Chapter 11 Investments in Noncurrent Operating Assets Utilization and Retirement 1. The annual depreciation expense 2. The depletion of natural resources 3. The changes in estimates and methods in the computation of depreciation 4. The impairment of asset 5. The amortization or impairment for intangible assets 6. The sale of depreciable assets in exchange for cash and in exchange for other depreciable assets 7. The depreciation for partial periods 8. The MACRS income tax depreciation system 11-1
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1. Use straight-line, accelerated, use-factor, and group depreciation methods to compute annual depreciation What is depreciation? Depreciation is not a process through which a company accumulates a cash fund to replace its long-lived fixed assets. Depreciation is not a way to compute the current value of long-lived assets. Depreciation is the systematic allocation of the cost of an asset over the different periods benefited by the use of the asset. 11-3
Factors Affecting the Periodic Depreciation Charge Four factors are taken into consideration in determining the appropriate amount of annual depreciation expense. Asset cost Residual or salvage value Useful life Pattern of use 11-4
Depreciation Vocabulary Asset cost is the purchase cost plus any capitalized expenditures. Residual (salvage) value of property is an estimate of the amount for which the asset can be sold when it is retired. Useful life is the expected life of the asset in years, hours of service, or per unit of output. 11-5
Useful Life The physical factors that limit the service life of an asset are 1) wear and tear, 2) deterioration and decay, and 3) damage or destruction. The primary functional factor limiting the useful life of assets is obsolescence. 11-6
Pattern of Use Depreciable Cost (Asset) To match asset cost against revenue, periodic depreciation charges should reflect as closely as possible the pattern of use. Period 1 Period 2 Period 3 11-7
Pattern of Use Depreciable Cost (Asset) A depreciation method is selected to assign these costs to future periods. Period 1 Period 2 Period 3 11-8
Pattern of Use Depreciable Cost (Asset) Period 1 Period 2 Period 3 11-9
Pattern of Use Depreciable Cost (Asset) Period 1 Period 2 Period 3 11-10
Recording Periodic Depreciation The general form of the journal entry used to recognize depreciation is as follows: Depreciation Expense Accumulated Depreciation xx xx The accumulation of expired cost in a separate account rather than crediting the asset account permits identification of the original cost of the asset and the accumulated depreciation. 11-11
Depreciation Formula Symbols The examples that follow assume the acquisition of a polyurethane plastic-molding machine at the beginning of 2013 by Schuss Boom Ski Manufacturing, Inc., at a cost of $100,000 with an estimated residual value of $5,000. C = Asset cost R = Estimated residual value n = Estimated life in years, hours of service, or units of output r = Depreciation rate per period, per hour of service, or per unit of output D = Periodic depreciation charge 11-12
Time-Factor Methods Straight-Line Of the time-factor methods, straight-line depreciation is by far the most popular. Straight-line depreciation relates to the passage of time and recognizes equal depreciation in each year of the life of the asset. This method assumes the asset is equally useful during each time period. 11-13
Straight-Line Depreciation Using data for the machine acquired by Schuss Boom Ski Manufacturing and assuming a 5-year life, annual depreciation is computed as follows: C R $100,000 $5,000 D = = N 5 years = $19,000 per year 11-14
Straight-Line Depreciation Equals the projected residual value 11-15
Sum-of-the-Years Digits Method The sum-of-the-years -digits depreciation method yields decreasing depreciation in each successive year. To determine the denominator, use the following formula (assuming 5 years): [n (n + 1)] SYD = 2 [5 (5 + 1)] SYD = 2 SYD = 15 Or, simple add 1 + 2 + 3 + 4 + 5 11-16
Sum-of-the-Years Digits Method Now that we know the denominator, we can determine the depreciation for the year using the following formula, where t equals years remaining at the beginning of the period. t D = SYD (C R) D = 5 15 ($100,000 $5,000) D = $31,667 11-17
