)11

Nokia determines through appraisal that the equipment now has a fair value of €570,000.
To report the equipment at fair value, Nokia does the following.

1. Reduces the Accumulated Depreciation—Equipment account of €237,500 to zero.

2. Reduces the Equipment account by €380,000 (€950,000 2 €570,000)—it then is
reported at its fair value of €570,000.
3. Reduces Unrealized Gain on Revaluation—Equipment by €112,500, to offset the
balance in the unrealized gain account (related to the revaluation in 2015).
4. Records a loss on impairment of €30,000.

The entry to record this transaction is as follows.

Accumulated Depreciation—Equipment 237,500
Loss on Impairment 30,000
Unrealized Gain on Revaluation—Equipment 112,500
Equipment 380,000
(To adjust the equipment to fair value and record
impairment loss)

Illustration 11A-5 provides a summary of the revaluation adjustments for Nokia in 2016.

ILLUSTRATION 11A-5
Accumulated Other
Revaluation Equipment Accumulated Retained Comprehensive
Summary—2016 Date Item Fair Value Depreciation Earnings Income (AOCI)
Jan. 1, 2015 Beginning balance €1,000,000 € 0
Dec. 31, 2015 Depreciation €200,000 €(200,000)
Dec. 31, 2015 Revaluation (50,000) (200,000) 150,000
Dec. 31, 2015 Ending balance 950,000 0 (200,000) 150,000

Jan. 1, 2016 Beginning balance € 950,000 € 0 €(200,000) €150,000

Dec. 31, 2016 Depreciation 237,500 (237,500)
Dec. 31, 2016 Transfer from AOCI 37,500 (37,500)
Dec. 31, 2016 Revaluation (380,000) (237,500) (30,000) (112,500)
Dec. 31, 2016 Ending balance 570,000 0 (430,000) 0

11
The entry for the transfer recognizes that any depreciation on the revalued part of the asset’s
carrying amount has been realized by being charged to retained earnings. By making this entry, it
should be noted that the historical cost carrying amount (as if no revaluations have been recorded)
can be determined by deducting the AOCI balance from the revalued carrying amount. In this
case, the historical cost carrying amount after two years is €600,000 (€1,000,000 2 €200,000 2
€200,000), which is equal to the revalued carrying amount of €712,500 less AOCI of €112,500.
 Appendix 11A: Revaluation of Property, Plant, and Equipment 527

Following the revaluation entry, the carrying amount of the equipment is now
€570,000. Nokia reports depreciation expense of €237,500 and an impairment loss of
€30,000 in the income statement (which reduces retained earnings).12 Nokia reports the
reversal of the previously recorded unrealized gain by recording the transfer to retained
earnings of €37,500 and the entry to Unrealized Gain on Revaluation—Equipment of
€112,500. These two entries reduce the balance in AOCI to zero.

Revaluation—2017: Recovery of Impairment Loss

Assuming no change in the useful life of the equipment, depreciation expense for Nokia
in 2017 is €190,000 (€570,000 4 3), and the entry to record depreciation expense is as
follows.

December 31, 2017

Depreciation Expense 190,000
Accumulated Depreciation—Equipment 190,000
(To record depreciation expense)

Nokia transfers the difference between depreciation based on the revalued carrying
amount of the equipment and depreciation based on the asset’s original cost from AOCI
to retained earnings. Depreciation based on the original cost was €200,000 (€1,000,000 4 5)
and on fair value is €190,000, or a difference of €10,000 (€200,000 2 €190,000). The entry
to record this transfer is as follows.

December 31, 2017

Retained Earnings 10,000
Accumulated Other Comprehensive Income 10,000
(To record transfer from AOCI to Retained Earnings)

At this point, before revaluation in 2017, Nokia has the following amounts related
to its equipment.

Equipment €570,000
Less: Accumulated depreciation—equipment 190,000
Carrying amount €380,000

Accumulated other comprehensive income € 10,000

Nokia determines through appraisal that the equipment now has a fair value of
€450,000. To report the equipment at fair value, Nokia does the following.

1. Reduces the Accumulated Depreciation—Equipment account of €190,000 to zero.

2. Reduces the Equipment account by €120,000 (€570,000 2 €450,000)—it then is
reported at its fair value of €450,000.
3. Records an Unrealized Gain on Revaluation—Equipment for €40,000.
4. Records a Recovery of Loss on Impairment for €30,000.

Another way to compute the loss on impairment of €30,000 is to determine the historical cost
12

carrying amount of the equipment at December 31, 2016, which is €600,000 (€1,000,000 2
€200,000 2 €200,000), and subtract the fair value of the equipment (€570,000).
528 Chapter 11 Depreciation, Impairments, and Depletion

The entry to record this transaction is as follows.

December 31, 2017
Accumulated Depreciation—Equipment 190,000
Unrealized Gain on Revaluation—Equipment 40,000
Equipment 120,000
Recovery of Loss on Impairment 30,000
(To adjust the equipment to fair value and record
mpairment recovery)

Illustration 11A-6 provides a summary of the revaluation adjustments for Nokia in 2017.

ILLUSTRATION 11A-6
Accumulated
Revaluation Equipment Accumulated Retained Other Comprehensive
Summary—2017 Date Item Fair Value Depreciation Earnings Income (AOCI)
Jan. 1, 2015 Beginning balance €1,000,000 € 0
Dec. 31, 2015 Depreciation €200,000 €(200,000)
Dec. 31, 2015 Revaluation (50,000) (200,000) 150,000
Dec. 31, 2015 Ending balance 950,000 0 (200,000) 150,000
Jan. 1, 2016 Beginning balance € 950,000 € 0 €(200,000) €150,000
Dec. 31, 2016 Depreciation 237,500 (237,500)
Dec. 31, 2016 Transfer from AOCI 37,500 (37,500)
Dec. 31, 2016 Revaluation (380,000) (237,500) (30,000) (112,500)
Dec. 31, 2016 Ending balance 570,000 0 (430,000) 0

Jan. 1, 2017 Beginning balance € 570,000 € 0 €(430,000) € 0

Dec. 31, 2017 Depreciation 190,000 (190,000)
Dec. 31, 2017 Transfer from AOCI (10,000) 10,000
Dec. 31, 2017 Revaluation (120,000) (190,000) 30,000 40,000
Dec. 31, 2017 Ending balance 450,000 0 (600,000) 50,000

Following the revaluation entry, the carrying amount of the equipment is now
€450,000. Nokia reports depreciation expense of €190,000 and an impairment loss re-
covery of €30,000 in the income statement. Nokia records €40,000 to Unrealized Gain on
Revaluation—Equipment, which increases AOCI to €50,000.
On January 2, 2018, Nokia sells the equipment for €450,000. Nokia makes the fol-
lowing entry to record this transaction.
January 2, 2018
Cash 450,000
Equipment 450,000
(To record sale of equipment)

Nokia does not record a gain or loss because the carrying amount of the equipment is
the same as its fair value. Nokia transfers the remaining balance in Accumulated Other
Comprehensive Income to Retained Earnings because the equipment has been sold. The
entry to record this transaction is as follows.
January 2, 2018
Accumulated Other Comprehensive Income 50,000
Retained Earnings 50,000
(To eliminate the remaining balance in AOCI)

The transfer from Accumulated Other Comprehensive Income does not increase net
income. Even though the equipment has appreciated in value by €50,000, the company
does not recognize this gain in net income over the periods that Nokia held the equipment.
 Questions 529

SUMMARY OF LEARNING OBJECTIVE

FOR APPENDIX 11A

9 Explain revaluation accounting procedures. The general rules for revalua-

tion accounting are as follows. (1) Companies record unrealized gains in other compre-
hensive income (the unrealized gain bypasses income). (2) Companies record losses on
impairment (decrease of value below historical cost) in net income. Thus, gains on re-
valuation increase equity but not net income, whereas losses decrease equity and net
income. (3) If a revaluation increase reverses a decrease that was reported as an impair-
ment loss, a company credits the revaluation increase in net income; any additional
valuation increase beyond the recovery is credited to other comprehensive income.

IFRS AUTHORITATIVE LITERATURE

Authoritative Literature References
[1] International Accounting Standard 16, Property, Plant and Equipment (London, U.K.: International Accounting
Standards Committee Foundation, 2003), par. BC29.
[2] International Accounting Standard 16, Property, Plant and Equipment (London, U.K.: International Accounting
Standards Committee Foundation, 2003), par. 60.
[3] International Financial Reporting Standard 36, Impairment of Assets (London, U.K.: International Accounting
Standards Committee Foundation, 2001).
[4] International Financial Reporting Standard 36, Impairment of Assets (London, U.K.: International Accounting
Standards Committee Foundation, 2001), par. 19.
[5] International Financial Reporting Standard 36, Impairment of Assets (London, U.K.: International Accounting
Standards Committee Foundation, 2001), par. 33.
[6] International Financial Reporting Standard 36, Impairment of Assets (London, U.K.: International Accounting
Standards Committee Foundation, 2001), par. 55.
[7] International Financial Reporting Standard 6, Exploration for and Evaluation of Natural Resources (London, U.K.: Inter-
national Accounting Standards Committee Foundation, 2004).
[8] International Accounting Standard 16, Property, Plant and Equipment (London, U.K.: International Accounting
Standards Committee Foundation, 2003), paras. 31–42.

Note: All asterisked Questions, Exercises, and Problems relate to material in the appendix
to the chapter.

QUESTIONS
1. Distinguish among depreciation, depletion, and amorti- 5. The plant manager of a manufacturing firm suggested in a
zation. conference of the company’s executives that accountants
2. Identify the factors that are relevant in determining the should speed up depreciation on the machinery in the fin-
annual depreciation charge, and explain whether these fac- ishing department because improvements were rapidly
tors are determined objectively or whether they are based making those machines obsolete, and a depreciation fund
on judgment. big enough to cover their replacement is needed. Discuss
the accounting concept of depreciation and the effect on a
3. Some believe that accounting depreciation measures the business concern of the depreciation recorded for plant
decline in the value of property, plant, and equipment. Do assets, paying particular attention to the issues raised by
you agree? Explain. the plant manager.
4. Explain how estimation of service lives can result in 6. For what reasons are plant assets retired? Define inade-
unrealistically high valuations of property, plant, and quacy, supersession, and obsolescence.
equipment.
530 Chapter 11 Depreciation, Impairments, and Depletion

7. What basic questions must be answered before the amount 19. It has been suggested that plant and equipment could be
of the depreciation charge can be computed? replaced more quickly if depreciation rates for income tax
8. Workman Company purchased a machine on January 2, and accounting purposes were substantially increased. As
2015, for €800,000. The machine has an estimated useful a result, business operations would receive the benefit of
life of 5 years and a residual value of €100,000. Deprecia- more modern and more efficient plant facilities. Discuss
tion was computed by the 150% declining-balance method. the merits of this proposition.
What is the amount of accumulated depreciation at the 20. List (a) the similarities and (b) the differences in the account-
end of December 31, 2016? ing treatments of depreciation and cost depletion.
9. Silverman Company purchased machinery for $162,000 on 21. Describe cost depletion.
January 1, 2015. It is estimated that the machinery will have
22. Explain the difference between exploration and develop-
a useful life of 20 years, residual value of $15,000, production
ment costs as used in the extractive industries.
of 84,000 units, and working hours of 42,000. During 2015,
the company uses the machinery for 14,300 hours, and the 23. In the extractive industries, businesses may pay dividends
machinery produces 20,000 units. Compute depreciation un- in excess of net income. What is the maximum permissible?
der the straight-line, units-of-output, working hours, sum- How can this practice be justified?
of-the-years’-digits, and double-declining-balance methods. 24. Shumway Oil uses successful-efforts accounting for its ex-
10. What are the major factors considered in determining ploration and evaluation costs but also provides full-cost
what depreciation method to use? results as well. Under full-cost, Shumway Oil would have
reported retained earnings of $42 million and net income
11. What is component depreciation?
of $4 million. Under successful-efforts, retained earnings
12. A building that was purchased December 31, 1991, for were $29 million and net income was $3 million. Explain
£2,500,000 was originally estimated to have a life of 50 years the difference between full-costing and successful-efforts
with no residual value at the end of that time. Depreciation accounting.
has been recorded through 2015. During 2016, an examina-
25. Tanaka Company has land that cost ¥15,000,000. Its fair
tion of the building by an engineering firm discloses that
value on December 31, 2015, is ¥20,000,000. Tanaka chooses
its estimated useful life is 15 years after 2015. What should
the revaluation model to report its land. Explain how the
be the amount of depreciation for 2016?
land and its related valuation should be reported.
13. Charlie Parker, president of Spinners Company, has re-
cently noted that depreciation increases cash provided by 26. Why might a company choose not to use revaluation
operations and therefore depreciation is a good source of accounting?
funds. Do you agree? Discuss. 27. Vodafone (GBR) reported net income of £3 billion, net
14. Andrea Shen purchased a computer for €8,000 on July 1, sales of £41 billion, and average total assets of £140 billion.
2015. She intends to depreciate it over 4 years using the What is Vodafone’s asset turnover? What is Vodafone’s
double-declining-balance method. Residual value is €1,000. return on assets?
Compute depreciation for 2016. 28. Briefly describe some of the similarities and differences be-
15. Walkin Inc. is considering the write-down of its long-term tween IFRS and U.S. GAAP with respect to the accounting
plant because of a lack of profitability. Explain to the man- for property, plant, and equipment.
agement of Walkin how to determine whether a write- 29. At a recent executive committee meeting, the controller for
down is permitted. Ricardo Company remarked, “With only a single key dif-
16. Last year, Wyeth Company recorded an impairment on an ference between IFRS and U.S. GAAP for property, plant,
asset held for use. Recent appraisals indicate that the asset and equipment, it should be smooth sailing for the IASB
has increased in value. Should Wyeth record this recovery and FASB to converge their standards in this area.” Pre-
in value? pare a response to the controller.
17. Toro Co. has equipment with a carrying amount of €700,000. *30. Mandive Corp., in accordance with IFRS, applies revalua-
The value-in-use of the equipment is €705,000, and its fair tion accounting to plant assets with a carrying amount of
value less cost of disposal is €590,000. The equipment is ex- $400,000, a useful life of 4 years, and no residual value. At
pected to be used in operations in the future. What amount (if the end of year 1, independent appraisers determine that
any) should Toro report as an impairment to its equipment? the asset has a fair value of $360,000. Prepare the entries
to record this revaluation and depreciation, assuming
18. Explain how gains or losses on impaired assets should be
straight-line depreciation.
reported in income.

BRIEF EXERCISES
3 BE11-1 Fernandez Corporation purchased a truck at the beginning of 2015 for $50,000. The truck is esti-
mated to have a residual value of $2,000 and a useful life of 160,000 miles. It was driven 23,000 miles in 2015
and 31,000 miles in 2016. Compute depreciation expense for 2015 and 2016.
 Brief Exercises 531

2 3 BE11-2 Lockard Company purchased machinery on January 1, 2015, for €80,000. The machinery is esti-
mated to have a residual value of €8,000 after a useful life of 8 years. (a) Compute 2015 depreciation
expense using the straight-line method. (b) Compute 2015 depreciation expense using the straight-line
method, assuming the machinery was purchased on September 1, 2015.
2 3 BE11-3 Use the information for Lockard Company given in BE11-2. (a) Compute 2015 depreciation expense
using the sum-of-the-years’-digits method. (b) Compute 2015 depreciation expense using the sum-of-the-
years’-digits method, assuming the machinery was purchased on April 1, 2015.
2 3 BE11-4 Use the information for Lockard Company given in BE11-2. (a) Compute 2015 depreciation expense
using the double-declining-balance method. (b) Compute 2015 depreciation expense using the double-
declining-balance method, assuming the machinery was purchased on October 1, 2015.
2 BE11-5 Cominsky Company purchased a machine on July 1, 2016, for $28,000. Cominsky paid $200 in
title fees and county property tax of $125 on the machine. In addition, Cominsky paid $500 shipping
charges for delivery, and $475 was paid to a local contractor to build and wire a platform for the
machine on the plant floor. The machine has an estimated useful life of 6 years with a residual value of
$3,000. Determine the depreciation base of Cominsky’s new machine. Cominsky uses straight-line
depreciation.
4 BE11-6 Ortiz purchased a piece of equipment that cost R$202,000 on January 1, 2015. The equipment has
the following components.

Component Cost Residual Value Estimated Useful Life

A R$70,000 R$7,000 10 years
B 50,000 5,000 5 years
C 82,000 4,000 12 years

Compute the depreciation expense for this equipment at December 31, 2015.

2 3 BE11-7 Holt Company purchased a computer for £8,000 on January 1, 2014. Straight-line depreciation
is used, based on a 5-year life and a £1,000 residual value. In 2016, the estimates are revised. Holt now
feels the computer will be used until December 31, 2017, when it can be sold for £500. Compute the 2016
depreciation.
4 BE11-8 Tan Chin Company purchases a building for HK$11,300,000 on January 2, 2015. An engineer’s
report shows that of the total purchase price, HK$11,000,000 should be allocated to the building (with a
40-year life, no residual value), HK$150,000 to 15-year property, and HK$150,000 to 5-year property. Com-
pute depreciation expense for 2015 using component depreciation.
5 BE11-9 Jurassic Company owns machinery that cost $900,000 and has accumulated depreciation of
$380,000. The present value of expected future net cash flows from the use of the asset are expected to be
$500,000. The fair value less cost of disposal of the equipment is $400,000. Prepare the journal entry, if any,
to record the impairment loss.
6 BE11-10 Everly Corporation acquires a coal mine at a cost of $400,000. Intangible development
costs total $100,000. After extraction has occurred, Everly must restore the property (estimated
fair value of the obligation is $80,000), after which it can be sold for $160,000. Everly estimates that
4,000 tons of coal can be extracted. If 700 tons are extracted the first year, prepare the journal entry to
record depletion.
7 9 *BE11-11 Obihiro Group has equipment with an original cost of ¥500,000,000 and related accumulated de-
preciation of ¥100,000,000 on December 31, 2015. The fair value of the equipment at December 31, 2015, is
¥650,000,000. The equipment has a useful life of 4 years remaining after December 31, 2015, with no residual
value. Obihiro uses the straight-line method of depreciation. Prepare the entry to (a) record the revaluation
of the equipment on December 31, 2015, and (b) record depreciation on the equipment at December 31,
2016.
8 BE11-12 In its annual report, Campbell Soup Company (USA) reports beginning-of-the-year
total assets of $7,745 million, end-of-the-year total assets of $6,445 million, total sales of $7,867 million,
and net income of $854 million. Compute Campbell’s (a) asset turnover and (b) profit margin on
sales. (c) Compute Campbell’s return on assets using (1) asset turnover and profit margin and (2) net
income.
532 Chapter 11 Depreciation, Impairments, and Depletion

EXERCISES
2 3 E11-1 (Depreciation Computations—SL, SYD, DDB) Lansbury Company purchases equipment on
January 1, Year 1, at a cost of £518,000. The asset is expected to have a service life of 12 years and a residual
value of £50,000.

Instructions
(a) Compute the amount of depreciation for each of years 1 through 3 using the straight-line depre-
ciation method.
(b) Compute the amount of depreciation for each of years 1 through 3 using the sum-of-the-years’-
digits method.
(c) Compute the amount of depreciation for each of years 1 through 3 using the double-declining-
balance method. (In performing your calculations, round constant percentage to the nearest one-
hundredth of a point and round answers to the nearest pound.)

2 3 E11-2 (Depreciation—Conceptual Understanding) Hasselback Company acquired a plant asset at the

beginning of year 1. The asset has an estimated service life of 5 years. An employee has prepared deprecia-
tion schedules for this asset using three different methods to compare the results of using one method with
the results of using other methods. You are to assume that the following schedules have been correctly
prepared for this asset using (1) the straight-line method, (2) the sum-of-the-years’-digits method, and
(3) the double-declining-balance method.
Sum-of-the- Double-Declining-
Year Straight-Line Years’-Digits Balance
1 $ 9,000 $15,000 $20,000
2 9,000 12,000 12,000
3 9,000 9,000 7,200
4 9,000 6,000 4,320
5 9,000 3,000 1,480
Total $45,000 $45,000 $45,000

Instructions
Answer the following questions.
(a) What is the cost of the asset being depreciated?
(b) What amount, if any, was used in the depreciation calculations for the residual value for this asset?
(c) Which method will produce the highest charge to income in year 1?
(d) Which method will produce the highest charge to income in year 4?
(e) Which method will produce the highest book value for the asset at the end of year 3?
(f) If the asset is sold at the end of year 3, which method would yield the highest gain (or lowest loss)
on disposal of the asset?

2 3 E11-3 (Depreciation Computations—SYD, DDB—Partial Periods) Cosby Company purchased a new

plant asset on April 1, 2015, at a cost of €774,000. It was estimated to have a service life of 20 years and a
residual value of €60,000. Cosby’s accounting period is the calendar year.

Instructions
(a) Compute the depreciation for this asset for 2015 and 2016 using the sum-of-the-years’-digits
method.
(b) Compute the depreciation for this asset for 2015 and 2016 using the double-declining-balance
method.

2 3 E11-4 (Depreciation Computations—Five Methods) Wenner Furnace Corp. purchased machinery for
$279,000 on May 1, 2015. It is estimated that it will have a useful life of 10 years, residual value of $15,000,
production of 240,000 units, and working hours of 25,000. During 2016, Wenner Corp. uses the machinery
for 2,650 hours, and the machinery produces 25,500 units.

