ILLUSTRATION 11-1 PATTERNS OF BOOK VALUE OVER LIFE OF ASSET

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1 ILLUSTRATION 11-1 PATTERNS OF BOOK VALUE OVER LIFE OF ASSET $ Cost of asset N PR: Book value activity methods Depreciable cost SL: Book value straight line Salvage value AC: Book value accelerated S E 0 Service life End of service life Time N: Book values for assets that are never depreciated such as land. E: This line which could be at zero if there were no salvage value can be used to represent the book value of 'assets' that are expensed immediately such as research and development, advertising, and personnel expenditures. SL: Book value under straight-line method. AC: Book value under accelerated methods such as double-declining balance, or sum-of-the-year's-digits when book value declines more rapidly in the earlier years than in the later years. PR: Book value under an activity method. This is only one of the possible patterns which the book value would follow. Patterns would normally be uneven proceeding in a zig-zag fashion depending upon production in a given period. It would coincide with the SL line if production was equal in each period. 83

2 ILLUSTRATION 11-2 CHANGE OF ESTIMATES: STRAIGHT-LINE METHODS Original cost $10,000 $ Original schedule = $900/year Revised schedule = $1050/year Original estimate of salvage value = $1,000 Revised estimate of salvage value = $ years Time End of service life = 10 years Original cost = $10,000 Useful life estimated = 10 years Initial estimate of salvage value = $1,000 Depreciation per year (straight-line) = $900 Revised estimate of salvage value = $100 Time of change: End of fourth year Revised depreciation = $10,000 ($900 4) $100 = $6300 = $1050 per year

3 ILLUSTRATION 11-3 ACCOUNTING FOR IMPAIRMENT Events which might lead to an impairment Recoverability Test Expected future net cash flows less than carrying amount YES Impairment Loss Impairment NO No impairment Assets held for use Assets held for disposal 1. Impairment loss: carrying amount less fair value 2. Depreciation on new cost basis 3. Restoration of impairment loss not permitted 1. Impairment loss: carrying amount less fair value less cost of disposal 2. No depreciation taken 3. Restoration of impairment loss permitted 85

4 ILLUSTRATION 11-4 FLOW OF ASSET COSTS Over Time ASSETS (Balance Sheet Debits) EXPENSES (Income Statement Debits) Inventory Gets Sold Cost of Goods Sold Property, Plant, Equipment Wears Out Depreciation Expense Natural Resources Extracted and Processed Depletion Expense Inventory of Processed Resources Gets Sold Cost of Goods Sold Intangible Assets Benefits Expire Amortization Expense 86

5 ILLUSTRATION 11-5 RATE OF RETURN ON TOTAL ASSETS Rate of Return on Total assets = Profit margin on sales Asset turnover = Net Income Net Sales Net Sales Average Total Assets = Net Income Average Total Assets Example (in millions of dollars): Net sales $1,500 Total assets (1/1) 1,200 Total assets (12/31) 1,400 Net income 150 ROR on total assets = $150 $1,500 $1,500 ($1,200 + $1,400)/2 = = 11.5% 87

6 ILLUSTRATION 11-6 MACRS PROPERTY CLASSES MACRS PROPERTY CLASSES 3-year property includes small tools, horses, and assets used in research and development activities. 5-year property includes automobiles, trucks, computers and peripheral equipment, and office machines. 7-year property includes office furniture and fixtures, agriculture equipment, oil exploration and development equipment, railroad track, manufacturing equipment, and any property not designated by law as being in any other class. 10-year property includes railroad tank cars, mobile homes, boilers, and certain public utility property. 15-year property includes roads, shrubbery, and certain low-income housing. 20-year property includes waste-water treatment plants and sewer systems year property includes residential rental property. 39-year property- includes nonresidential real property. 88

7 ILLUSTRATION 11-7 MACRS DEPRECIATION RATES MACRS DEPRECIATION RATES BY CLASS OF PROPERTY Recovery 3-year 5-year 7-year 10-year 15-year 20-year Year (200% DB) (200% DB) (200% DB) (200% DB) (150% DB) (150% DB) * * * * 5.90* * *Switchover to straight-line depreciation. Table incorporates half-year convention in the first and last recovery years. 89

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