Sum-of-the-Years Digits Method For the second year, we reduce the numerator by one. t D = SYD (C R) D = 4 15 ($100,000 $5,000) D = $25,333 (continued) 11-18
Sum-of-the-Years Digits Method The annual depreciation for all five years: (continued) Equals the projected residual value 11-19
Sum-of-the-Years Digits Method $35,000 $28,000 Annual Depreciation Expense $21,000 $14,000 $7,000 Residual Value of $5,000 $0 2013 2014 2015 2016 2017 11-20
Declining-Balance Method The declining-balance depreciation method provides decreasing charges by applying a constant percentage rate to a declining asset book value. First, the constant percentage must be calculated. The most popular rate is two times the straightline rate, and this method is called doubledeclining balance depreciation. The percentage to be used is calculated as shown in Slide 11-22. 11-21
Declining-Balance Method 11-22
Declining-Balance Method Or you can use the following formula to get the straight-line rate: 1/n Thus, the molding machine would have a straight-line rate of 20% (1/5). This number is doubled to arrive at the double-declining percentage of 40%. The chart shown on Slide 11-24 demonstrates how the constant rate is applied to the remaining asset book value each year. 11-23
Declining-Balance Method 11-24
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Factors Suggesting the Use of an Accelerated Method 1) The anticipation of a significant contribution in early periods with the extent of the contribution to be realized in later periods being less definite. 2) The possibility that inadequacy or obsolescence may result in premature retirement of the asset. 11-27
Use-Factor Methods Use-factor depreciation methods view asset exhaustion as related primarily to asset use or output and provide periodic charges varying with the degree of such services. Service-Hours Depreciation The first use-factor method we will examine is service-hours depreciation. This method is based on the theory that the purchase of an asset represents the purchase of a number of hours of direct service. 11-28
Service-Hours Depreciation Let s continue with the Schuss Boom Ski Manufacturing machine. It cost $100,000 and had a residual value of $5,000. It is estimated that the machine will perform for an estimated service life of 20,000 hours. Now we can determine the rate to be applied to each service hour. 11-29
Service-Hours Depreciation C R D = n = D = $4.75 per hour $100,000 $5,000 20,000 hours Equals the projected residual value 11-30
Productive-Output Depreciation Productive-output depreciation is based on the theory that an asset is acquired for the service it can provide in the form of production output. The Schuss Boom asset is estimated to have a productive life of 25,000 units. Assume the company produced 3,200 units in 2013 and 5,400 units in 2014. 11-31
Productive-Output Depreciation r = C R n = $100,000 $5,000 25,000 units r = $3.80 per unit Annual depreciation for 2013 and 2014: 2013: 3,200 units $3.80 = $12,160 2014: 5,400 units $3.80 = $20,520 11-32
Group and Composite Depreciation Group depreciation groups similar assets into depreciation accounts (e.g., all of a company s delivery vans). Composite depreciation refers to placing assets in the group that are related but dissimilar (e.g., all of a company s desks, chairs, and computers). The group depreciation procedure treats a collection of assets as a single group. 11-33
Group and Composite Depreciation The rate of 12.5%, applied to the cost of existing assets, $20,000, results in annual depreciation of $2,500. 11-34
Group and Composite Depreciation Because the accumulated depreciation account applies to the entire group of assets, no book value can be calculated for any specific asset. If asset B were sold for $3,500 after two years, the following entry would be as follows: Cash 3,500 Accumulated Depreciation 2,500 Equipment 6,000 No gain or loss is recognized. 11-35
Depreciation and IAS 16 The component approach is required under IASB standards. The following requirement is contained in IAS 16: Each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item shall be depreciated separately. 11-36
Depreciation and Accretion of an Asset Retirement Obligation Bryan Beach Company purchases and erects an oil platform at a total cost of $750,000. Bryan Beach is legally obligated to dismantle and remove the platform after 10 years. It is estimated that this will cost $100,000. Assuming an 8% interest rate, the present value of the obligation is $46,319 [46.319 (n = 10; i = 8%) $100,000]. 11-37