Instructions
From the information given, compute the depreciation charge for 2016 under each of the following methods.
(Round to the nearest dollar.)
(a) Straight-line. (d) Sum-of-the-years’-digits.
(b) Units-of-output. (e) Double-declining-balance.
(c) Working hours.
 Exercises 533

2 3 E11-5 (Depreciation Computations—Four Methods) Maserati Corporation purchased a new machine for
its assembly process on August 1, 2015. The cost of this machine was €150,000. The company estimated that
the machine would have a residual value of €24,000 at the end of its service life. Its life is estimated at
5 years, and its working hours are estimated at 21,000 hours. Year-end is December 31.
Instructions
Compute the depreciation expense under the following methods. Each of the following should be con-
sidered unrelated.
(a) Straight-line depreciation for 2015.
(b) Activity method for 2015, assuming that machine usage was 800 hours.
(c) Sum-of-the-years’-digits for 2016.
(d) Double-declining-balance for 2016.
2 3 E11-6 (Depreciation Computations—Five Methods, Partial Periods) Agazzi Company purchased equip-
ment for $304,000 on October 1, 2015. It is estimated that the equipment will have a useful life of 8 years
and a residual value of $16,000. Estimated production is 40,000 units, and estimated working hours are
20,000. During 2015, Agazzi uses the equipment for 525 hours, and the equipment produces 1,000 units.
Instructions
Compute depreciation expense under each of the following methods. Agazzi is on a calendar-year basis
ending December 31.
(a) Straight-line method for 2015.
(b) Activity method (units of output) for 2015.
(c) Activity method (working hours) for 2015.
(d) Sum-of-the-years’-digits method for 2017.
(e) Double-declining-balance method for 2016.
2 3 E11-7 (Different Methods of Depreciation) Jeeter Industries presents you with the following information.
Accumulated
Date Residual Life in Depreciation Depreciation to Depreciation
Description Purchased Cost Value Years Method 12/31/15 for 2016
Machine A 2/12/14 $159,000 $16,000 10 (a) $37,700 (b)
Machine B 8/15/13 (c) 21,000 5 SL 29,000 (d)
Machine C 7/21/12 88,000 28,500 8 DDB (e) (f)
Machine D 10/12/(g) 219,000 69,000 5 SYD 70,000 (h)

Instructions
Complete the table for the year ended December 31, 2016. The company depreciates all assets using the
half-year convention.
2 3 E11-8 (Depreciation Computation—Replacement, Non-Monetary Exchange) Goldman Corporation
bought a machine on June 1, 2013, for €31,800, f.o.b. the place of manufacture. Freight to the point where
it was set up was €200, and €500 was expended to install it. The machine’s useful life was estimated at
10 years, with a residual value of €2,500. On June 1, 2014, an essential part of the machine is replaced, at a
cost of €2,700, with one designed to reduce the cost of operating the machine. The book value of the old
part is estimated to be €900.
On June 1, 2017, the company buys a new machine of greater capacity for €35,000, delivered, trading
in the old machine which has a fair value and trade-in allowance of €20,000. To prepare the old machine for
removal from the plant cost €75, and expenditures to install the new one were €1,500. It is estimated that
the new machine has a useful life of 10 years, with a residual value of €4,000 at the end of that time. The
exchange has commercial substance.
Instructions
Assuming that depreciation is to be computed on the straight-line basis, compute the annual depreciation
on the new equipment that should be provided for the fiscal year beginning June 1, 2017.
2 3 E11-9 (Component Depreciation) Morrow Manufacturing has equipment that is comprised of five com-
4 ponents (amounts in thousands).
Component Cost Estimated Residual Estimated Life (in years)
A ¥40,500 ¥5,500 10
B 33,600 4,800 9
C 36,000 3,600 8
D 19,000 1,500 7
E 23,500 2,500 6
534 Chapter 11 Depreciation, Impairments, and Depletion

Instructions
(a) Prepare the adjusting entry necessary at the end of the year to record depreciation for the year.
Assume that Morrow uses straight-line depreciation.
(b) Prepare the entry to record the replacement of component B for cash of ¥40,000. It was used for
6 years.
2 3 E11-10 (Depreciation Computations, SYD) Pippen Company purchased a piece of equipment at the
beginning of 2012. The equipment cost 502,000. It has an estimated service life of 8 years and an expected
residual value of 70,000. The sum-of-the-years’-digits method of depreciation is being used. Someone has
already correctly prepared a depreciation schedule for this asset. This schedule shows that 60,000 will be
depreciated for a particular calendar year.

Instructions
Show calculations to determine for what particular year the depreciation amount for this asset will be
60,000.
2 3 E11-11 (Depreciation—Change in Estimate) Machinery purchased for $52,000 by Carver Co. in 2011 was
originally estimated to have a life of 8 years with a residual value of $4,000 at the end of that time. Depre-
ciation has been entered for 5 years on this basis. In 2016, it is determined that the total estimated life
should be 10 years with a residual value of $4,500 at the end of that time. Assume straight-line depreciation.

Instructions
(a) Prepare the entry to correct the prior years’ depreciation, if necessary.
(b) Prepare the entry to record depreciation for 2016.
2 3 E11-12 (Depreciation Computation—Addition, Change in Estimate) In 1988, Abraham Company com-
pleted the construction of a building at a cost of €1,900,000 and first occupied it in January 1989. It was esti-
mated that the building will have a useful life of 40 years and a residual value of €60,000 at the end of that time.
Early in 1999, an addition to the building was constructed at a cost of €470,000. At that time it was
estimated that the remaining life of the building would be, as originally estimated, an additional 30 years,
and that the addition would have a life of 30 years and a residual value of €20,000.
In 2017, it is determined that the probable life of the building and addition will extend to the end of
2048, or 20 years beyond the original estimate.

Instructions
(a) Using the straight-line method, compute the annual depreciation that would have been charged
from 1989 through 1998.
(b) Compute the annual depreciation that would have been charged from 1999 through 2016.
(c) Prepare the entry, if necessary, to adjust the account balances because of the revision of the esti-
mated life in 2017.
(d) Compute the annual depreciation to be charged beginning with 2017.
2 3 E11-13 (Depreciation—Replacement, Change in Estimate) Peloton Company constructed a building at a
cost of $2,400,000 and occupied it beginning in January 1996. It was estimated at that time that its life would
be 40 years, with no residual value.
In January 2016, a new roof was installed at a cost of $300,000, and it was estimated then that the build-
ing would have a useful life of 25 years from that date. The cost of the old roof was $180,000.

Instructions
(a) What amount of depreciation should have been charged annually from the years 1996 to 2015?
(Assume straight-line depreciation.)
(b) What entry should be made in 2016 to record the replacement of the roof?
(c) Prepare the entry in January 2016 to record the revision in the estimated life of the building, if
necessary.
(d) What amount of depreciation should be charged for the year 2016?
2 3 E11-14 (Error Analysis and Depreciation, SL and SYD) Kawasaki Company shows the following entries
in its Equipment account for 2016. All amounts (in yen, in thousands) are based on historical cost.
Equipment
2016 2016
Jan. 1 Balance 133,000 June 30 Cost of equipment sold
Aug. 10 Purchases 32,000 (purchased prior
12 Freight on equipment to 2016) 23,000
purchased 700
25 Installation costs 2,500
Nov. 10 Repairs 500
 Exercises 535

Instructions
(a) Prepare any correcting entries necessary.
(b) Assuming that depreciation is to be charged for a full year on the ending balance in the asset ac-
count, compute the proper depreciation charge for 2016 under each of the methods listed below.
Assume an estimated life of 10 years, with no residual value. The machinery included in the
January 1, 2016, balance was purchased in 2014.
(1) Straight-line.
(2) Sum-of-the-years’-digits.
2 3 E11-15 (Depreciation for Fractional Periods) On March 10, 2017, No Doubt Company sells equipment
that it purchased for $240,000 on August 20, 2010. It was originally estimated that the equipment would
have a life of 12 years and a residual value of $21,000 at the end of that time, and depreciation has been
computed on that basis. The company uses the straight-line method of depreciation.
Instructions
(a) Compute the depreciation charge on this equipment for 2010, for 2017, and the total charge for the
period from 2011 to 2016, inclusive, under each of the six following assumptions with respect to
partial periods.
(1) Depreciation is computed for the exact period of time during which the asset is owned.
(Use 365 days for the base.)
(2) Depreciation is computed for the full year on the January 1 balance in the asset account.
(3) Depreciation is computed for the full year on the December 31 balance in the asset account.
(4) Depreciation for one-half year is charged on plant assets acquired or disposed of during the year.
(5) Depreciation is computed on additions from the beginning of the month following acquisition
and on disposals to the beginning of the month following disposal.
(6) Depreciation is computed for a full period on all assets in use for over one-half year, and no
depreciation is charged on assets in use for less than one-half year.
(b) Briefly evaluate the methods above, considering them from the point of view of basic accounting
theory as well as simplicity of application.
4 E11-16 (Component Depreciation) Brazil Group purchases a tractor at a cost of €50,000 on January 2,
2015. Individual components of the tractor and useful lives are as follows (zero residual value).
Cost Useful Lives
Tires € 6,000 2 years
Transmission 10,000 5 years
Tractor 34,000 10 years
Instructions
(a) Compute depreciation expense for 2015, assuming Brazil depreciates the tractor as a single unit.
(b) Compute depreciation expense for 2015, assuming Brazil uses component depreciation.
(c) Why might a company want to use component depreciation to depreciate its assets?
4 E11-17 (Component Depreciation) Presented below are the components related to an office block that
Veenman Company is considering purchasing for €10,000,000.
Component Useful Life Value
Land Indefinite life €3,000,000
Building structure 60-year life 4,200,000
Building engineering 30-year life 2,100,000
Building external works 30-year life 700,000
Instructions
(a) Compute depreciation expense for 2015, assuming that Veenman uses component depreciation
(zero residual value).
(b) Assume that the building engineering was replaced in 20 years at a cost of €2,300,000. Prepare the
entry to record the replacement of the old component with the new component.
5 E11-18 (Impairment) Presented below is information related to equipment owned by Pujols Company at
December 31, 2015.
Cost €9,000,000
Accumulated depreciation to date 1,000,000
Value-in-use 7,000,000
Fair value less cost of disposal 4,400,000
Assume that Pujols will continue to use this asset in the future. As of December 31, 2015, the equipment has
a remaining useful life of 4 years.
536 Chapter 11 Depreciation, Impairments, and Depletion

Instructions
(a) Prepare the journal entry (if any) to record the impairment of the asset at December 31, 2015.
(b) Prepare the journal entry to record depreciation expense for 2016.
(c) The recoverable amount of the equipment at December 31, 2016, is €6,000,000. Prepare the journal
entry (if any) necessary to record this increase.

5 E11-19 (Impairment) Assume the same information as E11-18, except that Pujols intends to dispose of the
equipment in the coming year.

Instructions
(a) Prepare the journal entry (if any) to record the impairment of the asset at December 31, 2015.
(b) Prepare the journal entry (if any) to record depreciation expense for 2016.
(c) The asset was not sold by December 31, 2016. The fair value of the equipment on that date is
€5,100,000. Prepare the journal entry (if any) necessary to record this increase. It is expected that
the cost of disposal is €20,000.

5 E11-20 (Impairment) The management of Sprague Inc. was discussing whether certain equipment should
be written off as a charge to current operations because of obsolescence. This equipment has a cost of
$900,000 with depreciation to date of $400,000 as of December 31, 2015. On December 31, 2015, manage-
ment projected the present value of future net cash flows from this equipment to be $300,000 and its fair
value less cost of disposal to be $280,000. The company intends to use this equipment in the future. The
remaining useful life of the equipment is 4 years.

Instructions
(a) Prepare the journal entry (if any) to record the impairment at December 31, 2015.
(b) Where should the gain or loss (if any) on the write-down be reported in the income statement?
(c) At December 31, 2016, the equipment’s recoverable amount is $270,000. Prepare the journal entry
(if any).
(d) What accounting issues did management face in accounting for this impairment?

6 E11-21 (Depletion Computations—Oil) Federer Drilling Company has leased property on which oil has
been discovered. Wells on this property produced 18,000 barrels of oil during the past year that sold at an
average sales price of €65 per barrel. Total oil resources of this property are estimated to be 250,000 barrels.
The lease provided for an outright payment of €600,000 to the lessor (owner) before drilling could be
commenced and an annual rental of €31,500. A premium of 5% of the sales price of every barrel of oil
removed is to be paid annually to the lessor. In addition, Federer (lessee) is to clean up all the waste and
debris from drilling and to bear the costs of reconditioning the land for farming when the wells are aban-
doned. The estimated fair value, at the time of the lease, of this clean-up and reconditioning is €30,000.

Instructions
From the provisions of the lease agreement, compute the cost per barrel for the past year, exclusive of
operating costs, to Federer Drilling Company.

6 E11-22 (Depletion Computations—Mining) Henrik Mining Company purchased land on February 1,

2015, at a cost of €1,250,000. It estimated that a total of 60,000 tons of mineral was available for mining.
After it has removed all the mineral resources, the company will be required to restore the property to its
previous state because of strict environmental protection laws. It estimates the fair value of this restoration
obligation at €90,000. It believes it will be able to sell the property afterwards for €100,000. It incurred
developmental costs of €200,000 before it was able to do any mining. In 2015, resources removed totaled
30,000 tons. The company sold 24,000 tons.

Instructions
Compute the following information for 2015.
(a) Per unit mineral cost.
(b) Total material cost of December 31, 2015, inventory.
(c) Total materials cost in cost of goods sold at December 31, 2015.

6 E11-23 (Depletion Computations—Minerals) At the beginning of 2015, Callaway Company acquired a

mine for $850,000. Of this amount, $100,000 was ascribed to the land value and the remaining portion to
the minerals in the mine. Surveys conducted by geologists have indicated that approximately 12,000,000
units of the ore appear to be in the mine. Callaway incurred $170,000 of development costs associated with
this mine prior to any extraction of minerals. It also determined that the fair value of its obligation to pre-
pare the land for an alternative use when all of the mineral has been removed was $40,000. During 2015,
2,500,000 units of ore were extracted and 2,200,000 of these units were sold.
 Exercises 537

Instructions
Compute the following.
(a) The total amount of depletion for 2015.
(b) The amount that is charged as an expense for 2015 for the cost of the minerals sold during 2015.

7 E11-24 (Revaluation Accounting) Croatia Company purchased land in 2015 for $300,000. The land’s fair
value at the end of 2015 is $320,000; at the end of 2016, $280,000; and at the end of 2017, $305,000. Assume
that Croatia chooses to use revaluation accounting to account for its land.

Instructions
Prepare the journal entries to record the land using revaluation accounting for 2015–2017.

7 E11-25 (Revaluation Accounting) Pengo Company owns land that it purchased at a cost of ¥400 million
in 2013. The company chooses to use revaluation accounting to account for the land. The land’s value fluc-
tuates as follows (all amounts in thousands as of December 31): 2013, ¥450,000; 2014, ¥360,000; 2015,
¥385,000; 2016, ¥410,000; and 2017, ¥460,000.

Instructions
Complete the following table below.
Value at Accumulated Other Other Comprehensive Recognized in
December 31 Comprehensive Income Income Net Income
2013
2014
2015
2016
2017

7 E11-26 (Revaluation Accounting) Use the information in E11-25.

Instructions
Prepare the journal entries to record the revaluation of the land in each year.

7 E11-27 (Revaluation Accounting) Falcetto Company acquired equipment on January 1, 2014, for €12,000.
Falcetto elects to value this class of equipment using revaluation accounting. This equipment is being
depreciated on a straight-line basis over its 6-year useful life. There is no residual value at the end of the
6-year period. The appraised value of the equipment approximates the carrying amount at December 31,
2014 and 2016. On December 31, 2015, the fair value of the equipment is determined to be €7,000.

Instructions
(a) Prepare the journal entries for 2014 related to the equipment.
(b) Prepare the journal entries for 2015 related to the equipment.
(c) Determine the amount of depreciation expense that Falcetto will record on the equipment in 2016.

8 E11-28 (Ratio Analysis) A recent annual report of Eastman Company contains the following information.
(in millions) Current Year-End Prior Year-End
Total assets £13,659 £14,320
Total liabilities 10,630 12,932
Net sales 10,301 10,568
Net income 676 (601)

Instructions
Compute the following ratios for Eastman Company for the current year.
(a) Asset turnover.
(b) Return on assets.
(c) Profit margin on sales.
(d) How can the asset turnover be used to compute the return on assets?

7 9 *E11-29 (Revaluation Accounting) Su Company acquired an excavator on January 1, 2013, for ¥10,000 (all
amounts in thousands). This excavator represents the company’s only piece of equipment, and Su chooses
revaluation accounting. This excavator is being depreciated on a straight-line basis over its 10-year useful
life. There is no residual value at the end of the 10-year period. The appraised value of the excavator
approximates the carrying value at December 31, 2013 and 2015. On December 31, 2014, the fair value is
determined to be ¥8,800; on December 31, 2016, the fair value is determined to be ¥5,000.
538 Chapter 11 Depreciation, Impairments, and Depletion

Instructions
(a) Show all journal entries for each year from 2013 through 2016.
(b) Su also owns some property and buildings for which revaluation accounting is not used. Briefly
discuss why Su might not use revaluation accounting for these assets.

PROBLEMS
2 3 P11-1 (Depreciation for Partial Period—SL, SYD, and DDB) Alladin Company purchased Machine
#201 on May 1, 2015. The following information relating to Machine #201 was gathered at the end of May.
Price $85,000
Credit terms 2/10, n/30
Freight-in costs $ 800
Preparation and installation costs $ 3,800
Labor costs during regular production operations $10,500

It was expected that the machine could be used for 10 years, after which the residual value would be zero.
Alladin intends to use the machine for only 8 years, however, after which it expects to be able to sell it for
$1,500. The invoice for Machine #201 was paid May 5, 2015. Alladin uses the calendar year as the basis for
the preparation of financial statements.

Instructions
(a) Compute the depreciation expense for the years indicated using the following methods. (Round to
the nearest dollar.)
(1) Straight-line method for 2015.
(2) Sum-of-the-years’-digits method for 2016.
(3) Double-declining-balance method for 2015.
(b) Suppose Kate Crow, the president of Alladin, tells you that because the company is a new organi-
zation, she expects it will be several years before production and sales reach optimum levels. She
asks you to recommend a depreciation method that will allocate less of the company’s deprecia-
tion expense to the early years and more to later years of the assets’ lives. What method would you
recommend?
2 3 P11-2 (Depreciation for Partial Periods—SL, Act., SYD, and DDB) The cost of equipment purchased by
Charleston, Inc., on June 1, 2015, is €89,000. It is estimated that the machine will have a €5,000 residual
value at the end of its service life. Its service life is estimated at 7 years; its total working hours are esti-
mated at 42,000 and its total production is estimated at 525,000 units. During 2015, the machine was oper-
ated 6,000 hours and produced 55,000 units. During 2016, the machine was operated 5,500 hours and pro-
duced 48,000 units.
Instructions
Compute depreciation expense on the machine for the year ending December 31, 2015, and the year ending
December 31, 2016, using the following methods.
(a) Straight-line. (d) Sum-of-the-years’-digits.
(b) Units-of-output. (e) Declining-balance (twice the straight-line rate).
(c) Working hours.
2 3 P11-3 (Depreciation—SYD, Act., SL, and DDB) The following data relate to the Plant Assets account
of Eshkol, Inc. at December 31, 2015.
Plant Assets
A B C D
Original cost £46,000 £51,000 £80,000 £80,000
Year purchased 2010 2011 2012 2014
Useful life 10 years 15,000 hours 15 years 10 years
Residual value £ 3,100 £ 3,000 £ 5,000 £ 5,000
Depreciation Sum-of-the- Double-declining-
method years’-digits Activity Straight-line balance
Accum. Depr.
through 2015* £31,200 £35,200 £15,000 £16,000
*In the year an asset is purchased, Eshkol, Inc. does not record any depreciation expense on the asset.
In the year an asset is retired or traded in, Eshkol, Inc. takes a full year’s depreciation on the asset.
 Problems 539

The following transactions occurred during 2016.

(a) On May 5, Asset A was sold for £13,000 cash. The company’s bookkeeper recorded this retirement
in the following manner in the cash receipts journal.
Cash 13,000
Plant Assets (Asset A) 13,000

(b) On December 31, it was determined that Asset B had been used 2,100 hours during 2016.
(c) On December 31, before computing depreciation expense on Asset C, the management of Eshkol,
Inc. decided the useful life remaining from January 1, 2016, was 10 years.
(d) On December 31, it was discovered that a plant asset purchased in 2015 had been expensed com-
pletely in that year. This asset cost £28,000 and has a useful life of 10 years and no residual value.
Management has decided to use the double-declining-balance method for this asset, which can be
referred to as “Asset E.”
Instructions
Prepare the necessary correcting entries for the year 2016. Record the appropriate depreciation expense on
the above-mentioned assets.
2 3 P11-4 (Depreciation and Error Analysis) A depreciation schedule for semi-trucks of Ichiro Manufactur-
ing Company was requested by your auditor soon after December 31, 2016, showing the additions, retire-
ments, depreciation, and other data affecting the income of the company in the 4-year period 2013 to 2016,
inclusive. The following data were ascertained (amounts in thousands).
Balance of Trucks account, Jan. 1, 2013
Truck No. 1 purchased Jan. 1, 2010, cost ¥18,000
Truck No. 2 purchased July 1, 2010, cost 22,000
Truck No. 3 purchased Jan. 1, 2012, cost 30,000
Truck No. 4 purchased July 1, 2012, cost 24,000
Balance, Jan. 1, 2013 ¥94,000

The Accumulated Depreciation—Trucks account previously adjusted to January 1, 2013, and entered
in the ledger, had a balance on that date of ¥30,200 (depreciation on the four trucks from the respective
dates of purchase, based on a 5-year life, no residual value). No charges had been made against the account
before January 1, 2013.
Transactions between January 1, 2013, and December 31, 2016, which were recorded in the ledger, are
as follows.
July 1, 2013 Truck No. 3 was traded for a larger one (No. 5), the agreed purchase price of which was ¥40,000.
Ichiro paid the automobile dealer ¥22,000 cash on the transaction. The entry was a debit to Trucks
and a credit to Cash, ¥22,000. The transaction has commercial substance.
Jan. 1, 2014 Truck No. 1 was sold for ¥3,500 cash; entry debited Cash and credited Trucks, ¥3,500.
July 1, 2015 A new truck (No. 6) was acquired for ¥42,000 cash and was charged at that amount to the Trucks
account. (Assume Truck No. 2 was not retired.)
July 1, 2015 Truck No. 4 was damaged in a wreck to such an extent that it was sold as junk for ¥700 cash. Ichiro
received ¥2,500 from the insurance company. The entry made by the bookkeeper was a debit to
Cash, ¥3,200, and credits to Miscellaneous Income ¥700 and Trucks ¥2,500.

Entries for depreciation had been made at the close of each year as follows: 2013, ¥21,000; 2014, ¥22,500;
2015, ¥25,050; and 2016, ¥30,400.
Instructions
(a) For each of the 4 years, compute separately the increase or decrease in net income arising from the
company’s errors in determining or entering depreciation or in recording transactions affecting
trucks, ignoring income tax considerations.
(b) Prepare one compound journal entry as of December 31, 2016, for adjustment of the Trucks ac-
count to reflect the correct balances as revealed by your schedule, assuming that the books have
not been closed for 2016.
2 3 P11-5 (Comprehensive Property, Plant, and Equipment Problem) Darby Sporting Goods Inc. has been
7 experiencing growth in the demand for its products over the last several years. The last two Olympic
Games greatly increased the popularity of basketball around the world. As a result, a European sports
retailing consortium entered into an agreement with Darby’s Roundball Division to purchase basketballs
and other accessories on an increasing basis over the next 5 years.
To be able to meet the quantity commitments of this agreement, Darby had to obtain additional manu-
facturing capacity. A real estate firm located an available factory in close proximity to Darby’s Roundball
manufacturing facility, and Darby agreed to purchase the factory and used machinery from Quay Athletic
540 Chapter 11 Depreciation, Impairments, and Depletion

Equipment Company on October 1, 2014. Renovations were necessary to convert the factory for Darby’s
manufacturing use.
The terms of the agreement required Darby to pay Quay £50,000 when renovations started on January 1,
2015, with the balance to be paid as renovations were completed. The overall purchase price for the factory
and machinery was £400,000. The building renovations were contracted to Malone Construction at
£100,000. The payments made, as renovations progressed during 2015, are shown below. The factory was
placed in service on January 1, 2016.
1/1 4/1 10/1 12/31
Quay £50,000 £90,000 £110,000 £150,000
Malone 30,000 30,000 40,000

On January 1, 2015, Darby secured a £500,000 line-of-credit with a 12% interest rate to finance the pur-
chase cost of the factory and machinery, and the renovation costs. Darby drew down on the line-of-credit
to meet the payment schedule shown above; this was Darby’s only outstanding loan during 2015.
Bob Sprague, Darby’s controller, will capitalize the maximum allowable interest costs for this project.
Darby’s policy regarding purchases of this nature is to use the appraisal value of the land for book pur-
poses and prorate the balance of the purchase price over the remaining items. The building had originally
cost Quay £300,000 and had a net book value of £50,000, while the machinery originally cost £125,000 and
had a net book value of £40,000 on the date of sale. The land was recorded on Quay’s books at £40,000. An
appraisal, conducted by independent appraisers at the time of acquisition, valued the land at £290,000, the
building at £105,000, and the machinery at £45,000.
Angie Justice, chief engineer, estimated that the renovated plant would be used for 15 years, with an
estimated residual value of £30,000. Justice estimated that the productive machinery would have a remain-
ing useful life of 5 years and a residual value of £3,000. Darby’s depreciation policy specifies the 200%
declining-balance method for machinery and the 150% declining-balance method for the plant. One-half
year’s depreciation is taken in the year the plant is placed in service and one-half year is allowed when the
property is disposed of or retired. Darby uses a 360-day year for calculating interest costs.