Depreciation and Accretion of an Asset Retirement Obligation The journal entries to record the purchase of the oil platform and the recognition of the asset retirement obligation are as follows: Oil Platform 750,000 Cash 750,000 Oil Platform 46,319 Asset Retirement Obligation 46,319 11-38
Depreciation and Accretion of an Asset Retirement Obligation The cost of the oil platform asset, including the estimated retirement obligation, is depreciated just like any other long-term asset. Depreciation Expense 79,632* Accumulated Depreciation Oil Platform 79,632 *Assuming straight-line depreciation [($750,000 + $46,319)/10] 11-39
Depreciation and Accretion of an Asset Retirement Obligation Each year an entry must be made to recognize the increase in the present value of the asset retirement obligation. Accretion Expense 3,706* Asset Retirement Obligation 3,706 * ($46,319 x 0.08) = $3,706 11-40
2. Apply the productive-output method to the depletion of natural resources Depletion of Natural Resources Natural resources (also called wasting assets) are consumed as the physical units representing these resources are removed and sold. The computation of depletion expense is an adaption of the productive-output method of depreciation. Perhaps the most difficult problem is estimating the amount of resources available for economical removal from the land. 11-41
Depletion of Natural Resources Land containing mineral deposits is purchased at a cost of $5,500,000. It is expected to have a residual value of $250,000. The natural resource supply is estimated at 1,000,000 tons. The unit-depletion charge and the total depletion charge for the first year, assuming the withdrawal of 80,000 tons, are calculated on Slide 11-43. 11-42
Depletion of Natural Resources Depletion charge per ton = $5,500,000 $250,000 1,000,000 tons Depletion charge per ton = $5.25 Depletion for 2013 = $5.25 80,000 tons = $420,000 11-43
Depletion of Natural Resources Record the initial purchase as follows: Mineral Deposits 5,500,000 Cash 5,500,000 Record the depletion for 2013 as follows: Depletion Expense 420,000 Accumulated Depletion (or Mineral Deposits) 420,000 If only 60,000 tons are sold, $105,000 is reported as part of ending inventory. 11-44
28. Incorporate changes in estimates and methods into the computation of depreciation for current and future periods Change in Estimated Life A company purchased $50,000 of equipment and estimated a 10-year life. Using the straightline method with no residual value, the annual depreciation would be $5,000. After four years, accumulated depreciation would amount to $20,000, and the remaining book value would be $30,000. Early in the fifth year, a reevaluation of the life indicates only four more years of service can be expected from the asset. 11-45
Change in Estimated Life Divide the book value by the new estimated remaining life After four years, the book value is $30,000 ($50,000 $20,000) 11-46
Change in Estimated Units of Production A change in accounting for natural resources occurs when the estimate of the recoverable units changes as a result of further discoveries, improved extraction processes, or changes in sales prices that indicate changes in the number of units that can be extracted profitably. 11-47
Change in Estimated Units of Production Land is purchased at a cost of $5,500,000 with estimated net residual value of $250,000. The original estimate of natural resources in the land was 1,000,000 tons. In the second year of operations, 100,000 tons of ore are withdrawn. At the end of that year appraisers indicate a remaining tonnage of 950,000. 11-48
Change in Estimated Units of Production Cost assignable to recoverable tons as of the beginning of second year: Original costs applicable to depletable resources $5,250,000 Deduct: Depletion charge for first year 420,000 Balance of cost subject to depletion $4,830,000 11-49
Change in Estimated Units of Production Estimated recoverable tons as of the beginning of second year: Number of tons withdrawn in 2 nd year 100,000 Estimated recoverable tons as of the end of the second year 950,000 Total recoverable tons as of the beginning of the second year 1,050,000 Depletion charge per ton for second year: $4,830,000/1,050,000 = $4.60 Depletion charge for second year: 100,000 $4.60 = $460,000 11-50