Instructions
(a) Determine the amounts to be recorded on the books of Darby Sporting Goods Inc. as of December 31,
2015, for each of the following properties acquired from Quay Athletic Equipment Company.
(1) Land. (2) Building. (3) Machinery.
(b) Calculate Darby Sporting Goods Inc.’s 2016 depreciation expense, for book purposes, for each of
the properties acquired from Quay Athletic Equipment Company.
(c) Discuss the arguments for and against the capitalization of interest costs.
(d) Given the enhancements to the building, Darby thinks it would make its financial position look
better if it used revaluation accounting. Advise Darby management on whether the company can
use revaluation accounting for this building. Should Darby management use revaluation account-
ing? Briefly discuss some of the reasons for and against use of revaluation accounting.

2 3 P11-6 (Comprehensive Depreciation Computations) Kohlbeck Corporation, a manufacturer of steel

products, began operations on October 1, 2014. The accounting department of Kohlbeck has started the
plant asset and depreciation schedule presented on page 541. You have been asked to assist in completing
this schedule. In addition to ascertaining that the data already on the schedule are correct, you have
obtained the following information from the company’s records and personnel.
1. Depreciation is computed from the first of the month of acquisition to the first of the month of disposition.
2. Land A and Building A were acquired from a predecessor corporation. Kohlbeck paid $800,000 for
the land and building together. At the time of acquisition, the land had an appraised value of $90,000,
and the building had an appraised value of $810,000.
3. Land B was acquired on October 2, 2014, in exchange for 2,500 newly issued shares of Kohlbeck’s
ordinary shares. At the date of acquisition, the shares had a par value of $5 per share and a fair value
of $30 per share. During October 2014, Kohlbeck paid $16,000 to demolish an existing building on
this land so it could construct a new building.
4. Construction of Building B on the newly acquired land began on October 1, 2015. By September 30,
2016, Kohlbeck had paid $320,000 of the estimated total construction costs of $450,000. It is estimated
that the building will be completed and occupied by July 2017.
5. A grant for certain equipment was given to the corporation by the local community. An independent
appraisal of the equipment when granted placed the fair value at $40,000 and the residual value at
$3,000. The grant is recorded as deferred grant revenue.
 Problems 541

6. Machinery A’s total cost of $182,900 includes installation expense of $600 and normal repairs and main-
tenance of $14,900. Residual value is estimated at $6,000. Machinery A was sold on February 1, 2016.
7. On October 1, 2015, Machinery B was acquired with a down payment of $5,740 and the remaining
payments to be made in 11 annual installments of $6,000 each beginning October 1, 2015. The prevail-
ing interest rate was 8%. The following data were abstracted from present value tables (rounded).
Present value of $1.00 at 8% Present value of an ordinary annuity of $1.00 at 8%
10 years .463 10 years 6.710
11 years .429 11 years 7.139
15 years .315 15 years 8.559

KOHLBECK CORPORATION
Plant Asset and Depreciation Schedule
For Fiscal Years Ended September 30, 2015, and September 30, 2016
Depreciation
Expense
Estimated Year Ended
Acquisition Residual Depreciation Life in September 30
Assets Date Cost Value Method Years 2015 2016
Land A October 1, 2014 $ (1) N/A N/A N/A N/A N/A
Building A October 1, 2014 (2) $40,000 Straight-line (3) $13,600 (4)
Land B October 2, 2014 (5) N/A N/A N/A N/A N/A
Building B Under 320,000 — Straight-line 30 — (6)
Construction to date
Donated Equipment October 2, 2014 (7) 3,000 150% declining- 10 (8) (9)
balance
Machinery A October 2, 2014 (10) 6,000 Sum-of-the- 8 (11) (12)
years’-digits
Machinery B October 1, 2015 (13) — Straight-line 20 — (14)
N/A—Not applicable

Instructions
For each numbered item on the schedule above, supply the correct amount. (Round each answer to the
nearest dollar.)
2 3 P11-7 (Depreciation for Partial Periods—SL, Act., SYD, and DDB) On January 1, 2013, a machine was
purchased for $90,000. The machine has an estimated residual value of $6,000 and an estimated useful life
of 5 years. The machine can operate for 100,000 hours before it needs to be replaced. The company closed
its books on December 31 and operates the machine as follows: 2013, 20,000 hours; 2014, 25,000 hours; 2015,
15,000 hours; 2016, 30,000 hours; and 2017, 10,000 hours.
Instructions
(a) Compute the annual depreciation charges over the machine’s life assuming a December 31 year-
end for each of the following depreciation methods.
(1) Straight-line method. (3) Sum-of-the-years’-digits method.
(2) Activity method. (4) Double-declining-balance method.
(b) Assume a fiscal year-end of September 30. Compute the annual depreciation charges over the
asset’s life applying each of the following methods.
(1) Straight-line method. (3) Double-declining-balance method.
(2) Sum-of-the-years’-digits method.
2 3 P11-8 (Depreciation Methods) On January 1, 2014, Luis Company, a small machine-tool manufacturer,
acquired for R$1,260,000 a piece of new industrial equipment. The new equipment had a useful life of
5 years, and the residual value was estimated to be R$60,000. Luis estimates that the new equipment can
produce 12,000 machine tools in its first year and 50,000 units over its life. It estimates that production will
decline by 1,000 units per year over the remaining useful life of the equipment.
The following depreciation methods may be used: (1) straight-line, (2) double-declining-balance,
(3) sum-of-the-years’-digits, and (4) units-of-output.
Instructions
Which depreciation method would maximize net income for financial statement reporting for the 3-year
period ending December 31, 2016? Prepare a schedule showing the amount of accumulated depreciation at
542 Chapter 11 Depreciation, Impairments, and Depletion

December 31, 2016, under the method selected. (Ignore present value, income tax, and deferred income tax
considerations.)
5 P11-9 (Impairment) Roland Company uses special strapping equipment in its packaging business. The
equipment was purchased in January 2014 for €10,000,000 and had an estimated useful life of 8 years with
no residual value. At December 31, 2015, new technology was introduced that would accelerate the obso-
lescence of Roland’s equipment. Roland’s controller estimates that the present value of expected future
net cash flows on the equipment will be €5,300,000 and that the fair value less costs to sell the equipment
will be €5,600,000. Roland intends to continue using the equipment, but it is estimated that the remaining
useful life is 4 years. Roland uses straight-line depreciation.

Instructions
(a) Prepare the journal entry (if any) to record the impairment at December 31, 2015 (depreciation for
2015 has been recorded).
(b) Prepare any journal entries for the equipment at December 31, 2016. The recoverable amount of
the equipment at December 31, 2016, is estimated to be €4,900,000.
(c) Repeat the requirements for (a) and (b), assuming that Roland intends to dispose of the equipment
and that it has not been disposed of as of December 31, 2016.
5 P11-10 (Impairment) At the end of 2015, Sapporo Group tests a machine for impairment. The machine is
carried at depreciated historical cost, and its carrying amount is ¥150,000. It has an estimated remaining use-
ful life of 10 years. The machine’s recoverable amount is determined on the basis of a value-in-use calcula-
tion, using a pretax discount rate of 15%. Management-approved budgets reflect estimated costs necessary
to maintain the level of economic benefit expected to arise from the machine in its current condition. The
following information related to future cash flows is available at the end of 2015 (amounts in thousands).
Year Future Cash Flow Year Future Cash Flow
2016 ¥22,165 2021 ¥24,825
2017 21,450 2022 24,123
2018 20,550 2023 25,533
2019 24,725 2024 24,234
2020 25,325 2025 22,850

Instructions
Part I
(a) Compute the amount of the impairment loss at December 31, 2015.
(b) Prepare the journal entry to record the impairment loss, if any, at December 31, 2015.
Part II
In the years 2016–2018, no event occurs that requires the machine’s recoverable amount to be re-estimated.
At the end of 2019, costs of ¥25,000 are incurred to enhance the machine’s performance. Revised estimated
cash flows in management’s most recent budget are as follows.
Year Future Cash Flow Year Future Cash Flow
2020 ¥30,321 2023 ¥31,950
2021 32,750 2024 33,100
2022 31,721 2025 27,999

(c) Prepare the journal entry for an impairment or reversal of an impairment at December 31, 2019.
6 P11-11 (Mineral Resources) Phelps Oil Wildcatters Group has leased property on which oil has been dis-
covered. Wells on this property produced 36,000 barrels of oil during the past year, which sold at an aver-
age sales price of £65 per barrel. Total oil resources of this property are estimated to be 500,000 barrels. The
lease provided for an outright payment of £1,200,000 to the lessor (owner) before drilling could be com-
menced and an annual rental of £62,000. A premium of 4% of the sales price of every barrel of oil removed
is to be paid annually to the lessor. In addition, Phelps (lessee) is to clean up all the waste and debris from
drilling and to bear the costs of reconditioning the land for farming when the wells are abandoned. The
estimated fair value, at the time of the lease, of this clean-up and reconditioning is £50,000.

Instructions
(a) From the provisions of the lease agreement, compute the cost per barrel for the past year, exclusive
of operating costs, to Phelps.
(b) Compute the impact on Phelps’ current year profit and loss of the operation of the leased property.
(c) Phelps is considering putting in a bid to lease an adjacent tract of land for development, based on
some preliminary geological surveys and exploratory drilling. Advise Phelps on how to account
for these exploration and evaluation costs.
 Concepts for Analysis 543

3 6 P11-12 (Depletion and Depreciation—Mining) Khamsah Mining Company has purchased a tract of
mineral land for $900,000. It is estimated that this tract will yield 120,000 tons of ore with sufficient mineral
content to make mining and processing profitable. It is further estimated that 6,000 tons of ore will be
mined the first and last year and 12,000 tons every year in between. (Assume 11 years of mining opera-
tions.) The land will have a residual value of $30,000.
The company builds necessary structures and sheds on the site at a cost of $36,000. It is estimated that
these structures can serve 15 years. But, because they must be dismantled if they are to be moved, they have
no residual value. The company does not intend to use the buildings elsewhere. Mining machinery installed
at the mine was purchased secondhand at a cost of $60,000. This machinery cost the former owner $150,000
and was 50% depreciated when purchased. Khamsah Mining estimates that about half of this machinery will
still be useful when the present mineral resources have been exhausted but that dismantling and removal
costs will just about offset its value at that time. The company does not intend to use the machinery else-
where. The remaining machinery will last until about one-half the present estimated mineral ore has been
removed and will then be worthless. Cost is to be allocated equally between these two classes of machinery.

Instructions
(a) As chief accountant for the company, you are to prepare a schedule showing estimated depletion
and depreciation costs for each year of the expected life of the mine.
(b) Also compute the depreciation and depletion for the first year assuming actual production of 5,000
tons. Nothing occurred during the year to cause the company engineers to change their estimates
of either the mineral resources or the life of the structures and equipment.
7 9 *P11-13 (Revaluations) Wang Company owns land (cost HK$200,000) for which it uses revaluation
accounting. It has the following information related to this asset, the only land asset that Wang owns.
Date Fair Value
January 1, 2014 HK$200,000
December 31, 2014 215,000
December 31, 2015 185,000
December 31, 2016 205,000

Instructions
(a) Prepare all entries related to the land for 2014.
(b) Determine the amounts to be reported by Wang at December 31, 2015 and 2016, as Land, Other
Comprehensive Income, Impairment Loss, and Accumulated Other Comprehensive Income.
(c) Prepare the entry for any revaluation adjustments at December 31, 2015 and 2016.
(d) Prepare the entries for the sale of the property by Wang on January 15, 2017, for HK$220,000.
7 9 *P11-14 (Revaluations) Parnevik Group uses revaluation accounting for a class of equipment it uses in its
golf club refurbishing business. The equipment was purchased on January 2, 2015, for €500,000; it has a
10-year useful life with no residual value. Parnevik has the following information related to the equipment.
(Assume that estimated useful life and residual value does not change during the periods presented below.)
Date Fair Value
January 2, 2015 €500,000
December 31, 2015 468,000
December 31, 2016 380,000
December 31, 2017 355,000

Instructions
(a) Prepare all entries related to the equipment for 2015.
(b) Determine the amounts to be reported by Parnevik at December 31, 2016 and 2017, as Equipment,
Other Comprehensive Income, Depreciation Expense, Impairment Loss, and Accumulated Other
Comprehensive Income.
(c) Prepare the entry for any revaluation adjustments at December 31, 2016 and 2017.
(d) Prepare the entries for the sale of the equipment by Parnevik on January 2, 2018, for €330,000.

C O N C E P T S F O R A N A LY S I S
CA11-1 (Depreciation Basic Concepts) Hakodat Manufacturing Company was organized January 1,
2015. During 2015, it has used in its reports to management the straight-line method of depreciating its
plant assets.
544 Chapter 11 Depreciation, Impairments, and Depletion

On November 8, you are having a conference with Hakodat’s officers to discuss the depreciation
method to be used for income tax and shareholder reporting. Tao Chen, president of Hakodat, has sug-
gested the use of a new method, which he feels is more suitable than the straight-line method for the
needs of the company during the period of rapid expansion of production and capacity that he foresees.
Following is an example in which the proposed method is applied to a fixed asset with an original cost of
¥248,000, an estimated useful life of 5 years, and a residual value of approximately ¥8,000 (amounts in
thousands).
Accumulated
Years of Depreciation Book Value
Life Fraction Depreciation at End at End
Year Used Rate Expense of Year of Year
1 1 1/15 ¥16,000 ¥ 16,000 ¥232,000
2 2 2/15 32,000 48,000 200,000
3 3 3/15 48,000 96,000 152,000
4 4 4/15 64,000 160,000 88,000
5 5 5/15 80,000 240,000 8,000

The president favors the new method because he has heard that:
1. It will increase the funds recovered during the years near the end of the assets’ useful lives when
maintenance and replacement disbursements are high.
2. It will result in increased write-offs in later years and thereby will reduce taxes.

Instructions
(a) What is the purpose of accounting for depreciation?
(b) Is the president’s proposal within the scope of international financial reporting standards? In
making your decision discuss the circumstances, if any, under which use of the method would be
reasonable and those, if any, under which it would not be reasonable.
(c) The president wants your advice on the following issues.
(1) Do depreciation charges recover or create funds? Explain.
(2) Assume that the taxing authorities accept the proposed depreciation method in this case. If the
proposed method were used for shareholder and tax reporting purposes, how would it affect
the availability of cash flows generated by operations?
CA11-2 (Depreciation—Strike, Units-of-Production, Obsolescence) Presented below are three differ-
ent and unrelated situations involving depreciation accounting. Answer the question(s) at the end of each
situation.
Situation I: Recently, Nai Su Company experienced a strike that affected a number of its operating plants.
The controller of this company indicated that it was not appropriate to report depreciation expense during
this period because the equipment did not depreciate and an improper matching of costs and revenues
would result. She based her position on the following points.
1. It is inappropriate to charge the period with costs for which there are no related revenues arising
from production.
2. The basic factor of depreciation in this instance is wear and tear, and because equipment was idle, no
wear and tear occurred.
Instructions
Comment on the appropriateness of the controller’s comments.
Situation II: Etheridge Company manufactures electrical appliances, most of which are used in homes.
Company engineers have designed a new type of blender which, through the use of a few attachments, will
perform more functions than any blender currently on the market. Demand for the new blender can be
projected with reasonable probability. In order to make the blenders, Etheridge needs a specialized ma-
chine that is not available from outside sources. It has been decided to make such a machine in Etheridge’s
own plant.
Instructions
(a) Discuss the effect of projected demand in units for the new blenders (which may be steady, de-
creasing, or increasing) on the determination of a depreciation method for the machine.
(b) What other matters should be considered in determining the depreciation method? Ignore income
tax considerations.
Situation III: Haley Paper Company operates a 300-ton-per-day kraft pulp mill and four sawmills. The
company is in the process of expanding its pulp mill facilities to a capacity of 1,000 tons per day and plans
 Using Your Judgment 545

to replace three of its older, less efficient sawmills with an expanded facility. One of the mills to be replaced
did not operate for most of 2015 (current year), and there are no plans to reopen it before the new sawmill
facility becomes operational.
In reviewing the depreciation rates and in discussing the residual values of the sawmills that were to
be replaced, it was noted that if present depreciation rates were not adjusted, substantial amounts of plant
costs on these three mills would not be depreciated by the time the new mill came online.

Instructions
What is the proper accounting for the four sawmills at the end of 2015?

CA11-3 (Depreciation Concepts) As a cost accountant for San Francisco Cannery, you have been ap-
proached by Phil Perriman, canning room supervisor, about the 2015 costs charged to his department. In
particular, he is concerned about the line item “depreciation.” Perriman is very proud of the excellent con-
dition of his canning room equipment. He has always been vigilant about keeping all equipment serviced
and well oiled. He is sure that the huge charge to depreciation is a mistake; it does not at all reflect the cost
of minimal wear and tear that the machines have experienced over the last year. He believes that the charge
should be considerably lower.
The machines being depreciated are six automatic canning machines. All were put into use on
January 1, 2015. Each cost $625,000, having a residual value of $55,000 and a useful life of 12 years. San
Francisco depreciates this and similar assets using double-declining-balance depreciation. Perriman
has also pointed out that if you used straight-line depreciation the charge to his department would not
be so great.

Instructions
Write a memo to Phil Perriman to clear up his misunderstanding of the term “depreciation.” Also, calculate
year-1 depreciation on all machines using both methods. Explain the theoretical justification for double-
declining-balance and why, in the long run, the aggregate charge to depreciation will be the same under
both methods.

CA11-4 (Depreciation Choice) Jerry Prior, Beeler Corporation’s controller, is concerned that net income
may be lower this year. He is afraid upper-level management might recommend cost reductions by laying
off accounting staff, including him.
Prior knows that depreciation is a major expense for Beeler. The company currently uses the double-
declining-balance method for both financial reporting and tax purposes, and he’s thinking of selling equip-
ment that, given its age, is primarily used when there are periodic spikes in demand. The equipment has a
carrying amount of €2,000,000 and a fair value of €2,180,000. The gain on the sale would be reported in the
income statement. He doesn’t want to highlight this method of increasing income. He thinks, “Why don’t
I increase the estimated useful lives and the residual values? That will decrease depreciation expense and
require less extensive disclosure, since the changes are accounted for prospectively. I may be able to save
my job and those of my staff.”

Instructions
Answer the following questions.
(a) Who are the stakeholders in this situation?
(b) What are the ethical issues involved?
(c) What should Prior do?

USING YOUR JUDGMENT

FINANCIAL REPORTING
Financial Reporting Problem
Marks and Spencer plc (M&S)
The financial statements of M&S (GBR) are presented in Appendix A. The company’s complete annual
report, including the notes to the financial statements, is available online.
546 Chapter 11 Depreciation, Impairments, and Depletion

Instructions
Refer to M&S’s financial statements and the accompanying notes to answer the following questions.
(a) What descriptions are used by M&S in its statement of financial position to classify its property,
plant, and equipment?
(b) What method or methods of depreciation does M&S use to depreciate its property, plant, and
equipment?
(c) Over what estimated useful lives does M&S depreciate its property, plant, and equipment?
(d) What amounts for depreciation expense did M&S charge to its income statement in 2013 and 2012?
(e) What were the capital expenditures for property, plant, and equipment made by M&S in 2013 and
2012?

Comparative Analysis Case

adidas and Puma
The financial statements of adidas (DEU) and Puma (DEU) are presented in Appendices B and C, respec-
tively. The complete annual reports, including the notes to the financial statements, are available online.
Instructions
Use the companies’ financial information to answer the following questions.
(a) What amount is reported in the statements of financial position as property, plant, and equipment
(net) of adidas at year-end 2012 and of Puma at year-end 2012? What percentage of total assets is
invested in property, plant, and equipment by each company?
(b) What depreciation methods are used by adidas and Puma for property, plant, and equipment?
How much depreciation was reported by adidas and Puma in 2012 and 2011?
(c) Compute and compare the following ratios for adidas and Puma for 2012.
(1) Asset turnover.
(2) Profit margin on sales.
(3) Return on assets.
(d) What amount was spent in 2012 for capital expenditures by adidas and Puma? What amount of
interest was capitalized in 2012?

Financial Statement Analysis Case

Carrefour Group
Carrefour Group (FRA), the top retailer in Europe (second worldwide), recently had €108.629 billion
in sales. It has more than 495,000 employees worldwide, with operations in 31 countries. It is the seventh
largest employer worldwide, with 15,430 stores. Carrefour provided the following information in a recent
annual report related to its property and equipment.

Carrefour Group
(in millions)

Notes to the Financial Statements (in part)

(3) Tangible fixed assets
In accordance with IAS 16 “Tangible Fixed Assets,” land, buildings, equipment, fixtures and fittings are valued at their
cost price at acquisition, or at production cost less depreciation and loss in value. The cost of borrowing is not in-
cluded in the acquisition price of fixed assets. Tangible fixed assets in progress are posted at cost less any identified
loss in value. Depreciation of these assets begins when the assets are ready for use. Tangible fixed assets are depre-
ciated on a straight-line basis according to the following average useful lives:
• Construction: • Buildings 40 years
• Grounds 10 years
• Car parks 6-and-two-thirds years
• Equipment, fixtures, fittings and installations 6-and-two-thirds years to 8 years
• Other fixed assets 4 to 10 years
Note 8: Depreciation, amortization and provisions
Current Year Prior Year Change
Depreciation of tangible fixed assets €1,623 €1,484 9.4%
 Using Your Judgment 547

Note 15: Tangible fixed assets

Current Year Prior Year
Land € 2,913 € 2,934
Buildings 9,838 9,628
Equipment, fixtures, fittings and installations 14,006 13,219
Other fixed assets 1,159 1,148
Fixed assets in progress 769 790
Leased land, buildings, fixtures 1,717 1,720
Gross tangible fixed assets 30,402 29,439
Accumulated Depreciation (15,333) (14,486)
Impairment (260) (202)
Net tangible fixed assets € 14,809 € 14,751

Cash Provided by Operations

(euros in millions) Current Year Prior Year
Cash provided by operations €4,887 €3,912
Capital expenditures 2,918 3,069
Cash provided by operations
as a percent of capital expenditures 167% 127%

Instructions
(a) What method of depreciation does Carrefour use?
(b) Does depreciation and amortization expense cause cash flow from operations to increase? Explain.
(c) What do the schedule of cash flow measures indicate?