Change in Estimated Units of Production Cost assignable to recoverable tons as of the beginning of second year: Original costs applicable to depletable resources $5,250,000 Add: Additional costs incurred in 2 nd year 525,000 $5,775,000 Deduct: Depletion charge for first year 420,000 Balance of cost subject to depletion $5,355,000 Estimated recoverable tons as of the beginning of second year 1,050,000 Depletion charge per ton for second year: $5,355,000/1,050,000 = $5.10 Depletion for second year: 100,000 $5.10 = $510,000 11-51
Change in Depreciation Method Another change in estimate occurs when the actual pattern of consumption of an asset doesn t match the pattern of consumption implicit in the depreciation method. Example: An asset is purchased for $120,000 with a 12-year expected useful life and zero salvage value. After two years of straight line depreciation, the asset has a remaining book value of $10,000. 11-52
Change in Depreciation Method The company decides the double-decliningbalance method would yield a better estimate of periodic depreciation. The straight-line depreciation rate is 10% (1/n = 1/10 = 10%). Double that rate is 20%. Year 3 depreciation is $100,000 x 0.20, or $20,000. 11-53
4. Identify whether an asset is impaired, and measure the amount of the impairment loss using both U.S. GAAP and IASB standards Accounting for Asset Impairment FASB Statement No. 144 addresses four questions: 1. When should an asset be reviewed for possible impairment? An impairment review should be conducted whenever there has been a material change in the way an asset is used or in the business environment. 11-54
Accounting for Asset Impairment 2. When is an asset impaired? An asset is impaired when the undiscounted sum of estimated future cash flows from an asset is less than the book value of the asset. 11-55
Accounting for Asset Impairment 3. How should an impairment loss be measured? The impairment loss is the difference between the book value of the asset and the asset s fair value. The fair value can be approximated using the present value of estimated future cash flows from the asset. 11-56
Accounting for Asset Impairment 4. What information should be disclosed about an impairment? Disclosure should include a description of the impaired asset, reasons for the impairment, a description of the measurement assumptions, and the business segment or segments affected. 11-57
Accounting for Asset Impairment Guangzhou Company purchased a building five years ago for $600,000. It has an expected life of 20 years and no residual value. Guangzhou has decided that the building should be evaluated for possible impairment. Guangzhou estimates that the building has a remaining useful life of 15 years, that net cash inflow from the building will be $25,000 per year, and that the fair value of the building is $230,000. 11-58
Accounting for Asset Impairment The $450,000 book value is compared to the $375,000 ($25,000 15 years) undiscounted future cash flows. An impairment loss should be recognized. The loss is $220,000 ($450,000 $230,000). The impairment loss would be recorded as follows: Accumulated Depreciation Building 150,000 Loss on Impairment of Building 220,000 Building ($600,000 $230,000) 370,000 11-59
Accounting for Asset Impairment In many cases, it is more appropriate to estimate a range of possible future cash flows rather than make a specific point estimate. It is estimated that the following two cash flow scenarios are possible: Future Cash Inflow Probability Scenario 1 $20,000 per year for 15 years 85% Scenario 2 $50,000 per year for 15 years 15% 11-60
Accounting for Asset Impairment Undiscounted Future Cash Inflow Probability Scenario 1 $20,000 x 15 years = $300,000 85% Scenario 2 $50,000 x 15 years = $750,000 15% Probability-Weighted Future Cash Flows Scenario 1 $255,000 Scenario 2 112,500 $367,500 The $367,500 is compared to the book value of the building, indicating impairment. 11-61
Accounting for Asset Impairment Assume there is no observable market value of the building and that the market value must be estimated using present value techniques. If the risk-free interest rate is 6.0%, the expected present value is computed as follows: Future Cash Inflow PV (at 6%) Probability Scenario 1 $20,000 x 15 years $194,245 85% Scenario 2 $50,000 x 15 years $485,612 15% 11-62