Accounting, Analysis, and Principles

Electroboy Enterprises, Inc. operates several stores throughout northern Belgium and the southern part of
the Netherlands. As part of an operational and financial reporting review in a response to a downturn in it
markets, the company’s management has decided to perform an impairment test on five stores (combined).
The five stores’ sales have declined due to aging facilities and competition from a rival that opened new
stores in the same markets. Management has developed the following information concerning the five
stores as of the end of fiscal 2015.
Original cost €36 million
Accumulated depreciation €10 million
Estimated remaining useful life 4 years
Estimated expected future annual cash flows
(not discounted) €4.0 million per year
Appropriate discount rate 5%
Fair value less cost of disposal €23 million

Accounting
(a) Determine the amount of impairment loss, if any, that Electroboy should report for fiscal 2015 and
the carrying amount at which Electroboy should report the five stores on its fiscal year-end 2015
statement of financial position. Assume that the cash flows occur at the end of each year.
(b) Repeat part (a), but instead assume that (1) the estimated remaining useful life is 10 years, (2) the
estimated annual cash flows are €2,720,000 per year, and (3) the appropriate discount rate is 6%.
Analysis
Assume that you are a financial analyst and you participate in a conference call with Electroboy manage-
ment in early 2016 (before Electroboy closes the books on fiscal 2015). During the conference call, you learn
that management is considering selling the five stores, but the sale will not likely be completed until the
second quarter of fiscal 2016. Briefly discuss what implications this would have for Electroboy’s 2015 finan-
cial statements. Assume the same facts as in part (b) above.

Principles
Electroboy management would like to know the accounting for the impaired asset in periods subsequent
to the impairment.
(a) Suppose conditions improve in its markets. Can the assets be written back up? Briefly discuss the
conceptual arguments for this accounting.
(b) Briefly describe how IFRS differs from U.S. GAAP with respect to accounting for impaired tangi-
ble, long-lived assets. Does U.S. accounting better align with the concept of neutrality? Explain.
548 Chapter 11 Depreciation, Impairments, and Depletion

International Reporting Case

Liberty International (GBR), a real estate company, follows IFRS. In a recent year, Liberty disclosed the
following information on revaluations of its tangible fixed assets. The revaluation reserve measures the
amount by which tangible fixed assets are recorded above historical cost and is reported in Liberty’s
equity.

Liberty International
Completed Investment Properties
Completed investment properties are professionally valued on a market value basis by external valuers at the balance
sheet date. Surpluses and deficits arising during the year are reflected in the revalution reserve.

Liberty reported the following additional data. Amounts for Kimco Realty (USA) (which follows U.S.
GAAP) in the same year are provided for comparison.

Liberty Kimco
(pounds sterling, in thousands) (dollars, in millions)
Total revenues £ 741 $ 517
Average total assets 5,577 4,696
Net income 125 297

Instructions
(a) Compute the following ratios for Liberty and Kimco.
(1) Return on assets.
(2) Profit margin.
(3) Asset turnover.
How do these companies compare on these performance measures?
(b) Liberty reports a revaluation surplus in Accumulated Other Comprehensive Income of £1,952. As-
sume that £1,550 of this amount arose from an increase in the net replacement value of investment
properties during the year. Prepare the journal entry to record this increase.
(c) Under IFRS, are Liberty’s assets and equity overstated? If so, why? When comparing Liberty to U.S.
companies, like Kimco, what adjustments would you need to make in order to have valid com-
parisons of ratios such as those computed in (a) above?

IFRS BRIDGE TO THE PROFESSION

Professional Research
Matt Holmes recently joined Klax Company as a staff accountant in the controller’s office. Klax Company
provides warehousing services for companies in several European cities.
The location in Koblenz, Germany, has not been performing well due to increased competition and the
loss of several customers that have recently gone out of business. Matt’s department manager suspects that
the plant and equipment may be impaired and wonders whether those assets should be written down.
Given the company’s prior success, this issue has never arisen in the past, and Matt has been asked to con-
duct some research on this issue.
Instructions
Access the IFRS authoritative literature at the IASB website (http://eifrs.iasb.org/) (you may register for free
eIFRS access at this site). When you have accessed the documents, you can use the search tool in your
Internet browser to respond to the following questions. (Provide paragraph citations.)
(a) What is the authoritative guidance for asset impairments? Briefly discuss the scope of the standard
(i.e., explain the types of transactions to which the standard applies).
(b) Give several examples of events that would cause an asset to be tested for impairment. Does it
appear that Klax should perform an impairment test? Explain.
(c) What is the best evidence of fair value? Describe alternate methods of estimating fair value.
 Using Your Judgment 549

Professional Simulation
In this simulation, you are asked to address questions regarding the accounting for property, plant, and
equipment. Prepare responses to all parts.

© KWW_Professional _Simulation

Property, Plant, Time Remaining

copy paste calculator sheet standards
?
help spliter done
and Equipment 1 hour 40 minutes

Directions Situation Explanation Measurement Journal Entry Resources

Whitley Corporation purchased machinery on January 1, 2015, at a cost of €100,000. The estimated
useful life of the machinery is 4 years, with an estimated residual value of €10,000 at the end of that
period. The company is considering different depreciation methods that could be used for financial
reporting purposes.

Directions Situation Explanation Measurement Journal Entry Resources

(a) What is the purpose of depreciation?

(b) Identify the factors that are relevant in determining annual depreciation, and explain whether those
factors are determined objectively or whether they are based on judgment.

Directions Situation Explanation Measurement Journal Entry Resources

(a) Which depreciation method would result in the highest reported 2015 income? Explain.
(b) Which method would result in the highest total reported earnings over the 4-year period? Explain.
(c) Which method would result in the highest 2015 cash flow? Explain.

Directions Situation Explanation Measurement Journal Entry Resources

Assume that the company sold the machinery on January 1, 2017, for €84,000 and that the company used
the straight-line method. Prepare the journal entry to record the transaction.

Remember to check the book’s companion website, at www.wiley.com/

college/kieso, to find additional resources for this chapter.
 CHAPTER 11
Depreciation, Impairments, and Depletion

ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)

Brief Concepts
Topics Questions Exercises Exercises Problems for Analysis

1. Depreciation methods; 1, 2, 3, 4, 5, 1, 2, 3, 4, 5, 1, 2, 3 1, 2, 3, 4
meaning of depreciation; 6, 10, 13, 19, 8, 14, 15
choice of depreciation 20, 28
methods.

2. Computation of 7, 8, 9, 1, 2, 3, 4 1, 2, 3, 4, 1, 2, 3, 4, 1, 2
depreciation. 12, 30 5, 6, 7, 5, 6, 7, 8
10, 15

3. Depreciation base. 2, 7 5 8, 14, 18 1, 2, 3, 2

5, 6

4. Errors; changes in 12 7 11, 12, 3, 4 2

estimate. 13, 14

5. Depreciation of partial 14 2, 3, 4 3, 4, 5, 6, 1, 2, 3,
periods. 7, 15 6, 7

6. Component depreciation. 11 6, 8 9, 16, 17

7. Impairment of value. 15, 16, 17, 9 18, 19, 20 9, 10

18, 28

8. Depletion. 20, 21, 22, 10 21, 22, 23 11, 12

23, 24

9. Ratio analysis. 27 12 28

10. Convergence. 28, 29

*11. Revaluation accounting. 25, 26, 28, 11 24, 25, 26, 13, 14
29, 30 27, 29

*This material is covered in an appendix to the chapter.

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-1
ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Brief
Learning Objectives Exercises Exercises Problems

1. Explain the concept of depreciation.

2. Identify the factors involved in the depreciation 2, 3, 4, 5, 7 1, 2, 3, 4, 5, 6, 1, 2, 3,

process. 7, 8, 9, 10, 11, 4, 5, 6,
12, 13, 14, 15 7, 8

3. Compare activity, straight-line and diminishing- 1, 2, 3, 4, 7 1, 2, 3, 4, 5, 6, 1, 2, 3, 4,

charge methods of depreciation. 7, 8, 9, 10, 11, 5, 6, 7,
12, 13, 14, 15 8, 12

4. Explain component depreciation. 6, 8 9, 16, 17

5. Explain the accounting issues related to asset 9 18, 19, 20 9, 10

impairment.

6. Explain the accounting procedures for 10 21, 22, 23 11, 12

depletion of mineral resources.

7. Explain the accounting for revaluations. 11 24, 25, 26, 5, 13, 14

27, 29

8. Explain how to report and analyze property, 12 28

plant, equipment, and mineral resources.

*9. Explain revaluation accounting procedures. 11 29 13, 14

11-2 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
ASSIGNMENT CHARACTERISTICS TABLE
Level of Time
Item Description Difficulty (minutes)
E11-1 Depreciation computations—SL, SYD, DDB. Simple 15–20
E11-2 Depreciation—conceptual understanding. Moderate 20–25
E11-3 Depreciation computations—SYD, DDB—partial periods. Simple 15–20
E11-4 Depreciation computations—five methods. Simple 15–25
E11-5 Depreciation computations—four methods. Simple 20–25
E11-6 Depreciation computations—five methods, partial periods. Moderate 20–30
E11-7 Different methods of depreciation. Simple 25–35
E11-8 Depreciation computation—replacement, nonmonetary Moderate 20–25
exchange.
E11-9 Component depreciation. Simple 15–20
E11-10 Depreciation computations, SYD. Simple 10–15
E11-11 Depreciation—change in estimate. Simple 10–15
E11-12 Depreciation computation—addition, change in estimate. Simple 20–25
E11-13 Depreciation—replacement, change in estimate. Simple 15–20
E11-14 Error analysis and depreciation, SL and SYD. Moderate 20–25
E11-15 Depreciation for fractional periods. Moderate 25–35
E11-16 Component depreciation. Simple 10–15
E11-17 Component depreciation. Simple 10–15
E11-18 Impairment. Simple 10–15
E11-19 Impairment. Simple 15–20
E11-20 Impairment. Simple 15–20
E11-21 Depletion computations—oil. Simple 10–15
E11-22 Depletion computations—mining. Simple 15–20
E11-23 Depletion computations—minerals. Simple 15–20
E11-24 Revaluation accounting. Simple 10–15
E11-25 Revaluation accounting. Simple 10–15
E11-26 Revaluation accounting. Moderate 15–20
E11-27 Revaluation accounting. Moderate 10–15
E11-28 Ratio analysis. Moderate 15–20
*E11-29 Revaluation accounting. Moderate 20–25

P11-1 Depreciation for partial period—SL, SYD, and DDB. Simple 25–30
P11-2 Depreciation for partial periods—SL, Act., SYD, and DDB. Simple 25–35
P11-3 Depreciation—SYD, Act., SL, and DDB. Moderate 40–50
P11-4 Depreciation and error analysis. Complex 45–60
P11-5 Comprehensive property, plant, and equipment problem. Moderate 25–35
P11-6 Comprehensive depreciation computations. Complex 45–60
P11-7 Depreciation for partial periods—SL, Act., SYD, Moderate 30–35
and DDB.

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-3
ASSIGNMENT CHARACTERISTICS TABLE (Continued)

Level of Time
Item Description Difficulty (minutes)
P11-8 Depreciation methods. Moderate 25–35
P11-9 Impairment. Moderate 15–25
P11-10 Impairment. Moderate 30–35
P11-11 Mineral resources. Moderate 15–20
P11-12 Depletion and depreciation—mining. Moderate 25–30
*P11-13 Revaluations. Moderate 20–25
*P11-14 Revaluations. Moderate 25–35

CA11-1 Depreciation basic concepts. Moderate 25–35

CA11-2 Depreciation—strike, units-of-production, obsolescence. Moderate 25–35
CA11-3 Depreciation concepts. Moderate 25–35
CA11-4 Depreciation choice. Moderate 20–25

11-4 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
 ANSWERS TO QUESTIONS

1. The differences among the terms depreciation, depletion, and amortization are that they imply a
cost allocation of different types of assets. Depreciation is employed to indicate that tangible plant
assets have decreased in carrying value. Where mineral resources (wasting assets) such as timber,
oil, coal, and lead are involved, the term depletion is used. The expiration of intangible assets such
as patents or copyrights is referred to as amortization.

2. The factors relevant in determining the annual depreciation for a depreciable asset are the initial
recorded amount (cost), estimated residual value, estimated useful life, and depreciation method.

Assets are typically recorded at their acquisition cost, which is in most cases objectively determinable.
But cost assignment in other cases—“basket purchases” and the selection of an implicit interest rate in
asset acquisitions under deferred-payment plans—may be quite subjective, involving considerable
judgment.

The residual value is an estimate of an amount potentially realizable when the asset is retired from
service. The estimate is based on judgment and is affected by the length of the useful life of the asset.

The useful life is also based on judgment. It involves selecting the “unit” of measure of service life
and estimating the number of such units embodied in the asset. Such units may be measured in
terms of time periods or in terms of activity (for example, years or machine hours). When selecting the
life, one should select the lower (shorter) of the physical life or the economic life. Physical life involves
wear and tear and casualties; economic life involves such things as technological obsolescence
and inadequacy.

Selecting the depreciation method is generally a judgment decision, but a method may be inherent
in the definition adopted for the units of service life, as discussed earlier. For example, if such units
are machine hours, the method is a function of the number of machine hours used during each
period. A method should be selected that will best measure the portion of services expiring each
period. Once a method is selected, it may be objectively applied by using a predetermined, objec-
tively derived formula.

3. Disagree. Accounting depreciation is defined as an accounting process of allocating the costs of

tangible assets to expense in a systematic and rational manner to the periods expected to benefit from
the use of the asset. Thus, depreciation is not a matter of valuation but a means of cost allocation.

4. The carrying value of property, plant, and equipment is its cost less accumulated depreciation. If the
company estimates that the asset will have an unrealistically long life, periodic depreciation
charges, and hence accumulated depreciation, will be lower. As a result the carrying value of the
asset will be higher.

5. A change in the amount of annual depreciation recorded does not change the facts about the decline
in economic usefulness. It merely changes reported figures. Depreciation in accounting consists of
allocating the cost of an asset over its useful life in a systematic and rational manner. Abnormal
obsolescence, as suggested by the plant manager, would justify more rapid depreciation, but
increasing the depreciation charge would not necessarily result in funds for replacement. It would
not increase revenue but simply make reported income lower than it would have been, thus
preventing overstatement of net income.

Recording depreciation on the books does not set aside any assets for eventual replacement of
the depreciated assets. Fund segregation can be accomplished but it requires additional managerial
action. Unless an increase in depreciation is accompanied by an increase in sales price of the
product, or unless it affects management’s decision on dividend policy, it does not affect funds.

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-5
Questions Chapter 11 (Continued)

Ordinarily higher depreciation will not lead to higher sales prices and thus to more rapid “recovery”
of the cost of the asset, and the economic factors present would have permitted this higher price
regardless of the excuse given or the particular rationalization used. The price could have been
increased without a higher depreciation charge.

The funds of a firm operating profitably do increase, but these may be used as working capital
policy may dictate. The measure of the increase in these funds from operations is not merely net
income, but that figure plus charges to operations which did not require working capital, less
credits to operations which did not create working capital. The fact that net income alone does not
measure the increase in funds from profitable operations leads some non-accountants to the
erroneous conclusion that a fund is being created and that the amount of depreciation recorded
affects the fund accumulation.

Acceleration of depreciation for purposes of income tax calculation stands in a slightly different
category, since this is not merely a matter of recordkeeping. Increased depreciation will tend to
postpone tax payments, and thus temporarily increase funds (although the liability for taxes may
be the same or even greater in the long run than it would have been) and generate gain to the firm
to the extent of the value of use of the extra funds.

6. Assets are retired for one of two reasons: physical factors or economic factors—or a combination
of both. Physical factors are the wear and tear, decay, and casualty factors which hinder the asset
from performing indefinitely. Economic factors can be interpreted to mean any other constraint that
develops to hinder the service life of an asset. Some accountants attempt to classify the economic
factors into three groups: inadequacy, supersession, and obsolescence. Inadequacy is defined
as a situation where an asset is no longer useful to a given enterprise because the demands of the
firm have increased. Supersession is defined as a situation where the replacement of an asset
occurs because another asset is more efficient and economical. Obsolescence is the catchall
term that encompasses all other situations and is sometimes referred to as the major concept
when economic factors are considered.

7. Before the amount of the depreciation charge can be computed, three basic questions must be
answered:
(1) What is the depreciation base to be used for the asset?
(2) What is the asset’s useful life?
(3) What method of cost apportionment is best for this asset?

8. Cost €800,000 Cost €800,000

Depreciation rate X 30%* Depreciation for 2015 (240,000)
Depreciation for 2015 €240,000 Undepreciated cost in 2016 560,000
Depreciation rate X 30%
2015 Depreciation €240,000 Depreciation for 2016 €168,000
2016 Depreciation 168,000
Accumulated depreciation
at December 31, 2016 €408,000

*(1÷ 5) X 150%

11-6 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
Questions Chapter 11 (Continued)

9. Depreciation base:
Cost $162,000 Straight-line, $147,000 ÷ 20 = $ 7,350
Residual (15,000)
$147,000 Units-of-output, $147,000
X 20,000 = $35,000
84,000
Working hours, $147,000
X 14,300 = $50,050
42,000
Sum-of-the-years’-digits, $147,000 X 20/210* = $14,000
Double-declining-balance, $162,000 X 10% = $16,200

*20(20 +1)
= 210
2

10. From a conceptual point of view, the method which best matches revenue to expenses should be
used; in other words, the answer depends on the decline in the service potential of the asset. If the
service potential decline is faster in the earlier years, an accelerated method would seem to be
more desirable. On the other hand, if the decline is more uniform, perhaps a straight-line approach
should be used. Many firms adopt depreciation methods for more pragmatic reasons. Some
companies use accelerated methods for tax purposes but straight-line for book purposes because
a higher net income figure is shown on the books in the earlier years, but a lower tax is paid to the
government. Others attempt to use the same method for tax and accounting purposes because it
eliminates some recordkeeping costs. Tax policy sometimes also plays a role.

11. Component depreciation involves depreciating separately each part of an item of property, plant,
and equipment that is significant to the total cost of the asset.

12. Original estimate: £2,500,000 ÷ 50 = £50,000 per year

Depreciation to January 1, 2016: £50,000 X 24 = £1,200,000
Depreciation in 2016 (£2,500,000 – £1,200,000) ÷ 15 years = £86,667

13. No, depreciation does not provide cash; revenues do. The funds for the replacement of the assets
come from the revenues; without the revenues no income materializes and no cash inflow results.
A separate decision must be made by management to set aside cash to accumulate asset replace-
ment funds. Depreciation is added to net income on the statement of cash flows (indirect method)
because it is a noncash expense, not because it is a cash inflow.

14. 25% straight-line rate X 2 = 50% double-declining rate

€8,000 X 50% = €4,000 Depreciation for first full year.
€4,000 X 6/12 = €2,000 Depreciation for half a year (first year), 2015.
€6,000 X 50% = €3,000 Depreciation for 2016.

15. To determine whether an asset is impaired, on an annual basis, companies review the asset for
indicators of impairment – that is, a decline in the asset’s cash-generating ability through use or
sale. If the recoverable amount is less than the carrying amount, the asset has been impaired. The
impairment loss is measured as the amount by which the carrying amount exceeds the
recoverable amount of the asset. The recoverable amount of assets is defined as the higher of fair
value less costs to sell or value-in-use.

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-7
Questions Chapter 11 (Continued)

16. Under IFRS, impairment losses on plant assets may be restored as long as the write-up does not
result in a carrying amount greater than the carrying amount before impairment.

17. An impairment is deemed to have occurred if, in applying the impairment test, the carrying amount
of the asset exceeds the recoverable amount of the asset. In this case, the value-in-use of
€705,000 exceeds the carrying amount of the equipment of €700,000 so no impairment is
assumed to have occurred; thus no measurement of the loss is made or recognized even though
the fair value is €590,000.

18. Impairment losses are reported as part of operating income generally in the “Other income and
expense” section. Impairment losses (and recovery of impairment losses) are similar to other costs
that would flow through operations. Thus, gains (recoveries of losses) on long-lived assets should be
reported as part of operating income in the “Other income and expense” section of the income
statement.

19. In a decision to replace or not to replace an asset, the undepreciated cost of the old asset is not a
factor to be considered. Therefore, the decision to replace plant assets should not be affected by
the amount of depreciation that has been recorded. The relative efficiency of new equipment as
compared with that presently in use, the cost of the new facilities, the availability of capital for the
new asset, etc., are the factors entering into the decision. Normally, the fact that the asset had
been fully depreciated through the use of some accelerated depreciation method, although the
asset was still in use, should not cause management to decide to replace the asset. If the new
asset under consideration for replacement was not any more efficient than the old, or if it cost a
good deal more in relationship to its efficiency, it is illogical for management to replace it merely
because all or the major portion of the cost had been charged off for tax and accounting purposes.

If depreciation rates were higher it might be true that a business would be financially more able to
replace assets, since during the earlier years of the asset’s use a larger portion of its cost would
have been charged to expense, and hence during this period a smaller amount of income tax paid.
By selling the old asset, which might result in a capital gain, and purchasing a new asset, the
higher depreciation charge might be continued for tax purposes. However, if the asset were traded
in, having taken higher depreciation could result in a lower basis for the new asset, if the exchange
lacks commercial substance.

It should be noted that expansion (not merely replacement) might be encouraged by increased
depreciation rates. Management might be encouraged to expand, believing that in the first few
years when they are reasonably sure that the expanded facilities will be profitable, they can
charge off a substantial portion of the cost as depreciation for tax purposes. Similarly, since a
replacement involves additional capital outlays, the tax treatment may have some influence.

Also, because of the inducement to expand or to start new businesses, there may be a tendency
in the economy as a whole for the accounting and tax treatment of the cost of plant assets to
influence the retirement of old plant assets.

It should be noted that to the extent that increased depreciation causes management to alter its
decision about replacement, it is not matching costs and revenues in the closest possible manner.

11-8 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
Questions Chapter 11 (Continued)

20. (a) Depreciation and cost depletion are similar in the accounting sense in that:
1. The cost of the asset is the starting point from which computation of the amount of the
periodic charge to operations is made.
2. The estimated life is based on economic or productive life.
3. The accumulated total of past charges to operations is deducted from the original cost of
the asset on the statement of financial position.
4. When output methods of computing depreciation charges are used, the formulas are
essentially the same as those used in computing depletion charges.
5. Both represent an apportionment of cost under the process of matching costs with revenue.
6. Assets subject to either are reported in the same classification on the balance sheet.
7. Appraisal values are sometimes used for depreciation while discovery values are sometimes
used for depletion.
8. Residual value is properly recognized in computing the charge to operations.
9. They may be included in inventory if the related asset contributed to the production of the
inventory.
10. The rates may be changed upon revision of the estimated productive life used in the
original rate computations.

(b) Depreciation and cost depletion are dissimilar in the accounting sense in that:
1. Depletion is almost always based on output whereas depreciation is usually based on time.
2. Many formulas are used in computing depreciation but only one is used to any extent in
computing depletion.
3. Depletion applies to natural resources while depreciation applies to plant and equipment.
4. Depletion refers to the physical exhaustion or consumption of the asset while depreciation
refers to the wear, tear, and obsolescence of the asset.
5. Under statutes which base the legality of dividends on accumulated earnings, depreciation
is usually a required deduction but depletion is usually not a required deduction.
6. The computation of the depletion rate is usually much less precise than the computation of
depreciation rates because of the greater uncertainty in estimating the productive life.
7. A difference that is temporary in nature arises from the timing of the recognition of depre-
ciation under conventional accounting and under tax laws, and it results in the recording of
deferred income taxes. On the other hand, the difference between cost depletion under
conventional accounting and its counterpart, percentage depletion, under the tax laws is
permanent and does not require the recording of deferred income taxes.

21. Cost depletion is the procedure by which the capitalized costs, less residual land values, of a natural
resource are systematically charged to operations. The purpose of this procedure is to match the
cost of the resource with the revenue it generates. The usual method is to divide the total cost less
residual value by the estimated number of recoverable units to arrive at a depletion charge for
each unit removed. A change in the estimate of recoverable units will necessitate a revision of the
unit charge.

22. Exploration costs include expenditures for topographical and geophysical study exploratory drilling
and activities to evaluate the technical feasibility of extracting a mineral resource. Development
costs are exploration costs reclassified once technical feasibility and commercial viability of
production are demonstrated.

23. The maximum dividend permissible is the amount of accumulated net income (after depletion) plus
the amount of depletion charged. This practice can be justified for companies that expect to extract
natural resources and not purchase additional properties. In effect, such companies are distributing
gradually to stockholders their original investments.

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-9
Questions Chapter 11 (Continued)

24. Using full-cost accounting, the cost of unsuccessful ventures as well as those that are successful are
capitalized, because a cost of drilling a dry hole is a cost that is needed to find the commercially
profitable wells. Successful efforts accounting capitalizes only those costs related to successful
projects. They contend that to measure cost and effort accurately for a single property unit, the only
measure is in terms of the cost directly related to that unit. In addition, it is argued that full-cost is
misleading because capitalizing all costs will make an unsuccessful company over a short period of
time show no less income than does one that is successful.
25. The land should be reported on the statement of financial position at ¥20,000,000 and an
unrealized gain of ¥5,000,000 is reported as other comprehensive income in the statement of
comprehensive income.

26. A major reason most companies do not use revaluation accounting is the substantial and
continuing costs associated with appraisals to determine fair value. In addition, losses associated
with revaluation below historical cost decrease net income, while gains are not recorded in
income. However, revaluation increases result in higher depreciation expense and lower income.

27. Asset turnover:

£41
= .293 times
£140

Rate of return on assets:

£3
= 2.1%
£140

28. IFRS adheres to many of the same principles of U.S. GAAP in the accounting for property, plant,
and equipment. Key similarities are: (1) Under IFRS, capitalization of interest or borrowing costs
incurred during construction of assets can either be expensed or capitalized. Once certain criteria
are met, interest must be capitalized (this accounting has recently converged to U.S. GAAP;
(2) IFRS, like U.S. GAAP, capitalizes all direct costs in self-constructed assets. IFRS does not
address the capitalization of fixed overhead, although in practice, these costs are generally capitalized;
(3) The accounting for exchange of non-monetary assets has recently converged between IFRS
and U.S. GAAP. U.S GAAP now requires that gains on exchanges of non-monetary assets be
recognized if the exchange has commercial substance. This is the framework used in IFRS;
(4) IFRS also views depreciation as an allocation of cost over an asset’s life; IFRS permits the
same depreciation methods (straight-line, accelerated, units-of-production) as U.S. GAAP. Key
Difference: IFRS permits asset revaluations (which are not permitted in U.S. GAAP.) Conse-
quently, for the companies that use the revaluation framework, revaluation depreciation procedures
must be followed. According to IAS 16, if revaluation is used, it must be applied to all assets in a
class of assets and assets must be revalued on an annual basis.

29. While there is a single key difference, it is an important one–the issue of revaluations. With respect
to revaluations, the IASB and the FASB are working on a joint project to converge their conceptual
frameworks. One element of that project will examine the measurement bases used in accounting.
It is too early to say whether a converged conceptual framework will recommend fair value
measurement (and revaluation accounting for property, plant, and equipment.) However, this is
likely to be one of the more contentious issues, given the long-standing use of historical cost as a
measurement basis in U.S. GAAP.

11-10 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
Questions Chapter 11 (Continued)

*30. Mandive makes the following journal entries in year 1, assuming straight-line depreciation.

Depreciation Expense ................................................................................... 100,000

Accumulated Depreciation—Plant Assets ........................................ 100,000
To record depreciation expense in year 1

Accumulated Depreciation—Plant Assets .................................................... 100,000

Plant Assets....................................................................................... 40,000
Unrealized Gain on Revaluation—Equipment .................................. 60,000
To adjust the plant assets to fair value and record unrealized gain

Thus, there is a 2-step process. First, record depreciation based on the cost of $400,000. As a result,
depreciation expense of $100,000 is reported on the income statement. Secondly, the revaluation of
$60,000 which is the difference between the fair value of $360,000 and the book value of $300,000
is recorded.

Note to Instructor: The unrealized gain is reported in equity as a component of other comprehensive
income. Mandive now reports the following information at the end of year 1 for its plant assets:

Plant Assets ($400,000 – $40,000) .............................................................. $360,000

Accumulated depreciation—Plant assets ..................................................... –0–
Book value .................................................................................................... $360,000
Unrealized gain ............................................................................................. $ 60,000

As indicated, $360,000 is the new basis of the asset. Depreciation expense of $100,000 is reported
in the income statement and $60,000 is reported in other comprehensive income. The $60,000 of
other comprehensive income then is also reported as an unrealized gain in the statement of financial
position. Assuming no change in the useful life, depreciation in year 2 will be $120,000 ($360,000 ÷ 3).

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-11
 SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 11-1

($50,000 – $2,000) X 23,000

2015: = $6,900
160,000

($50,000 – $2,000) X 31,000

2016: = $9,300
160,000

BRIEF EXERCISE 11-2

€80,000 – €8,000
(a) = €9,000
8

€80,000 – €8,000
(b) X 4/12 = €3,000
8

BRIEF EXERCISE 11-3

(a) (€80,000 – €8,000) X 8/36* = €16,000

(b) [(€80,000 – €8,000) X 8/36] X 9/12 = €12,000

*[8(8 + 1)] ÷ 2

BRIEF EXERCISE 11-4

(a) €80,000 X 25%* = €20,000

(b) (€80,000 X 25%) X 3/12 = €5,000

*(1/8 X 2)

11-12 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
BRIEF EXERCISE 11-5

Depreciable Base = ($28,000 + $200 + $125 + $500 + $475) – $3,000 = $26,300.

BRIEF EXERCISE 11-6

Component Depreciation Expense

A (R$70,000 – R$7,000)/10 = R$ 6,300
B (R$50,000 – R$5,000)/5 = 9,000
C (R$82,000 – R$4,000)/12 = 6,500
R$21,800

BRIEF EXERCISE 11-7

Annual depreciation expense: (£8,000 – £1,000)/5 = £1,400

Book value, 1/1/16: £8,000 – (2 X £1,400) = £5,200
Depreciation expense, 2016: (£5,200 – £500)/2 = £2,350

BRIEF EXERCISE 11-8

Component Depreciation Expense

Building (HK$11,000,000 – 0) ÷ 40 = HK$275,000
15-year property (HK$ 150,000 – 0) ÷ 15 = 10,000
5-year property (HK$ 150,000 – 0) ÷ 5 = 30,000
HK$315,000

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-13
BRIEF EXERCISE 11-9

Impairment test:
Present value of future net cash flows* ($500,000) < Carrying amount
($520,000*); therefore, the asset has been impaired.

*$900,000 – $380,000

Journal entry:
Loss on Impairment ................................................. 20,000
Accumulated Depreciation—Machinery
($520,000 – $500,000) .................................... 20,000

*Used as recoverable amount because it is greater than fair value less costs
to sell.

BRIEF EXERCISE 11-10

Inventory ............................................................................. 73,500

Accumulated Depletion ........................................... 73,500

$400,000 + $100,000 + $80,000 – $160,000

= $105 per ton
4,000

700 X $105 = $73,500

BRIEF EXERCISE 11-11

(a) Accumulated Depreciation—Equipment ....... 100,000,000

Equipment ......................................................... 150,000,000
Unrealized Gain on Revaluation ........ 250,000,000

(b) Depreciation Expense

[(¥650,000,000 – 0) ÷ 4].................................. 162,500,000
Accumulated Depreciation—
Equipment ......................................... 162,500,000

11-14 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
BRIEF EXERCISE 11-12

(a) Asset turnover:

$7,867
= 1.109 times
$7,745 + $6,445
2

(b) Profit margin on sales:

$854
= 10.86%
$7,867

(c) Return on assets:

1. 1.109 X 10.86% = 12.04%

2. $854
= 12.04%
$7,745 + $6,445
2

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-15
 SOLUTIONS TO EXERCISES

EXERCISE 11-1 (15–20 minutes)

(a) Straight-line method depreciation for each of Years 1 through 3 =

£518,000 – £50,000
= £39,000
12

12 X 13
(b) Sum-of-the-Years’-Digits = = 78
2

12/78 X (£518,000 – £50,000) = £72,000 depreciation Year 1

11/78 X (£518,000 – £50,000) = £66,000 depreciation Year 2
10/78 X (£518,000 – £50,000) = £60,000 depreciation Year 3

(c) Double-Declining-Balance method 100%

X 2 = 16.67%
depreciation rate. 12

£518,000 X 16.67% = £86,351 depreciation Year 1

(£518,000 – £86,351) X 16.67% = £71,956 depreciation Year 2
(£518,000 – £86,351 – £71,956) X 16.67% = £59,961 depreciation Year 3

EXERCISE 11-2 (20–25 minutes)

(a) If there is any residual value and the amount is unknown (as is the case
here), the cost would have to be determined by looking at the data for
the double-declining balance method.

100%
= 20%; 20% X 2 = 40%
5

Cost X 40% = $20,000

$20,000 ÷ .40 = $50,000 Cost of asset

11-16 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
EXERCISE 11-2 (Continued)

(b) $50,000 cost [from (a)] – $45,000 total depreciation = $5,000 residual
value.

(c) The highest charge to income for Year 1 will be yielded by the double-
declining-balance method.

(d) The highest charge to income for Year 4 will be yielded by the straight-
line method.

(e) The method that produces the highest book value at the end of Year 3
would be the method that yields the lowest accumulated depreciation
at the end of Year 3, which is the straight-line method.

Computations:
St.-line = $50,000 – ($9,000 + $9,000 + $9,000) = $23,000 book value,
end of Year 3.
S.Y.D. = $50,000 – ($15,000 + $12,000 + $9,000) = $14,000 book value,
end of Year 3.
D.D.B. = $50,000 – ($20,000 + $12,000 + $7,200) = $10,800 book value,
end of Year 3.

(f) The method that will yield the highest gain (or lowest loss) if the asset
is sold at the end of Year 3 is the method which will yield the lowest
book value at the end of Year 3, which is the double-declining balance
method in this case.

EXERCISE 11-3 (15–20 minutes)

20 (20 + 1)
(a) = 210
2

3/4 X 20/210 X (€774,000 – €60,000) = €51,000 for 2015

1/4 X 20/210 X (€774,000 – €60,000) = €17,000

+ 3/4 X 19/210 X (€774,000 – €60,000) = 48,450
€65,450 for 2016

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-17
EXERCISE 11-3 (Continued)

100%
(b) = 5%; 5% X 2 = 10%
20

3/4 X 10% X €774,000 = €58,050 for 2015

10% X (€774,000 – €58,050) = €71,595 for 2016

EXERCISE 11-4 (15–25 minutes)

(a) $279,000 – $15,000 = $264,000; $264,000 ÷ 10 yrs. = $26,400

(b) $264,000 ÷ 240,000 units = $1.10; 25,500 units X $1.10 = $28,050

(c) $264,000 ÷ 25,000 hours = $10.56 per hr.; 2,650 hrs. X $10.56 = $27,984

n(n + 1) 10(11)
(d) 10 + 9 + 8 + 7 + 6 + 5 + 4 + 3 + 2 + 1 = 55 OR = = 55
2 2

10
X $264,000 X 1/3 = $16,000
55

9
X $264,000 X 2/3 = 28,800
55

Total for 2016 $44,800

(e) $279,000 X 20% X 1/3 = $18,600

[$279,000 – ($279,000 X 20%)] X 20% X 2/3 = 29,760

Total for 2016 $48,360

[May also be computed as 20% of ($279,000 – 2/3 of 20% of $279,000)]

11-18 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
EXERCISE 11-5 (20–25 minutes)

(€150,000 – €24,000)
(a) = €25,200/yr. = €25,200 X 5/12 = €10,500
5

2015 Depreciation—Straight line = €10,500

(€150,000 – €24,000)
(b) = €6.00/hr.
21,000

2015 Depreciation—Machine Usage = 800 X €6.00 = €4,800

(c) Machine Allocated to

Year Total 2015 2016
1 5/15 X €126,000 = €42,000 €17,500* €24,500**
2 4/15 X €126,000 = €33,600 14,000***
€17,500 €38,500
* €42,000 X 5/12 = €17,500
** €42,000 X 7/12 = €24,500
*** €33,600 X 5/12 = €14,000

2016 Depreciation—Sum-of-the-Years’-Digits = €38,500

(d) 2015 40% X (€150,000) X 5/12 = €25,000

2016 40% X (€150,000 – €25,000) = €50,000

OR

1st full year (40% X €150,000) = €60,000

2nd full year [40% X (€150,000 – €60,000)] = €36,000

2015 Depreciation = 5/12 X €60,000 = €25,000

2016 Depreciation = 7/12 X €60,000 = €35,000

5/12 X €36,000 = 15,000
€50,000

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-19
EXERCISE 11-6 (20–30 minutes)

$304,000 – $16,000
(a) 2015 Straight-line = $36,000/year
8

3 months—Depreciation ($36,000 X 3/12) = $9,000

$304,000 – $16,000
(b) 2015 Output = $7.20/output unit
40,000

1,000 units X $7.20 = $7,200

$304,000 – $16,000
(c) 2015 Working hours = $14.40/hour
20,000

525 hours X $14.40 = $7,560

n(n + 1) 8(9)
(d) 8 + 7 + 6 + 5 + 4 + 3 + 2 + 1 = 36 OR = = 36
2 2

Allocated to
Sum-of-the-years’-digits Total 2015 2016 2017
Year 1 8/36 X $288,000 = $64,000 $16,000 $48,000
2 7/36 X $288,000 = $56,000 14,000 $42,000
3 6/36 X $288,000 = $48,000 12,000
$16,000 $62,000 $54,000

2017: $54,000 = (9/12 of 2nd year of machine’s life plus 3/12 of 3rd year
of machine’s life)

(e) Double-declining-balance 2016: 1/8 X 2 = 25%.

2015: 25% X $304,000 X 3/12 = $19,000

2016: 25% X ($304,000 – $19,000) = $71,250

OR

1st full year (25% X $304,000) = $76,000

11-20 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
EXERCISE 11-6 (Continued)

2nd full year [25% X ($304,000 – $76,000)] = $57,000

2015 Depreciation 3/12 X $76,000 = $19,000

2016 Depreciation 9/12 X $76,000 = $57,000

3/12 X $57,000 = 14,250
$71,250

EXERCISE 11-7 (25–35 minutes)

Methods of Depreciation
Date Accum. Depr.
Description Purchased Cost Residual Life Method to 2015 2016 Depr.
A 2/12/14 $159,000 $16,000 10 (a) SYD $37,700 (b) $22,100
B 8/15/13 (c) 79,000 21,000 5 SL 29,000 (d) 11,600
C 7/21/12 88,000 28,500 8 DDB (e) 55,516 (f) 3,984
D (g) 10/12/14 219,000 69,000 5 SYD 70,000 (h) 35,000

Machine A—Testing the methods

(a) Straight-Line Method for 2014 $ 7,150 [($159,000 – $16,000) ÷
10] X 1/2
Straight-Line Method for 2015 $14,300
Total Straight Line $21,450

Double-Declining-Balance for 2014 $15,900 ($159,000 X .2 X .5)

Double-Declining-Balance for 2015 $28,620 [($159,000 – $15,900) X .2]
Total Double Declining Balance $44,520

Sum-of-the-Years-Digits for 2014 $13,000 [($159,000 – $16,000) X

10/55 X .5]
Sum-of-the-Years-Digits for 2015 $24,700 ($143,000 X 10/55 X 1/2) +
($143,000 X 9/55 X .5)
Total Sum-of-the-Years-Digits $37,700

Method used must be SYD

(b) Using SYD, 2016 Depreciation is $22,100 ($143,000 X 9/55 X 1/2) +
($143,000 X 8/55 X .5)

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-21
EXERCISE 11-7 (Continued)

Machine B—Computation of the cost

(c) Asset has been depreciated for 2 1/2 years using the straight-line
method.

Annual depreciation is then equal to $29,000 divided by 2 1/2 or $11,600.

11,600 times 5 plus the residual value is equal to the cost.
Cost is $79,000 [($11,600 X 5) + $21,000].

(d) Using SL, 2016 Depreciation is $11,600.

Machine C—Using the double-declining-balance method of depreciation

(e) 2012’s depreciation is $11,000 ($88,000 X .25 X .5)
2013’s depreciation is $19,250 ($88,000 – $11,000) X .25
2014’s depreciation is $14,438 ($88,000 – $30,250) X .25
2015’s depreciation is $10,828 ($88,000 – $44,688) X .25
Accumulated Depreciation
at 12/31/15 $55,516

(f) Using DDB, 2016 Depreciation is $3,984, which results in the carrying
value of the machine equal to the residual value.

Machine D—Computation of Year Purchased

(g) First Half Year using SYD = $25,000 [($219,000 – $69,000) X
5/15 X .5]
Second Year using SYD = $45,000 ($150,000 X 5/15 X .5) +
($150,000 X 4/15 X .5)
$70,000

Thus the asset must have been purchased on October 12, 2014

(h) Using SYD, 2016 Depreciation is $35,000 ($150,000 X 4/15 X .5) +

($150,000 X 3/15 X .5)

11-22 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
EXERCISE 11-8 (20–25 minutes)

Old Machine

June 1, 2013 Purchase ........................................ €31,800

Freight ............................................ 200
Installation ..................................... 500
Total cost .............................. €32,500

Annual depreciation charge: (€32,500 – €2,500) ÷ 10 = €3,000

On June 1, 2014, debit the old machine for €2,700 and reduce the book
value by €900; the revised total cost is €34,300 (€32,500 + €2,700 – €900);
thus the revised annual depreciation charge is: (€34,300 – €2,500 –
€3,000) ÷ 9 = €3,200.

Book value, old machine, June 1, 2017:

[€34,300 – €3,000 – (€3,200 X 3)] = ................................ € 21,700
Fair value ............................................................................ (20,000)
Loss on exchange ............................................................. 1,700
Cost of removal .................................................................. 75
Total loss ................................................................... € 1,775

(Note to instructor: The above computation is done to determine whether

there is a gain or loss from the exchange of the old machine with the new
machine and to show how the cost of removal might be reported.

New Machine
Basis of new machine Cash paid (€35,000 – €20,000) €15,000
Fair value of old machine 20,000
Installation cost 1,500
Total cost of new machine €36,500

Depreciation for the year beginning June 1, 2017 = (€36,500 – €4,000) ÷ 10 =

€3,250.

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-23
EXERCISE 11-9 (15–20 minutes)

(a) Estimated Depreciable Estimated Depreciation

Component Cost Residual Cost Life per Year
A ¥ 40,500 ¥ 5,500 ¥ 35,000 10 ¥ 3,500
B 33,600 4,800 28,800 9 3,200
C 36,000 3,600 32,400 8 4,050
D 19,000 1,500 17,500 7 2,500
E 23,500 2,500 21,000 6 3,500
¥152,600 ¥17,900 ¥134,700 ¥16,750

Depreciation Expense........................................................
16,750
Accumulated Depreciation—Equipment ............... 16,750

(b) Equipment ...........................................................................

40,000
Accumulated Depreciation—Equipment ......................... 19,200*
Loss on Disposal of Equipment ....................................... 14,400**
Equipment.................................................................. 33,600
Cash............................................................................ 40,000

*¥3,200 X 6 = ¥19,200
**¥33,600 – ¥19,200

EXERCISE 11-10 (10–15 minutes)

8X9
Sum-of-the-years’-digits = = 36
2

Using Y to stand for the years of remaining life:

Y/36 X (₺502,000 – ₺70,000) = ₺60,000
Multiplying both sides by 36:
₺432,000 X Y = ₺2,160,000
Y = ₺2,160,000 ÷ ₺432,000
Y=5
The year in which there are five remaining years of life at the beginning of
that given year is 2015.

11-24 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
EXERCISE 11-11 (10–15 minutes)

(a) No correcting entry is necessary because changes in estimate are

handled in the current and prospective periods.

(b) Revised annual charge

Book value as of 1/1/2016 [$52,000 – ($6,000 X 5)] = $22,000
Remaining useful life, 5 years (10 years – 5 years)
Revised residual value, $4,500
($22,000 – $4,500) ÷ 5 = $3,500

Depreciation Expense ........................................................3,500

Accumulated Depreciation—Equipment ............... 3,500

EXERCISE 11-12 (20–25 minutes)

(a) 1989–1998—(€1,900,000 – €60,000) ÷ 40 = €46,000/yr.

(b) 1999–2016—Building (€1,900,000 – €60,000) ÷ 40 = €46,000/yr.

Addition (€470,000 – €20,000) ÷ 30 = 15,000/yr.
€61,000/yr.

(c) No adjusting entry required.