Accounting for Asset Impairment Probability-Weighted Present Value Scenario 1 $165,108 Scenario 2 72,842 $237,950 The impairment loss entry would be Accumulated Depreciation Building 150,000 Loss on Impairment of Building 212,050 Building ($600,000 $237,950) 362,050 11-63
International Accounting for Asset Impairment: IAS 36 IAS 36 requires that a company recognize an impairment loss whenever the recoverable amount of an asset is less than its book value. Recoverable amount is the higher of the selling price of the asset or the discounted future cash flows associated with the asset s use. IAS 36 allows for the reversal of an impairment loss if events in subsequent years suggest the asset is no longer impaired. 11-64
Recognizing an Upward Asset Revaluation Using the Guangzhou Company example, assume that after five years the fair market value is $540,000. Guangzhou elects to employ the allowable alternative under international standards. The journal entry is needed to recognize the asset revaluation is as follows: Accumulated Depreciation Building 150,000 Revaluation Equity Reserve 90,000 Building ($600,000 $540,000) 60,000 11-65
Recording the Disposal of Revalued Asset Assume that immediately after revaluing the building to $540,000, Guangzhou Company sells it for $540,000 in cash. The disposal would be recorded as follows: Cash 540,000 Building 540,000 Revaluation Equity Reserve 90,000 Retained Earnings 90,000 Note that because Guangzhou chose to revalue the asset, the gain is never reported as a gain. 11-66
5. Discuss the issues impacting proper recognition of amortization or impairment for intangible assets Amortization and Impairment of Intangible Assets Subject to Amortization Intangible assets are to be amortized by the straight-line method unless there is strong justification for using another method. Because companies must disclose both the original cost and the accumulated amortization for an amortizable intangible, the credit should be to a separate accumulated amortization account. 11-67
Amortization and Impairment of Intangible Assets Subject to Amortization Ethereal Company purchased a customer list for $30,000 on January 1, 2013. It is expected to have economic value for four years. The expected residual value is zero. On December 31, 2013, the following journal entry is made to recognize amortization expense: Amortization Expense ($30,000/4 years) 7,500 Accumulated Amortization Customer List 7,500 11-68
Amortization and Impairment of Intangible Assets Subject to Amortization During 2014, before the amortization entry is made, a test for impairment is made. The future cash flow of the list is expected to be $15,000 which is less than the book value of $22,500 ($30,000 $7,500). The amount of the impairment loss is $10,500. Impairment Loss ($22,500 $12,000) 10,500 Accumulated Amortization Customer List 7,500 Customer List ($30,000 $12,000) 18,000 11-69
Impairment of Intangibles Not Subject to Amortization The FASB describes the following examples of intangibles with indefinite lives: Broadcast licenses often have a renewal period of 10 years. Because renewal is virtually automatic, such licenses are considered to have an indefinite life. A trademark right is granted for a limited time, but can be renewed almost routinely. If economic factors suggest that the trademark will continue to have value in the foreseeable future, then its useful life is indefinite. 11-70
Impairment of Intangibles Not Subject to Amortization Impalpable Company has a broadcast license that has no foreseeable end to its useful life. The license cost $60,000, and it was estimated that the license generated cash flows of $7,000 per year. Recent events have convinced management that the cash flow will be reduced. The weighted probability shows that the estimated fair value is $52,000. 11-71
Impairment of Intangibles Not Subject to Amortization Because the estimated fair value is less than the book value ($52,000 < $60,000), the intangible asset is impaired. The loss is recognized with the following journal entry: Impairment Loss ($60,000 $52,000) 8,000 Broadcast License 8,000 11-72