(d) Revised annual depreciation

Building
Book value: (€1,900,000 – €1,288,000*) ............... €612,000
Residual value ......................................................... (60,000)
552,000
Remaining useful life ............................................. ÷ 32 years
Annual depreciation ............................................... € 17,250

*€46,000 X 28 years = €1,288,000

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-25
EXERCISE 11-12 (Continued)

Addition
Book value: (€470,000 – €270,000**) ................... €200,000
Residual value ......................................................... (20,000)
180,000
Remaining useful life ............................................. ÷ 32 years
Annual depreciation ............................................... € 5,625

**€15,000 X 18 years = €270,000

Annual depreciation expense—building (€17,250 + €5,625) €22,875

EXERCISE 11-13 (15–20 minutes)

(a) $2,400,000 ÷ 40 = $60,000

(b) Loss on Disposal of Plant Assets .................................... 90,000

Accumulated Depreciation—Buildings
($180,000 X 20/40) ...........................................................
90,000
Buildings .................................................................... 180,000

Buildings .............................................................................
300,000
Cash............................................................................ 300,000

Note: The most appropriate entry would be to remove the old roof and
record a loss on disposal, because the cost of the old roof is given.
Another alternative would be to debit Accumulated Depreciation on
the theory that the replacement extends the useful life of the building.
The entry in this case would be as follows:

Accumulated Depreciation—Buildings ........................... 300,000

Cash............................................................................ 300,000

As indicated, this approach does not seem as appropriate as the first

approach.

11-26 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
EXERCISE 11-13 (Continued)

(c) No entry necessary.

(d) (Assume the cost of the old roof is removed)

Building ($2,400,000 – $180,000 + $300,000) ......................... $2,520,000
Accumulated Depreciation ($60,000 X 20 – $90,000) ............ (1,110,000)
1,410,000
Remaining useful life ................................................................ ÷ 25 years
Depreciation—2016 ($1,410,000 ÷ 25) ..................................... $ 56,400

Note to Instructor:
If it is assumed that the cost of the new roof is
debited to Accumulated Depreciation:
Book value of the building prior to the replacement
of roof $2,400,000 – ($60,000 X 20) = ................................... $1,200,000
Cost of new roof ........................................................................ 300,000
$1,500,000
Remaining useful life ................................................................ ÷ 25 years
Depreciation—2016 ($1,500,000 ÷ 25) ..................................... $ 60,000

EXERCISE 11-14 (20–25 minutes)

(a) Maintenance and Repairs Expense.................................. 500

Equipment .................................................................. 500

(b) The proper ending balance in the asset account is:

January 1 balance ....................................... ¥133,000
Add: New equipment:
Purchases .............................................. ¥32,000
Freight .................................................... 700
Installation ............................................. 2,500
35,200
Less: Cost of equipment sold .................. 23,000
December 31 balance ................................. ¥145,200

(1) Straight-line: ¥145,200 ÷ 10 = ¥14,520

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-27
EXERCISE 11-14 (Continued)

(2) Sum-of-the-years’-digits: 10 + 9 + 8 + 7 + 6 + 5 + 4 + 3 + 2 + 1 = 55

n(n + 1) 10(11)
OR = = 55
2 2

For equipment purchased in 2014: ¥110,000 (¥133,000 – ¥23,000) of

the cost of equipment purchased in 2014, is still on hand.
8/55 X ¥110,000 = ......................................................... ¥16,000
For equipment purchased in 2016: 10/55 X ¥35,200 = ...... 6,400
Total ............................................................................... ¥22,400

EXERCISE 11-15 (25–35 minutes)

(a) 2011–2016
2010 Incl. 2017 Total
(1) $240,000 – $21,000 = $219,000
$219,000 ÷ 12 = $18,250
per yr. ($50 per day)
133*/365 of $18,250 = $ 6,650
2011–2016 Include. (6 X $18,250) $109,500
68/365 of $18,250 = $ 3,400 $119,550
(2) 0 109,500 18,250 127,750
(3) 18,250 109,500 0 127,750
(4) 9,125 109,500 9,125 127,750
(5) 4/12 of $18,250 6,083
2011–2016 Inc. 109,500
3/12 of $18,250 4,563 120,146
(6) 0 109,500 0 109,500
*(11 + 30 + 31 + 30 + 31)

(b) The most accurate distribution of cost is given by methods 1 and 5 if

it is assumed that straight-line depreciation is satisfactory. Reasonable
accuracy is normally given by 2, 3, or 4. The simplest of the applica-
tions are 6, 2, 3, 4, 5, and 1, in about that order. Methods 2, 3, and 4
combine reasonable accuracy with simplicity of application.

11-28 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
EXERCISE 11-16 (10–15 minutes)

(a) (€50,000 – 0) ÷ 10 = €5,000

(b) Component Depreciation Expense

Tires (€ 6,000 – 0) ÷ 2 = €3,000
Transmission (€10,000 – 0) ÷ 5 = 2,000
Tractor (€34,000 – 0) ÷ 10 = 3,400
€8,400

(c) A company would want to use component depreciation if it believed

this method produced more accurate results.

EXERCISE 11-17 (10–15 minutes)

(a) Component Depreciation Expense

Building structure €4,200,000 ÷ 60 = € 70,000
Building engineering 2,100,000 ÷ 30 = 70,000
Building external works 700,000 ÷ 30 = 23,333
€163,333

(b) Building Engineering ....................................... 2,300,000

Accumulated Depreciation—Building
Engineering (€2,100,000 X 20/30) ............... 1,400,000
Loss on Disposal of Plant Assets .................. 700,000
Building Engineering ............................ 2,100,000
Cash ........................................................ 2,300,000

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-29
EXERCISE 11-18 (10–15 minutes)

(a) December 31, 2015

Loss on Impairment ...........................................................
1,000,000
Accumulated Depreciation—Equipment ............... 1,000,000

Cost .................................................. €9,000,000

Accumulated depreciation ............ (1,000,000)
Carrying amount ............................. 8,000,000
Recoverable amount* .................... (7,000,000)
Loss on impairment ....................... €1,000,000
*Larger of value in use and fair value less cost of disposal.

(b) December 31, 2016

Depreciation Expense........................................................
1,750,000
Accumulated Depreciation—Equipment ............... 1,750,000

New carrying amount ..................... €7,000,000

Useful life ........................................ ÷ 4 years
Depreciation per year .................... €1,750,000

(c) Accumulated Depreciation—Equipment ................ 750,000

Recovery of Impairment Loss ..................... 750,000
(€6,000,000 – [€7,000,000 – €1,750,000])

EXERCISE 11-19 (15–20 minutes)

(a) Loss on Impairment ...........................................................

3,600,000
Accumulated Depreciation—Equipment ............... 3,600,000

Cost .................................................. €9,000,000

Accumulated depreciation ............ (1,000,000)
Carrying amount ............................. 8,000,000
Less: Recoverable amount .......... 4,400,000
Loss on impairment ....................... €3,600,000

11-30 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
EXERCISE 11-19 (Continued)

(b) No entry necessary. Depreciation is not taken on assets intended to

be sold.
(c) Accumulated Depreciation—Equipment ....... 680,000
Recovery of Loss on Impairment.......... 680,000
Fair value ........................................................... €5,100,000
Less: Cost of disposal .................................... 20,000 5,080,000
Carrying amount ............................................... (4,400,000*)
Recovery of impairment loss .......................... € 680,000
*(€9,000,000 – €1,000,000 – €3,600,000)

EXERCISE 11-20 (15–20 minutes)

(a) December 31, 2015

Loss on Impairment ...........................................................
200,000
Accumulated Depreciation—Equipment ............... 200,000

Cost .................................................. $900,000

Accumulated depreciation ............ (400,000)
Carrying amount ............................. 500,000
Recoverable amount ...................... (300,000*)
Loss on impairment ....................... $200,000

*Use $300,000 (value-in-use) because it is greater than fair value less

cost of disposal.

(b) It should be reported in the other income and expense section in the
income statement.
(c) Accumulated Depreciation—Equipment ................. 45,000
Recovery of Impairment Loss
[$270,000 – ($300,000 – $75,000)]..................... 45,000

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-31
EXERCISE 11-20 (Continued)

(d) To determine whether an asset is impaired, on an annual basis,

companies review the asset for indicators of impairment—that is, a
decline in the asset’s cash-generating ability through use or sale. If
impairment indicators are present, then the company compares the
asset’s recoverable amount with its carrying amount. If the carrying
amount is higher than the recoverable amount, the difference is an
impairment loss. Recoverable amount is defined as the higher of fair
value less costs to sell or value-in-use.

EXERCISE 11-21 (10–15 minutes)

Cost per barrel of oil:

€600,000
Initial payment = = €2.40
250,000
€31,500
Rental = = 1.75
18,000

Premium, 5% of €65 = 3.25

€30,000
Reconditioning of land = = .12
250,000
Total cost per barrel €7.52

EXERCISE 11-22 (15–20 minutes)

Depletion base: €1,250,000 + €90,000 – €100,000 + €200,000 = €1,440,000

Depletion rate: €1,440,000 ÷ 60,000 = €24/ton

(a) Per unit mineral cost: €24/ton

(b) 12/31/15 inventory: €24 X 6,000 tons = €144,000
(c) Cost of goods sold 2015: €24 X 24,000 tons = €576,000

11-32 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
EXERCISE 11-23 (15–20 minutes)

(a) $850,000 + $170,000 + $40,000* – $100,000 = $.08 depletion per unit

12,000,000

*Note to instructor: The $40,000 should be depleted because it is an

environmental liability provision.

2,500,000 units extracted X $.08 = $200,000 depletion for 2015

(b) 2,200,000 units sold X $.08 = $176,000 charged to cost of goods sold
for 2015

EXERCISE 11-24 (10–15 minutes)

During 2015
Land .............................................................................. 300,000
Cash ..................................................................... 300,000

December 31, 2015

Land .............................................................................. 20,000
Unrealized Gain on Revaluation—Land ........... 20,000

December 31, 2016

Unrealized Gain on Revaluation—Land ................... 20,000
Loss on Impairment .................................................... 20,000
Land...................................................................... 40,000

December 31, 2017

Land .............................................................................. 25,000
Recovery of Impairment Loss ........................... 20,000
Unrealized Gain on Revaluation—Land ........... 5,000

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-33
EXERCISE 11-25 (10–15 minutes)

Accumulated Other Other

Value at Comprehensive Comprehensive Recognized in
December 31 Income Income Net Income
2013 ¥50,000 ¥50,000 —
2014 — (50,000) (¥40,000)
2015 — — 25,000
2016 10,000 10,000 15,000
2017 60,000 50,000 —

EXERCISE 11-26 (15–20 minutes)

December 31, 2013

Land (¥450,000 – ¥400,000) ........................................ 50,000
Unrealized Gain on Revaluation—Land........... 50,000

December 31, 2014

Unrealized Gain on Revaluation—Land ................... 50,000
Loss on Impairment (¥400,000 – ¥360,000) ............. 40,000
Land (¥450,000 – ¥360,000) ............................... 90,000

December 31, 2015

Land (¥385,000 – ¥360,000) ........................................ 25,000
Recovery of Impairment Loss ........................... 25,000

December 31, 2016

Land (¥410,000 – ¥385,000) ........................................ 25,000
Recovery of Impairment Loss
(¥40,000 – ¥25,000) .......................................... 15,000
Unrealized Gain on Revaluation—Land........... 10,000

December 31, 2017

Land (¥460,000 – ¥410,000) ........................................ 50,000
Unrealized Gain on Revaluation—Land........... 50,000

11-34 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
EXERCISE 11-27 (10–15 minutes)

(a) January 1, 2014

Equipment ................................................................ 12,000
Cash ................................................................. 12,000

December 31, 2014

Depreciation Expense ............................................ 2,000
Accumulated Depreciation—Equipment ..... 2,000

(b) December 31, 2015

Depreciation Expense ............................................ 2,000
Accumulated Depreciation—Equipment ..... 2,000

Accumulated Depreciation—Equipment.............. 4,000

Loss on Impairment ................................................ 1,000
Equipment (€12,000 – €7,000) ....................... 5,000

(c) Depreciation expense—2016: (€12,000 – €5,000) ÷ 4 = €1,750

EXERCISE 11-28 (15–20 minutes)

(a) Asset turnover:

£10,301
= .736 times
£13,659 + £14,320
2

(b) Return on assets:

£676
= 4.83%
£13,659 + £14,320
2

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-35
EXERCISE 11-28 (Continued)

(c) Profit margin on sales:

£676
= 6.56%
£10,301

(d) The asset turnover times the profit margin on sales provides the
return on assets computed for Eastman as follows:

Profit margin on sales X Asset Turnover Return on Assets

6.56% X .736 = 4.83%

Note the answer 4.83% is the same as the return on assets computed
in (b) above.

*EXERCISE 11-29 (20–25 minutes)

(a) December 31, 2013

Depreciation Expense ............................................. 1,000
Accumulated Depreciation—Equipment ...... 1,000

December 31, 2014

Depreciation Expense ............................................. 1,000
Accumulated Depreciation—Equipment ...... 1,000

Accumulated Depreciation—Equipment............... 2,000

Equipment (¥10,000 – ¥8,800) ........................ 1,200
Unrealized Gain on Revaluation—
Equipment .................................................... 800

11-36 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
EXERCISE 11-29 (Continued)

December 31, 2015

Depreciation Expense (¥8,800 ÷ 8) ....................... 1,100
Accumulated Depreciation—Equipment ..... 1,100

Accumulated Other Comprehensive Income ...... 100

Retained Earnings (¥1,100 – ¥1,000) ............ 100

December 31, 2016

Depreciation Expense ............................................ 1,100
Accumulated Depreciation—Equipment ..... 1,100

Accumulated Other Comprehensive Income ...... 100

Retained Earnings .......................................... 100

Accumulated Depreciation—Equipment
(¥1,100 X 2) .......................................................... 2,200
Loss on Impairment ................................................ 1,000
Unrealized Gain on Revaluation
(¥800 – ¥100 – ¥100) ........................................... 600
Equipment (¥8,800 – ¥5,000) ......................... 3,800

(b) Su would probably not use revaluation accounting for assets whose fair
value is lower than their carrying value. When the fair value of property
and buildings is less than their carrying value, the difference must be
reported as a loss on impairment which reduces reported net income.

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-37
 TIME AND PURPOSE OF PROBLEMS
Problem 11-1 (Time 25–30 minutes)
Purpose—to provide the student with an opportunity to compute depreciation expense using a number
of different depreciation methods. The problem is complicated because the proper cost of the machine
to be depreciated must be determined. For example, purchase discounts and freight charges must be
considered. In addition, the student is asked to select a depreciation method that will allocate less
depreciation in the early years of the machine’s life than in the later years.

Problem 11-2 (Time 25–35 minutes)

Purpose—to provide the student with an opportunity to compute depreciation expense using the
following methods: straight-line, units-of-output, working hours, sum-of-the-years’-digits, and declining
balance. The problem is straightforward and provides an excellent review of the basic computational
issues involving depreciation methods.

Problem 11-3 (Time 40–50 minutes)

Purpose—to provide the student with an opportunity to compute depreciation expense using a number
of different depreciation methods. Before the proper depreciation expense can be computed, the accounts
must be corrected for a number of errors made by the company in its accounting for the assets. An
excellent problem for reviewing the proper accounting for plant assets and related depreciation expense.

Problem 11-4 (Time 45–60 minutes)

Purpose—to provide the student with an opportunity to correct the improper accounting for trucks and
determine the proper depreciation expense. The student is required to compute separately the errors
arising in determining or entering depreciation or in recording transactions affecting Semitrucks.

Problem 11-5 (Time 25–35 minutes)

Purpose—to provide the student with a comprehensive problem related to property, plant, and
equipment. The student must determine depreciable bases for assets, including capitalized interest,
and prepare depreciation entries using various methods of depreciation.

Problem 11-6 (Time 45–60 minutes)

Purpose—to provide the student with an opportunity to solve a complex problem involving a number of
plant assets. A number of depreciation computations must be made, specifically straight-line, 150%
declining balance, and sum-of-the-years’-digits. In addition, the cost of assets acquired is difficult to
determine.

Problem 11-7 (Time 30–35 minutes)

Purpose—to provide the student with the opportunity to solve a moderate problem involving a machinery
purchase and the depreciation computations using straight-line, activity, sum-of-the-years’-digits, and
the double-declining-balance methods, first for full periods and then for partial periods.

Problem 11-8 (Time 25–35 minutes)

Purpose—to provide the student with an opportunity to compute depreciation expense using a number
of different depreciation methods. The purpose of computing the depreciation expense is to determine
which method will result in the maximization of net income and which will result in the minimization of
net income over a three-year period. An excellent problem for reviewing the fundamentals of depreciation
accounting.

Problem 11-9 (Time 15–25 minutes)

Purpose—to provide the student with an opportunity to analyze impairments for assets to be used and
assets to be disposed of.

11-38 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
Time and Purpose of Problems (Continued)

Problem 11-10 (Time 30–35 minutes)

Purpose—to provide the student with an opportunity to compute the amount of an impairment loss. The
student is also required to prepare journal entries to record an impairment loss and a reversal of an
impairment loss.

Problem 11-11 (Time 15–20 minutes)

Purpose—to provide the student with a problem involving depletion and computation of profit or loss.
The student is asked to explain how to account for exploration and evaluation costs.

Problem 11-12 (Time 25–30 minutes)

Purpose—to provide the student with a problem involving the computation of estimated depletion and
depreciation costs associated with a tract of mineral land. The student must compute depletion and de-
preciation on a units-of-production basis (tons mined). A portion of the cost of machinery associated
with the product must be allocated over different periods. The student may experience some difficulty
with this problem.

*Problem 11-13 (Time 20–25 minutes)

Purpose—to provide the student with the opportunity to record land revaluation adjustments for 3 years.
The student is also required to determine the amount of other comprehensive income, impairment loss,
and accumulated other comprehensive income for 2 years.

*Problem 11-14 (Time 25–35 minutes)

Purpose—to provide the student with an opportunity to record equipment revaluation adjustments for
3 years. The student is also required to determine the amount of other comprehensive income,
depreciation expense, impairment loss, and accumulated other comprehensive income for 2 years.

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-39
 SOLUTIONS TO PROBLEMS

PROBLEM 11-1

(a) 1. Depreciable Base Computation:

Purchase price ................................ $85,000
Less: Purchase discount (2%) ...... 1,700
Freight-in .......................................... 800
Installation ....................................... 3,800
Cost .................................................. 87,900
Less: Residual value ..................... 1,500
Depreciation base ........................... $86,400

2015—Straight line: ($86,400 ÷ 8 years) X 2/3 year = $7,200

2. Sum-of-the-years’-digits for 2016

Total
Machine Year Depreciation 2015 2016
1 8/36 X $86,400 = $19,200 $12,800* $ 6,400**
2 7/36 X $86,400 = $16,800 11,200***
$17,600

* $19,200 X 2/3 = $12,800

** $19,200 X 1/3 = $6,400
*** $16,800 X 2/3 = $11,200

3. Double-declining-balance for 2015

($87,900 X 25% X 2/3) = $14,650

(b) An activity method.

11-40 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
 PROBLEM 11-2

Depreciation Expense
2015 2016
(a) Straight-line:
(€89,000 – €5,000) ÷ 7 = €12,000/yr.
2015: €12,000 X 7/12 €7,000
2016: €12,000 €12,000

(b) Units-of-output:
(€89,000 – €5,000) ÷ 525,000 units = €.16/unit
2015: €.16 X 55,000 8,800
2016: €.16 X 48,000 7,680

(c) Working hours:

(€89,000 – €5,000) ÷ 42,000 hrs. = €2.00/hr.
2015: €2.00 X 6,000 12,000
2016: €2.00 X 5,500 11,000

(d) Sum-of-the-years’-digits:

1 + 2 + 3 + 4 + 5 + 6 + 7 = 28 or n(n + 1) = 7(8) = 28
2 2

2015: 7/28 X €84,000 X 7/12 12,250

2016: 7/28 X €84,000 X 5/12 = € 8,750
6/28 X €84,000 X 7/12 = 10,500
€19,250 19,250

(e) Declining-balance:
Rate = 2/7
2015: 7/12 X 2/7 X €89,000 14,833
2016: 2/7 X (€89,000 – €14,833) = €21,191
OR
2016: 5/12 X 2/7 X €89,000 = €10,595
2/7 X (€89,000 – €25,428)
X 7/12 10,595
€21,190* 21,190
*Difference due to rounding.

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-41
 PROBLEM 11-3

(a) Depreciation Expense........................................................ 3,900

Accumulated Depreciation—Asset A
(5/55 X [£46,000 – £3,100]) .................................... 3,900

Accumulated Depreciation—Asset A .............................. 35,100

Asset A (£46,000 – £13,000) ..................................... 33,000
Gain on Disposal of Plant Assets ........................... 2,100

(b) Depreciation Expense........................................................ 6,720

Accumulated Depreciation—Asset B
([£51,000 – £3,000] ÷ [15,000 X 2,100]) ................ 6,720

(c) Depreciation Expense........................................................ 6,000

Accumulated Depreciation—Asset C
([£80,000 – £15,000 – £5,000] ÷ 10) ...................... 6,000

(d) Asset E .................................................................................

28,000
Retained Earnings .................................................... 28,000

Depreciation Expense........................................................5,600*
Accumulated Depreciation—Asset E ..................... 5,600

*(£28,000 X .20)

Note: No correcting entry is needed for asset D. In 2015, Eshkol

records depreciation expense of £80,000 X (10% X 2) = £16,000.

11-42 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
 (a) Per Company Books As Adjusted Net

Retained Acc. Dep., Retained Income

Acc. Dep.
Trucks Earnings Trucks Semitrucks Earnings Overstated
Semitrucks
dr. (cr.) dr. (cr.) dr. (cr.) dr, (cr.) dr, (cr.) (Understated)
dr. (cr.)

1/1/13 Balance ¥ 94,000 ¥(30,200) ¥94,000 ¥(30,200)

7/1/13 Purchase Truck #5 22,000 40,000

1
Trade Truck #3 (30,000) 9,000 ¥ 3,000 ¥ 3,000
2
12/31/13 Depreciation ________ (21,000) ¥21,000 _______ (19,800) 19,800 (1,200)
12/31/13 Balances 116,000 (51,200) 21,000 104,000 (41,000) 22,800 1,800

Copyright © 2014 John Wiley & Sons, Inc.

3
1/1/14 Sale of Truck #1 (3,500) (18,000) 14,400 100 100
4
12/31/14 Depreciation ________ (22,500) 22,500 _______ (17,200) 17,200 (5,300)
12/31/14 Balances 112,500 (73,700) 43,500 86,000 (43,800) 40,100 (3,400)

7/1/15 Purchase of Truck #6 42,000 42,000

5
7/1/15 Disposal of Truck #4 (2,500) (700) (24,000) 14,400 6,400 7,100
6
12/31/15 Depreciation ________ (25,050) 25,050 _______ (16,800) 16,800 (8,250)
PROBLEM 11-4

12/31/15 Balances 152,000 (98,750) 67,850 104,000 (46,200) 63,300 (4,550)

Kieso, IFRS, 2/e, Solutions Manual

7
12/31/16 Depreciation ________ (30,400) 30,400 _______ (16,400) 16,400 (14,000)
12/31/16 Balances ¥152,000 ¥(129,150) ¥98,250 ¥104,000 ¥(62,600) ¥79,700 ¥(18,550)
Income effect
1
Implied fair value of Truck #3 (¥40,000 – ¥22,000) ¥ 18,000
Book value of Truck #3 [¥30,000 – (¥30,000/5 X 1 1/2 yrs.)] = ¥30,000 – ¥9,000 = 21,000
Loss on Trade ¥ 3,000

2
Truck #1: $18,000/5 = ¥ 3,600

(For Instructor Use Only)

Truck #2: $22,000/5 = 4,400
Truck #3: $30,000/5 X 1/2 = 3,000
Truck #4:$24,000/5 = 4,800
Truck #5: $40,000/5 X 1/2 = 4,000
Total ¥19,800

11-43
PROBLEM 11-4 (Continued)

Book value of Truck #1 [¥18,000 – (¥18,000/5 X 4 yrs.)] =

3

¥18,000 – ¥14,400 ................................................................ = ¥3,600

Cash received on sale ................................................................. = (3,500)
Loss on sale ........................................................................ ¥ 100

4
Truck #2: ¥22,000/5 = ¥4,400
Truck #4: ¥24,000/5 = 4,800
Truck #5: ¥40,000/5 = 8,000
Total ¥17,200

Book value of Truck #4 ¥24,000 – [(¥24,000/5 X 3 yrs.)] ........

5
= ¥9,600
Cash received (¥700 + ¥2,500) .................................................... = (3,200)
Loss on disposal ................................................................ ¥6,400

6
Truck #2: ¥22,000/5 X 1/2 = ¥ 2,200
Truck #4: ¥24,000/5 X 1/2 = 2,400
Truck #5: ¥40,000/5 8,000
Truck #6: ¥42,000/5 X 1/2 = 4,200
Total ¥16,800

7
Truck #2: (fully dep.) = ¥ 0
Truck #5: ¥40,000/5 = 8,000
Truck #6: ¥42,000/5 = 8,400
Total ¥16,400

(b) Compound journal entry December 31, 2016:

Accumulated Depreciation—Trucks ........................ 66,550
Trucks................................................................. 48,000
Retained Earnings ............................................ 4,550
Depreciation Expense 2016 ............................. 14,000

11-44 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
PROBLEM 11-4 (Continued)

Summary of Adjustments:

Per As Adjustment
Books Adjusted Dr. or (Cr.)
Trucks ¥152,000 ¥104,000 ¥(48,000)
Accumulated Depreciation ¥129,150 ¥ 62,600 ¥ 66,550
Prior Years’ Income
Retained Earnings, 2013 ¥ 21,000 ¥ 22,800 ¥ 1,800
Retained Earnings, 2014 22,500 17,300 (5,200)
Retained Earnings, 2015 24,350 23,200 (1,150)
Totals ¥ 67,850 ¥ 63,300 ¥ (4,550)
Depreciation Expense, 2016 ¥ 30,400 ¥ 16,400 ¥(14,000)

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-45
 PROBLEM 11-5

(a) The amounts to be recorded on the books of Darby Sporting Goods

Inc. as of December 31, 2015, for each of the properties acquired from
Quay Athletic Equipment Company are calculated as follows:

Cost Allocations to Acquired Properties

Remaining
Purchase
Appraisal Price Capitalized
Value Allocations Renovations Interest Total
(1) Land £290,000 £290,000
(2) Building £ 77,0001 £100,000 £21,0002 198,000
(3) Machinery 33,0001 33,000
Totals £290,000 £110,000 £100,000 £21,000 £521,000

Supporting Calculations

1
Balance of purchase price to be allocated.
Total purchase price ............................................................. £400,000
Less: Land appraisal............................................................ 290,000
Balance to be allocated ............................................... £110,000

Appraisal Allocated
Values Ratios Values
Building £105,000 105/150 = .70 X £110,000 £ 77,000
Machinery 45,000 45/150 = .30 X £110,000 33,000
Totals £150,000 1.00 £110,000

11-46 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
PROBLEM 11-5 (Continued)

2
Capitalizable interest.
Expenditures Capitalization Weighted-Average
Date Amount Period Accumulated Expenditures
1/1 £ 50,000 12/12 £ 50,000
4/1 120,000 9/12 90,000
10/1 140,000 3/12 35,000
12/31 190,000 0/12 –0–
£500,000 £175,000

Weighted-Average Interest Avoidable

Accumulated Expenditures Rate Interest
£175,000 X 12% = £21,000

Note to instructor: If the interest is allocated between the building and the
machinery, £14,700 (£21,000 X 105/150) would be allocated to the building
and £6,300 (£21,000 X 45/150) would be allocated to the machinery.

(b) Darby Sporting Goods Inc.’s 2016 depreciation expense, for book
purposes, for each of the properties acquired from Quay Athletic
Equipment Company is as follows:

1. Land: No depreciation.

2. Building: Depreciation rate = 1.50 X 1/15 = .10

2016 depreciation expense = Cost X Rate X 1/2 year
= £198,000 X .10 X 1/2
= £9,900

3. Machinery: Depreciation rate = 2.00 X 1/5 = .40

2016 depreciation expense = Cost X Rate X 1/2
= £33,000 X .40 X 1/2
= £6,600

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-47
PROBLEM 11-5 (Continued)

(c) Arguments for the capitalization of interest costs include the following.
1. Diversity of practices among companies and industries called for
standardization in practices.
2. Total interest costs should be allocated to enterprise assets and
operations, just as material, labor, and overhead costs are allo-
cated. That is, under the concept of historical costs, all costs
incurred to bring an asset to the condition and location necessary
for its intended use should be reflected as a cost of that asset.

Arguments against the capitalization of interest include the following:

1. Interest capitalized in a period would tend to be offset by amorti-
zation of interest capitalized in prior periods.
2. Interest cost is a cost of financing, not of construction.

(d) If Darby decides to use revaluation accounting for this building, then
revaluation applies to all assets in that class of assets. Darby cannot
selectively apply revaluation accounting to certain buildings but keep
others at historical cost.

Darby should use revaluation accounting if they want to increase their

equity base to help them meet covenant requirements or provide
additional assurances to investors and creditors that the company is
solvent.

Darby should not use revaluation accounting because of the continuing

costs associated with appraisals to determine fair value. In addition,
losses associated with revaluations decrease net income but gains
associated with revaluations are not reported in net income but instead
go directly to equity.

11-48 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
 PROBLEM 11-6

(1) $80,000 Allocated in proportion to appraised values

(1/10 X $800,000).

(2) $720,000 Allocated in proportion to appraised values

(9/10 X $800,000).

(3) Fifty years Cost less residual ($720,000 – $40,000) divided by

annual depreciation ($13,600).

(4) $13,600 Same as prior year since it is straight-line depreciation.

(5) $91,000 [Number of shares (2,500) times fair value ($30)]

plus demolition cost of existing building ($16,000).

(6) None No depreciation before use.

(7) $40,000 Fair value.

(8) $6,000 Cost ($40,000) times percentage (1/10 X 150%).

(9) $5,100 Cost ($40,000) less prior year’s depreciation ($6,000)

equals $34,000. Multiply $34,000 times 15%.

(10) $168,000 Total cost ($182,900) less repairs and maintenance

($14,900).

(11) $36,000 Cost less residual ($168,000 – $6,000) times 8/36.

(12) $10,500 Cost less residual ($168,000 – $6,000) times 7/36 times
one-third of a year.

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-49
PROBLEM 11-6 (Continued)

(13) $52,000 Annual payment ($6,000) times present value of annuity

due at 8% for 11 years (7.710) plus down payment ($5,740).
This can be found in an annuity due table since the
payments are at the beginning of each year. Alternatively,
to convert from an ordinary annuity to an annuity due
factor, proceed as follows: For eleven payments use the
present value of an ordinary annuity for 11 years (7.139)
times 1.08. Multiply this factor (7.710) times $6,000 annual
payment to obtain $46,260, and then add the $5,740
down payment.

(14) $2,600 Cost ($52,000) divided by estimated life (20 years).

11-50 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
 PROBLEM 11-7

$90,000 – $6,000
(a) 1. Straight-line Method: = $16,800 a year
5 years

$90,000 – $6,000
2. Activity Method: = $.84 per hour
100,000 hours

Year 2013 20,000 hrs. X $.84 = $16,800

2014 25,000 hrs. X $.84 = 21,000
2015 15,000 hrs. X $.84 = 12,600
2016 30,000 hrs. X $.84 = 25,200
2017 10,000 hrs. X $.84 = 8,400

3. Sum-of-the-Years’-Digits: 5 + 4 + 3 + 2 + 1 = 15

Year 2013 5/15 X ($90,000 – $6,000) = $28,000

2014 4/15 X $84,000 = 22,400
2015 3/15 X $84,000 = 16,800
2016 2/15 X $84,000 = 11,200
2017 1/15 X $84,000 = 5,600

4. Double-Declining-Balance Method: Each year is 20% of its total

life. Double the rate to 40%.

Year 2013 40% X $90,000 = $36,000

2014 40% X ($90,000 – $36,000) = 21,600
2015 40% X ($90,000 – $57,600) = 12,960
2016 40% X ($90,000 – $70,560) = 7,776
2017 Enough to reduce to salvage = 5,664

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-51
PROBLEM 11-7 (Continued)

(b) 1. Straight-line Method:

$90,000 – $6,000
Year 2013 X 9/12 = $12,600
5 years
2014 Full year 16,800
2015 Full year 16,800
2016 Full year 16,800
2017 Full year 16,800
2018 Full year X 3/12 year = 4,200

2. Sum-of-the-Years’-Digits:

2013 (5/15 X $84,000) X 9/12 = $21,000

2014 (5/15 X $84,000) X 3/12 = $ 7,000

(4/15 X $84,000) X 9/12 = 16,800 23,800

2015 (4/15 X $84,000) X 3/12 = 5,600

(3/15 X $84,000) X 9/12 = 12,600 18,200

2016 (3/15 X $84,000) X 3/12 = 4,200

(2/15 X $84,000) X 9/12 = 8,400 12,600

2017 (2/15 X $84,000) X 3/12 = 2,800

(1/15 X $84,000) X 9/12 = 4,200 7,000

2018 (1/15 X $84,000) X 3/12 = 1,400

11-52 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
PROBLEM 11-7 (Continued)

3. Double-Declining-Balance Method:

Accum. Book
Depr. at Value at
beg. of beg. of Depr.
Year Cost Year Year Expense
2013 $90,000 — $90,000 $27,000 (1)
2014 90,000 $27,000 63,000 25,200 (2)
2015 90,000 52,200 37,800 15,120 (3)
2016 90,000 67,320 22,680 9,072 (4)
2017 90,000 76,392 13,608 5,443 (5)
2018 90,000 81,835 8,165 2,165 (6)

(1) $90,000 X 40% X 9/12

(2) ($90,000 – $27,000) X 40%
(3) ($90,000 – $52,200) X 40%
(4) ($90,000 – $67,320) X 40%
(5) ($90,000 – $76,392) X 40%
(6) to reduce to $6,000 residual value.

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-53
 PROBLEM 11-8

The straight-line method would provide the highest total net income for
financial reporting over the three years, as it reports the lowest total
depreciation expense. These computations are provided below.

Computations of depreciation expense and accumulated depreciation under

various assumptions:

(1) Straight-line:

R$1,260,000 – R$60,000 = R$240,000

5 years

Depreciation Accumulated
Year Expense Depreciation
2014 R$240,000 R$240,000
2015 240,000 R$480,000
2016 240,000 R$720,000
R$720,000

(2) Double-declining-balance:

Depreciation Accumulated
Year Expense Depreciation
2014 R$504,000 (40% X R$1,260,000) R$504,000
2015 302,400 (40% X R$756,000) R$806,400
2016 181,440 (40% X R$453,600) R$987,840
R$987,840

(3) Sum-of-the-years’-digits:

Depreciation Accumulated
Year Expense Depreciation
2014 R$400,000 (5/15 X R$1,200,000) R$400,000
2015 320,000 (4/15 X R$1,200,000) R$720,000
2016 240,000 (3/15 X R$1,200,000) R$960,000
R$960,000

11-54 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
PROBLEM 11-8 (Continued)

(4) Units-of-output:

Depreciation Accumulated
Year Expense Depreciation
2014 R$288,000 (R$24* X 12,000) R$288,000
2015 264,000 (R$24 X 11,000) R$552,000
2016 240,000 (R$24 X 10,000) R$792,000
R$792,000

*R$1,200,000 ÷ 50,000 (total units) = R$24 per unit

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-55
 PROBLEM 11-9

(a) Carrying value of asset: €10,000,000 – €2,500,000* = €7,500,000.

*(€10,000,000 ÷ 8) X 2

Recoverable amount (€5,600,000) < Carrying value (€7,500,000)

Impairment entry:
Loss on Impairment ........................................ 1,900,000*
Accumulated Depreciation—
Equipment ........................................... 1,900,000
*€7,500,000 – €5,600,000

(b) Depreciation Expense ..................................... 1,400,000**

Accumulated Depreciation—
Equipment ........................................... 1,400,000
**(€5,600,000 ÷ 4)

Accumulated Depreciation—Equipment ...... 700,000

Recovery of Impairment Loss .............. 700,000
€4,900,000 – (€5,600,000 –
€1,400,000)

(c) No depreciation is recorded on impaired assets to be disposed of.

Recovery of impairment losses are recorded.

December 31, 2015

Loss on Impairment ........................................ 1,900,000
Accumulated Depreciation—
Equipment ........................................... 1,900,000

December 31, 2016

Loss on Impairment ........................................ 700,000
Accumulated Depreciation—
Equipment (€5,600,000 –
€4,900,000) ....................................... 700,000

11-56 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
 PROBLEM 11-10

Part I
(a) Calculation of the machine’s value-in-use at the end of 2015

Future Cash Present Value Discounted

Year Flows Factor Cash Flow
2016 ¥22,165 0.86957 ¥ 19,274
2017 21,450 0.75614 16,219
2018 20,550 0.65752 13,512
2019 24,725 0.57175 14,137
2020 25,325 0.49718 12,591
2021 24,825 0.43233 10,733
2022 24,123 0.37594 9,069
2023 25,533 0.32690 8,347
2024 24,234 0.28426 6,889
2025 22,850 0.24719 5,648
Value in use ¥116,419

The calculation of the impairment loss at the end of 2015 is as follows.

Machine
Carrying amount before impairment loss ........ ¥150,000
Recoverable amount (value-in-use) .................. (116,419)
Impairment loss ................................................... ¥ 33,581

(b) December 31, 2015

Loss on Impairment ............................................ 33,581

Accumulated Depreciation—Machine ..... 33,581

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-57
PROBLEM 11-10 (Continued)

Part II
(c) Revised Cash Flows

Future Cash Present Value Discounted

Year Flows Factor 15% Cash Flow
2020 ¥30,321 .86957 ¥ 26,366
2021 32,750 .75614 24,764
2022 31,721 .65752 20,857
2023 31,950 .57175 18,267
2024 33,100 .49718 16,457
2025 27,999 .43233 12,105
Value-in-use ¥118,816

Calculation of the reversal of the impairment loss at the end of 2019

Carrying amount at the end of 2015 (Part I) ....... ¥116,419

Depreciation charge: 2016 to 2019
[(¥116,419/10) X 4] ............................................... (46,568)
Costs to enhance the asset’s performance ........ 25,000
Carrying amount before reversal ......................... ¥ 94,851

A—Recoverable amount (Value-in-use) .............. ¥118,816

B—Carrying amount based on depreciated
historical cost.................................................. ¥115,000*

*Original cost............................................... ¥150,000

Accumulated depreciation
based on historical cost (¥15,000 X 4) ... (60,000)
Costs to enhance ...................................... 25,000
¥115,000

Carrying amount after reversal—lower of A, B: ¥115,000

Reversal of the impairment loss ¥20,149 (¥115,000 – ¥94,851) is recorded

as follows.

Accumulated Depreciation—Machine ................. 20,149

Recovery of Impairment Loss ...................... 20,149

11-58 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
 PROBLEM 11-11

(a) Cost per barrel: (£1,200,000 + £50,000) ÷ 500,000 = £2.5/barrel

(b) Sales (36,000 X £65) ......................................... £2,340,000

Expenses:
Depletion (36,000 X £2.5) ......................... £90,000
Premium payment (£2,340,000 X .04) ..... 93,600
Annual rental ............................................. 62,000 245,600
Current year profit .................................... £2,094,400

(c) Phelps has a choice on how to account for its exploration and evaluation
costs. It can either write off these costs as incurred or capitalize them
pending evaluation.

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-59
 PROBLEM 11-12

(a) Estimated depletion:

Estimated Depletion
Depletion Estimated Per 1ST & 11th Each of Yrs.
Base Yield Ton Yrs. 2-10 Incl.
$870,000* 120,000 tons $7.25 $43,500** $87,000***

* ($900,000 – $30,000)
** ($7.25 X 6,000)
*** ($7.25 X 12,000)

Estimated depreciation:

Per ton 1st Yrs. 6th Yrs. 11th

Asset Cost Mined Yr. 2–5 Yr. 7–10 Yr.
Building $36,000 $.30* $1,800 $3,600 $3,600 $3,600 $1,800
Machinery (1/2) 30,000 .25** 1,500 3,000 3,000 3,000 1,500
Machinery (1/2) 30,000 .50*** 3,000 6,000 3,000 0 0

* $36,000 ÷ 120,000 = $.30

** $30,000 ÷ 120,000 = $.25
*** ($30,000 ÷ 120,000) X 2 = $.50

(b) Depletion: $7.25 X 5,000 tons = $36,250

Depreciation: Building $.30 X 5,000 = $1,500

Machinery $.25 X 5,000 = 1,250
Machinery $.50 X 5,000 = 2,500
Total depreciation $5,250

11-60 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
 *PROBLEM 11-13

(a) December 31, 2014

Land (HK$215,000 – HK$200,000) ....................... 15,000
Unrealized Gain on Revaluation—Land .... 15,000

(b) Dec. 31, 2015 Dec. 31, 2016

Land HK$185,000 HK$205,000
Other Comprehensive Income (15,000) 5,000
Impairment Loss (15,000) 15,000
Accumulated Other
Comprehensive — 5,000
Income

(c) December 31, 2015

Unrealized Gain on Revaluation—Land ............. 15,000

Loss on Impairment .............................................. 15,000
Land (HK$215,000 – HK$185,000) .............. 30,000

December 31, 2016

Land (HK$205,000 – HK$185,000) ....................... 20,000
Recovery of Impairment Loss .................... 15,000
Unrealized Gain on Revaluation—Land .... 5,000

(d) January 15, 2017

Cash ........................................................................ 220,000
Land ............................................................... 205,000
Gain on Disposal of Land ........................... 15,000

Accumulated Other Comprehensive Income .... 5,000

Retained Earnings ....................................... 5,000

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-61
 *PROBLEM 11-14

(a) January 2, 2015

Equipment ................................................................ 500,000

Cash ................................................................. 500,000

December 31, 2015

Depreciation Expense (€500,000 ÷ 10) ................. 50,000

Accumulated Depreciation—Equipment ...... 50,000

Accumulated Depreciation—Equipment ............. 50,000

Equipment (€500,000 – €468,000) ................ 32,000
Unrealized Gain on Revaluation—
Equipment .................................................... 18,000

(b) Dec. 31, 2016 Dec. 31, 2017

Equipment €380,000 €355,000
Other Comprehensive Income (16,000) 2,500
Depreciation Expense 52,000 47,500
Impairment Loss 20,000 (20,000)
Accumulated Other Comprehensive
Income (0) 5,000

(c) December 31, 2016

Depreciation Expense (€468,000 ÷ 9) ................... 52,000

Accumulated Depreciation—Equipment .... 52,000

Accumulated Other Comprehensive Income ...... 2,000

Retained Earnings (€52,000 – €50,000) ....... 2,000

Accumulated Depreciation .................................... 52,000

Unrealized Gain on Revaluation—Equipment ..... 16,000
Loss on Impairment (€400,000 – €380,000) ......... 20,000
Equipment (€468,000 – €380,000) ................ 88,000

11-62 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
*PROBLEM 11-14 (Continued)

(c) December 31, 2017

Depreciation Expense (€380,000 ÷ 8) ................... 47,500

Accumulated Depreciation—Equipment..... 47,500

Retained Earnings (€50,000 – €47,500) ................ 2,500

Accumulated Other Comprehensive
Income ......................................................... 2,500

Accumulated Depreciation—Equipment.............. 47,500

Recovery of Impairment Loss ...................... 20,000
Unrealized Gain on Revaluation .................. 2,500
Equipment (€380,000 – €355,000) ................ 25,000

(d) December 31, 2018

Cash .......................................................................... 330,000

Loss on Disposal of Equipment ............................ 25,000
Equipment ....................................................... 355,000

Accumulated Other Comprehensive Income ...... 5,000

Retained Earnings ......................................... 5,000

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-63
 TIME AND PURPOSE OF CONCEPTS FOR ANALYSIS

CA 11-1 (Time 25–35 minutes)

Purpose—to provide the student with an understanding of the basic objective of depreciation accounting.
In addition, the case involves a reverse sum-of-the-years’-digits situation and the student is to comment
on the propriety of such an approach. Finally, the classic issue of whether depreciation provides funds
must be considered. The tax effects of depreciation must be considered when this part of the case is
examined. An excellent case for covering the traditional issues involving depreciation accounting.

CA 11-2 (Time 25–35 minutes)

Purpose—to provide the student with an understanding of a number of unstructured situations involving
depreciation accounting. The first situation considers whether depreciation should be recorded during a
strike. The second situation involves the propriety of employing the units-of-production method in
certain situations. The third situation involves the step-up of depreciation charges because properties
are to be replaced due to obsolescence. The case is somewhat ambiguous, so cut-and-dried approaches
should be discouraged.

CA 11-3 (Time 25–35 minutes)

Purpose—to provide the student with an understanding of the objectives of depreciation and the
theoretical basis for accelerated depreciation methods.

CA 11-4 (Time 20–25 minutes)

Purpose—to provide the student with the opportunity to examine the ethical dimensions of the depre-
ciation method choice.

11-64 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
 SOLUTIONS TO CONCEPTS FOR ANALYSIS

CA 11-1
(a) The purpose of depreciation is to distribute the cost (or other book value) of tangible plant assets,
less residual value, over their useful lives in a systematic and rational manner. Under IFRS,
depreciation accounting is a process of allocation, not of valuation, through which the productive
effort (cost) is to be matched with productive accomplishment (revenue) for the period. Depreciation
accounting, therefore, is concerned with the timing of the expiration of the cost of tangible plant
assets.

(b) The proposed depreciation method is, of course, systematic. Whether it is rational in terms of cost
allocation depends on the facts of the case. It produces an increasing depreciation charge, which
is usually not justifiable in terms of the benefit from the use of the asset because manufacturers
typically prefer to use their new equipment as much as possible and their old equipment only as
needed to meet production quotas during periods of peak demand. As a general rule, then, the
benefit declines with age. Assuming that the actual operations (including equipment usage) of
each year are identical, maintenance and repair costs are likely to be higher in the later years of
usage than in the earlier years. Hence the proposed method would couple light depreciation and
repair charges in the early years. Reported net income in the early years would be much higher
than reported net income in the later years of asset life, an unreasonable and undesirable variation
during periods of identical operation.

On the other hand, if the expected level of operations (including equipment usage) in the early
years of asset life is expected to be low as compared to that of later years because of slack demand
or production policies, the pattern of the depreciation charges of the proposed method approximately
parallels expected benefits (and revenues) and hence is reasonable. Although the units-of-production
depreciation method is the usual selection to fit this case, the proposed method also conforms to
IFRS in this case provided that proper justification is given.

(c) (1) Depreciation charges neither recover nor create funds. Revenue-producing activities are the
sources of funds from operations: if revenues exceed out-of-pocket costs during a fiscal period,
funds are available to cover other than out-of-pocket costs; if revenues do not exceed out-of-
pocket costs, no funds are made available no matter how much, or little, depreciation is charged.

(2) Depreciation may affect funds in two ways. First, depreciation charges affect reported income
and hence may affect managerial decisions such as those regarding pricing, product selection,
and dividends. For example, the proposed method would result initially in higher reported
income than would the straight-line method, consequently shareholders might demand higher
dividends in the earlier years than they would otherwise expect.

The straight-line method, by causing a lower reported income during the early years of asset
life and thereby reducing the amount of possible dividends in early years as compared with the
proposed method, could encourage earlier reinvestments in other profit-earning assets in
order to meet increasing demand.

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-65
CA 11-1 (Continued)
Second, depreciation charges affect reported taxable income and hence affect directly the amount
of income taxes payable in the year of deduction.

Using the proposed method for tax purposes would reduce the total tax bill over the life of the
assets (1) if the tax rates were increased in future years or (2) if the business were doing poorly
now but were to do significantly better in the future. The first condition is political and speculative
but the second condition may be applicable to Hakodat Manufacturing Company in view of its
recent origin and its rapid expansion program. Consequently, more funds might be available for
reinvestment in plant assets in years of large deductions if one of the above assumptions were true.

If Hakodat is not profitable now, it would not benefit from higher deductions now and should
consider an increasing charge method for tax purposes, such as the one proposed. If Hakodat is
quite profitable now, the president should reconsider his proposal because it will delay the
availability of the tax shield provided by depreciation. However, this decision should not affect the
decision to use a depreciation method for shareholders’ reporting that is systematic and rational in
terms of cost allocation under IFRS as presently understood.

CA 11-2
Situation I. This position relates to the omission of a provision for depreciation during a strike. The same
question could be raised with respect to plant shut-downs for many reasons, such as for a lack of sales
or for seasonal business.

The method of depreciation used should be systematic and rational. The annual provision for
depreciation should represent a fair estimate of the loss in value arising from wear and usage and also
from obsolescence. Each company should analyze its own facts and establish the best method under
the circumstances. If the company was employing a straight-line depreciation method, for example, it is
inappropriate to stop depreciating the plant asset during the strike.

If the company employs a units-of-production method, however, it would be appropriate not to depreciate
the asset during this period. Even in this latter case, however, if the strike were prolonged, it might be
desirable to record some depreciation because of the obsolescence factors related to the passage of
time.

Situation II. (a) Steady demand for the new blenders suggests use of the straight-line method or the
units-of-production method, either of which will allocate cost evenly over the life of the machine.
Decreasing demand indicates use of an accelerated method (declining-balance or sum-of-the-years’-
digits) or the units-of-production method in order to allocate more of the cost to the earlier years of the
machine’s life. Increasing demand indicates the use of the units-of-production method to charge more
of the cost to the later years of the machine’s life.

11-66 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
CA 11-2 (Continued)
(b) In determining the depreciation method to be used for the machine, the objective should be to
allocate the cost of the machine over its useful life in a systematic and rational manner, so that
costs will be matched with the benefits expected to be obtained. In addition to demand, considera-
tion should be given to the items discussed below, their interrelationships, the relative importance
of each, and the degree of certainty with which each can be predicted:

The expected pattern of costs of repairs and maintenance should be considered. Costs which
vary with use of the machine may suggest the use of the units-of-production method. Costs
which are expected to be equal from period to period suggest the use of the straight-line
method. If costs are expected to increase with the age of the machine, an accelerated method
may be considered reasonable because it will tend to equalize total expenses from period to
period.

The operating efficiency of the machine may change with its age. A decrease in operating
efficiency may cause increases in such costs as labor and power; if so, an accelerated method
is indicated. If operating efficiency is not expected to decline, the straight-line method is
indicated.

Another consideration is the expiration of the physical life of the machine. If the machine wears
out in relation to the passage of time, the straight-line method is indicated. Within this maximum
life, if the usage per period varies, the units-of-production method may be appropriate.

The machine may become obsolete because of technological innovation; it may someday be
more efficient to replace the machine even though it is far from worn out. If the probability is
high that such obsolescence will occur in the near future, the shortened economic life should
be recognized. Within this shortened life, the depreciation method used would be determined
by evaluating such consideration as the anticipated periodic usage.

An example of the interrelationship of the items discussed above is the effect of the repairs
and maintenance policy on operating efficiency and physical life of the machine. For instance,
if only minimal repairs and maintenance are undertaken, efficiency may decrease rapidly and
life may be short.

It is possible that different considerations may indicate different depreciation methods for the
machine. If so, a choice must be made based on the relative importance of the considerations.
For instance, physical life may be less important than the strong chance of technological
obsolescence which would result in a shorter economic life.

Situation III. Depreciation rates should be adjusted in order that the operating sawmills which are to be
replaced will be depreciated to their residual value by the time the new facility becomes available. The
step-up in the depreciation rates should be considered as a change in estimate and prior years’
financial statements should not be adjusted.

The idle mill should be written off immediately as it appears to have no future service potential.

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-67
CA 11-3

To: Phil Perriman, Supervisor of Canning Room

From: Your name, Accountant

Date: January 22, 2015

Subject: Annual depreciation charge to the canning department

This memo addresses the questions you asked about the depreciation charge against your department.
Admittedly this charge of $625,000 is very high; however, it is not intended to reflect the wear and tear
which the machinery has undergone over the last year. Rather, it is a portion of the machines’ cost
which has been allocated to this period.

Depreciation is frequently thought to reflect an asset’s loss in value over time. For financial statement
purposes, however, depreciation allocates part of an asset’s cost in a systematic way to each period
during its useful life. Although there will always be a decline in an asset’s value over time, the deprecia-
tion charge is not supposed to measure that decline; instead, it is a periodic “charge” for using purchased
equipment during any given period. When you consider the effect which the alternative would have on
your departmental costs, expensing the total cost for all six machines this year is more equitable.

You also mentioned that using straight-line depreciation would result in a smaller charge than would
the current double-declining-balance method. This is true during the first years of the equipment’s life.
Straight-line depreciation expenses even amounts of depreciation for each canning machine’s twelve-
year life. Thus the straight-line charge for this and all subsequent years would be $47,500 per machine
for total annual depreciation of $285,000.

During the earlier years of an asset’s life, the double-declining-balance method results in higher deprecia-
tion charges because it approximately doubles the charge which would have been made under the
straight-line method. However, the same percentage depreciation in the first year is applied annually to
the asset’s declining book value. Therefore, the double-declining-balance charge becomes lower than
the straight-line charge during the last several years of the asset’s life. For this year, as mentioned
above, the charge is $625,000, but in subsequent years this expense will become lower. By the end of
the twelfth year, the same amount of depreciation will have been taken regardless of the method used.

The straight-line method would result in fewer charges against your department this year. However,
consider this: when the asset is new, additional costs for service and repairs are minimal. Thus a
greater part of the asset’s cost should be allocated to this optimal portion of the asset’s life. After a few
years, your department will have to absorb the additional burden of repair and maintenance costs.
During that time, wouldn’t you rather have a lower depreciation charge?

I hope that this explanation helps clarify any questions which you may have had about depreciation
charges to your department.

11-68 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
CA 11-4
(a) The stakeholders are Beeler’s employees, including Prior, current and potential investors and
creditors, and upper-level management.

(b) The ethical issues are honesty and integrity in financial reporting, job security, and the external
users’ right to know the financial picture.

(c) Prior should review the estimated useful lives and residual values of the depreciable assets.
Since they are estimates, it is possible that some should be changed. Any changes should be
based on sound, objective information without concern for the effect on the financial statements
(or anyone’s job).

(Note: This case can be used with Chapter 22, Accounting Changes and Error Analysis.)

Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only) 11-69
 FINANCIAL REPORTING PROBLEM

(a) M&S classifies its property, plant and equipment under three descrip-
tions in its balance sheet: Property, Plant and Equipment.

(b) M&S’s depreciation is provided to write off the cost of tangible non-
current assets less estimated residual value by equal annual
installments.

(c) M&S depreciates freehold and leasehold buildings with a remaining

lease term over 50 years; leasehold buildings with a remaining lease
term of less than 50 years—depreciated over the remaining period of
the lease; and fixtures, fittings and equipment over 3 to 25 years
according to the estimated life of the asset.

(d) M&S’s notes report depreciation expense of £374.1 million for the year
ended March 30, 2013 and £404.8 million for the year ended March 31,
2012.

(e) The statement of cash flows reports the following capital expenditures:
for the year ended March 30, 2013, £642.6 million and for the year
ended March 31, 2012, £564.3 million.

11-70 Copyright © 2014 John Wiley & Sons, Inc. Kieso, IFRS, 2/e, Solutions Manual (For Instructor Use Only)
 COMPARATIVE ANALYSIS CASE

(a) Property, plant, and equipment, net of accumulated depreciation:

Puma at 12/31/12 €226.8 million

adidas at 12/31/12 €1,095 million

Percent of total assets:

Puma (€226.8 ÷ €2,530.2) 9.0%

adidas (€1,095 ÷ €11,651) 9.4%

(b) Puma and adidas depreciate property, plant, and equipment princi-
pally by the straight-line method over the estimated useful lives of the
assets. Depreciation expense was reported by Puma and adidas as
follows:

Puma adidas
2012 €76.1 million €214 million
2011 63.4 million 205 million

(c) (1) Asset turnover:

Puma adidas
€3,270.7 €14,883
= 1.28 = 1.3
€2,581.8 + €2,530.2 €11,237 + €11,651
2 2

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COMPARATIVE ANALYSIS CASE (Continued)

(2) Profit margin on sales:

Puma adidas
€79.8 €524
= 2.4% = 3.5%
€3,270.7 €14,883

(3) Return on assets:

Puma adidas
€79.8 €524
= 3.1% = 4.6%
€2,581.8 + €2,530.3 €11,237 + €11,651
2 2

Each of adidas’s ratios is superior to Puma’s, especially the return on

assets. adidas’s profit margin is also higher than Puma’s.

(d) Puma’s capital expenditures were €81.2 million in 2012 while adidas’s
capital expenditures were €376 million in 2012.

Neither Puma nor adidas disclosed the amount of interest capitalized

in 2012.

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 FINANCIAL STATEMENT ANALYSIS CASE

(a) Carrefour used the straight-line method for depreciating its tangible
fixed assets.

(b) Depreciation and amortization charges do not increase cash flow

from operations. In a cash flow statement, these two items are often
added back to net income to arrive at cash flow from operations and
therefore some incorrectly conclude these expenses increase cash
flow. What affects cash flow from operations are cash revenues and
cash expenses. Noncash charges have no effect, except for positive
tax savings generated by these charges.

(c) The schedule of cash flow measures indicates that cash provided by
operations is expected to cover capital expenditures over the next few
years, even as expansion continues to accelerate. It is obvious that
Carrefour’s believes that cash flow measures are meaningful indicators
of growth and financial strength, when evaluated in the context of
absolute dollars or percentages.

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 ACCOUNTING, ANALYSIS, AND PRINCIPLES

ACCOUNTING

(amounts in €000,000)

(a) Book value = €36 – €10 = €26

Estimated fair value = (€4 X PVF – OA4.5%)

= (€4 X 3.54595)
= €14.1838

Impairment charge = €23 – €14.1838 = €8.8162

Post-impairment book value = €14.1838

(b) €2.72 X 7.3609 = €20.021648

Impairment = €23 – €20.021648 = €2.978352.

ANALYSIS

If the stores are in the process of being sold, they would likely be con-
sidered ‘held for sale’ for financial reporting purposes. If they are held for
sale, the impairment test is based on a lower-of-cost-or net realizable value
approach.

Therefore, Electroboy will need to write the stores down to €23 (fair value
less costs of disposal) from €26.0. No depreciation is recorded on assets
held-for-disposal.

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ACCOUNTING, ANALYSIS, AND PRINCIPLES (Continued)

PRINCIPLES

(a) Under IFRS, there can be a recovery of impairment loss, as long as the
recovery amount does not result in a carrying value greater than the
carrying value before the original impairment.

(b) The major differences between U.S. GAAP and IFRS regarding impair-
ments are as follows. First, IFRS determines the need for an impairment
charge by comparing the recoverable amount (the higher of value-in-
use and fair value less costs to sell) of the asset to its book value
instead of comparing undiscounted estimated future cash flows to book
value. This potentially makes impairment charges more likely under
IFRS than U.S. GAAP. Second, under IFRS, companies may write a
previously impaired asset back up to its original cost. Under U.S.
GAAP, the post-impairment book value can not be increased due to an
increase in the fair value of the previously impaired asset. Thus, IFRS
may provide a more faithful presentation but could be less neutral due
to the subjectivity in value-in-use measurements.

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 INTERNATIONAL REPORTING CASE

Liberty Kimco
(a) (1) ROA £125 $297
= 2.2% = 6.32%
£5,577 $4,696

Liberty Kimco
(2) Profit £125 $297
= 16.9% = 57.4%
Margin £741 $517

Liberty Kimco
(3) Asset £741 $517
= .13 = .11
Turnover £5,577 $4,696

Based on return on assets (ROA), Kimco is performing better than

Liberty. The main driver for this difference is strong profit margin,
which is over three times that of Liberty. Even though Liberty has a
higher asset turnover (.13 vs. .11), this results in only a 2.2% ROA
when multiplied by the lower profit margin.

(b) Summary Entry

Land and Buildings ................................................... 1,550
Unrealized Gain on Revaluation ..................... 1,550

(c) Relative to U.S. GAAP, an argument can be made that assets and
equity under IFRS are overstated. Note that in the entry in (b) above,
the revaluation adjustment increases Liberty’s asset values and
equity. To make Liberty’s reported numbers comparable to a U.S.
company like Kimco, you would need to adjust Liberty’s assets and
equity numbers downward by the amount of the unrealized gain.

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INTERNATIONAL REPORTING CASE (Continued)

For example, after adjusting Liberty’s assets downward by the amount

of the unrealized gain, Liberty’s ROA increases to:

$125
= 3.45%.
($5,577 – $1,952)

This is still lower than Kimco’s ROA but the gap is narrower after
adjusting for differences in revaluation.

Note to instructors: An alternative way to make Liberty and Kimco compa-

rable is to adjust Kimco’s assets to fair values. This approach could be
used to discuss the trade-off between relevance and faithful
representation.

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 PROFESSIONAL RESEARCH

(a) The authoritative guidance for asset impairments is IAS 36: Impairment
of Assets. This Standard shall be applied in accounting for the impair-
ment of all assets, other than:
a. inventories;
b. assets arising from construction contracts;
c. deferred tax assets;
d. assets arising from employee benefits;
e. financial assets that are within the scope of IAS 39 Financial
Instruments: Recognition and Measurement;
f. investment property that is measured at fair value;
g. biological assets related to agricultural activity that are measured
at fair value less costs to sell;
h. deferred acquisition costs, and intangible assets, arising from an
insurer’s contractual rights under insurance contracts within the
scope of IFRS 4 Insurance Contracts; and
i. non-current assets (or disposal groups) classified as held for sale
in accordance with IFRS 5 Non-current Assets Held for Sale and
Discontinued Operations (para. 2).

This Standard applies to financial assets classified as:

a. subsidiaries, as defined in IAS 27 Consolidated and Separate
Financial Statements;
b. associates, as defined in IAS 28 Investments in Associates; and
c. joint ventures, as defined in IAS 31 Interests in Joint Ventures.

For impairment of other financial assets, refer to IAS 39 (para. 4).

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PROFESSIONAL RESEARCH (Continued)

(b) In assessing whether there is any indication that an asset may be

impaired, an entry shall consider, as a minimum, the following indications.
(para. 12):

External sources of information

a. during the period, an asset’s market value has declined signifi-
cantly more than would be expected as a result of the passage of
time or normal use.
b. significant changes with an adverse effect on the entity have taken
place during the period, or will take place in the near future, in the
technological, market, economic or legal environment in which the
entity operates or in the market to which an asset is dedicated.
c. market interest rates or other market rates of return on investments
have increased during the period, and those increases are likely to
affect the discount rate used in calculating an asset’s value in use
and decrease the asset’s recoverable amount materially.
d. the carrying amount of the net assets of the entity is more than its
market capitalisation.

Internal sources of information

e. evidence is available of obsolescence or physical damage of an
asset.
f. significant changes with an adverse effect on the entity have taken
place during the period, or are expected to take place in the near
future, in the extent to which, or manner in which, an asset is used
or is expected to be used. These changes include the asset becoming
idle, plans to discontinue or restructure the operation to which an
asset belongs, plans to dispose of an asset before the previously
expected date, and reassessing the useful life of an asset as finite
rather than indefinite.
g. evidence is available from internal reporting that indicates that the
economic performance of an asset is, or will be, worse than
expected.

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PROFESSIONAL RESEARCH (Continued)

Dividend from a subsidiary, jointly controlled entity or associate

h. for an investment in a subsidiary, jointly controlled entity or
associate, the investor recognizes a dividend from the investment
and evidence is available that:
(i) the carrying amount of the investment in the separate financial
statements exceeds the carrying amounts in the consolidated
financial statements of the investee’s net assets, including
associated goodwill; or
(ii) the dividend exceeds the total comprehensive income of the
subsidiary, jointly controlled entity or associate in the period
the dividend is declared.

The list in paragraph 12 is not exhaustive. An entity may identify other

indications that an asset may be impaired and these would also
require the entity to determine the asset’s recoverable amount or, in
the case of goodwill, perform an impairment test in accordance with
paragraphs 80–99 (para. 13).

Evidence from internal reporting that indicates that an asset may be

impaired includes the existence of:
a. cash flows for acquiring the asset, or subsequent cash needs for
operating or maintaining it, that are significantly higher than those
originally budgeted;
b. actual net cash flows or operating profit or loss flowing from the
asset that are significantly worse than those budgeted;
c. a significant decline in budgeted net cash flows or operating profit,
or a significant increase in budgeted loss, flowing from the asset; or
d. operating losses or net cash outflows for the asset, when current
period amounts are aggregated with budgeted amounts for the
future. (para. 14)

Yes, it does appear that Klax should perform an impairment test

because market value of assets are most likely lower than current
carrying value.

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PROFESSIONAL RESEARCH (Continued)

(c) Different situations may lead to best evidence of fair value (i.e. could
be market value, revalued asset, etc.).
a. if the asset’s fair value is its market value, the only difference between
the asset’s fair value and its fair value less costs to sell is the direct
incremental costs to dispose of the asset:
(i) if the disposal costs are negligible, the recoverable amount of
the revalued asset is necessarily close to, or greater than, its
revalued amount (i.e., fair value). In this case, after the revaluation
requirements have been applied, it is unlikely that the revalued
asset is impaired and recoverable amount need not be estimated.
(ii) if the disposal costs are not negligible, the fair value less costs
to sell of the revalued asset is necessarily less than its fair
value. Therefore, the revalued asset will be impaired if its value
in use is less than its revalued amount (i.e., fair value). In this
case, after the revaluation requirements have been applied, an
entity applies this Standard to determine whether the asset
may be impaired.
b. if the asset’s fair value is determined on a basis other than its
market value, its revalued amount (i.e., fair value) may be greater
or lower than its recoverable amount. Hence, after the revaluation
requirements have been applied, an entity applies this Standard to
determine whether the asset may be impaired (para. 5).

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 PROFESSIONAL SIMULATION

Explanation

(a) The purpose of depreciation is to allocate the cost (or other book
value) of tangible plant assets, less residual value, over their useful
lives in a systematic and rational manner. Under IFRS, depreciation
accounting is a process of allocation, not of valuation, through which
the productive effort (cost) is to be matched with productive
accomplishment (revenue) for the period. Depreciation accounting,
therefore, is concerned with the timing of the expiration of the cost of
tangible plant assets.

(b) The factors relevant in determining the annual depreciation for a depre-
ciable asset are the initial recorded amount (cost), estimated residual
value, estimated useful life, and depreciation method.

Assets are typically recorded at their acquisition cost, which is in most

cases objectively determinable. Cost assignments in other cases—
“basket purchases” and the selection of an implicit interest rate in an
asset acquisitions or under deferred-payment plans—may be quite
subjective, involving considerable judgment.

The residual value is an estimate of an amount potentially realizable

when the asset is retired from service. The estimate is based on
judgment and is affected by the length of the useful life of the asset.

The useful life is also based on judgment. It involves selecting the

“unit” of measure of service life and estimating the number of such
units embodied in the asset. Such units may be measured in terms of
time periods or in terms of activity (for example, years or machine
hours). When selecting the life, one should select the lower (shorter)
of the physical life or the economic life. Physical life involves wear and
tear and casualties; economic life involves such things as technological
obsolescence and inadequacy.

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PROFESSIONAL SIMULATION (Continued)

Measurement

(a) Compared to the use of an accelerated method, straight-line deprecia-

tion would result in the lowest depreciation expense and the highest
income. For example, under straight-line depreciation, expense in
each year would be:

(€100,000 – €10,000)/4 = €22,500

Using the double-declining-balance method, depreciation expense in

2015 would be:

€100,000 X (1/4 X 2) = €50,000

Depending on the level of use in the first year, use of the units-of-
production method could yield an even lower expense in the first year
compared to straight-line.

(b) Over the entire four-year period, all methods will produce the same
total depreciation expense. Use of alternative methods only results in
differences in timing of the depreciation charges.

(c) All methods used for financial reporting purposes results in the same
cash flow in 2015—that is, a cash outflow of €100,000 for acquisition of
the machine. However, use of an accelerated method for tax purposes
results in the higher cash flow in 2015. This is because a larger tax
deduction can be taken for depreciation expense, which reduces taxable
income, resulting in less cash paid for taxes. Note that over the life of
the asset, cash flows for taxes are the same regardless of the tax
depreciation method used.

Journal Entry

Cash .................................................................... 84,000

Accumulated Depreciation—Equipment ....... 45,000*
Gain on Sale of Equipment .................... 29,000
Equipment ................................................ 100,000

*(€100,000 – €10,000)/4 = €22,500 per year X 2 years (2015, 2016)

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