Procedures in Testing Goodwill for Impairment The procedure in testing goodwill for impairment is a four step test. Buyer Company acquired Target Company on January 1, 2013. As part of the acquisition, $1,000 in goodwill was recognized; this goodwill was assigned to Buyer s Manufacturing unit. For 2013, earnings for the Manufacturing unit were $350. Separately traded companies with operations similar to the manufacturing reporting unit have market values approximately equal to six times earning. 11-73
Procedures in Testing Goodwill for Impairment As of December 31, 2013, book and fair values of assets and liabilities of the Manufacturing reporting units are as follow: Book Values Fair Values Identifiable assets $3,500 $4,000 Goodwill 1,000? Liabilities 2,000 2,000 11-74
Procedures in Testing Goodwill for Impairment 1. Compute the fair value of each reporting unit to which goodwill has been assigned. Using the earnings multiple, the fair value of the Manufacturing reporting unit is estimated to be $2,100 ($350 x 6). 11-75
Procedures in Testing Goodwill for Impairment 2. If the fair value of the reporting unit exceeds the net book value of the assets and liabilities of the reporting unit, the goodwill is assumed to not be impaired and no impairment is recognized. The net book value of the assets and liabilities of the Manufacturing reporting unit is $2,500 [($3,500 +$1,000) $2,000]. Since $2,100 (step 1) is less than $2,500, further computations are needed. 11-76
Procedures in Testing Goodwill for Impairment 3. If the fair value of the reporting unit is less than the net book value of the assets and liabilities of the reporting unit, then a new fair value of goodwill is computed. Goodwill value is always a residual value. Implied fair value of goodwill is calculated as follows: Estimated fair value of Manufacturing $2,100 Fair value of identifiable assets fair value of liabilities ($4,000 $2,000) 2,000 Implied fair value of goodwill $ 100 11-77
Procedures in Testing Goodwill for Impairment 4. If the implied amount of goodwill computed in (3) is less than the amount initially recorded, a goodwill impairment loss is recognized for the difference. The implied fair value of goodwill is less than the recorded amount of goodwill ($100 < $1,000). The journal entry necessary to recognize goodwill impairment loss is as follows: Goodwill Impairment Loss 900 Goodwill 900 11-78
6. Account for the sale of depreciable assets in exchange for cash and in exchange for other depreciable assets Asset Retirement by Sale On July 1, 2013, Landon Supply Co. sells machinery for $43,600 that is recorded on the books at a cost of $83,600 with accumulated depreciation as of January 1, 2013, of $50,600. Assume a 10 percent straight-line rate. Depreciation Expense Machinery 4,180 Accumulated Depreciation Machinery 4,180 To record depreciation for six months in 2013. $83,600 x.10 x 6/12 11-79
Asset Retirement by Sale The entry to record the sale is as follows: Cash 43,600 Accumulated Depreciation Machinery 54,780 Machinery 83,600 Gain on Sale of Machinery 14,780 To record sale of machinery at a gain. [$43,600 ($83,600 $54,780)] 11-80
Asset Classified as Held for Sale Special accounting is required if the following conditions are satisfied: Management commits to a plan to sell a longterm operating asset. The asset is available for immediate sale. An active effort to locate a buyer is underway. It is probable that the sale will be completed within one year. 11-81
Asset Classified as Held for Sale If the criteria are satisfied, two uncommon accounting actions are required. During the interval between being classified as held for sale and actually being sold: 1. No depreciation is to be recognized, and 2. The asset is to be reported at the lower of its book value or its fair value (less the estimated cost to sell). 11-82
Asset Classified as Held for Sale On July 1, 2013, Haas Company has a building that cost $100,000 and accumulated depreciation of $35,000. Haas commits to plans to sell the building by March 1, 2014. On July 1, 2013, the building has an estimated fair value of $40,000 and it is estimated that the selling costs will be $3,000. 11-83
Asset Classified as Held for Sale The following entry would be made on July 1: Building Held for Sale 37,000 Loss on Held-for-Sale Classification 28,000 Accumulated Depreciation Building 35,000 Building 100,000 If the net realizable value had been greater than the book value of $65,000 ($100,000 $35,000), no journal entry would have been made. 11-84
Asset Classified as Held for Sale On December 31, 2013, the estimated selling price was $58,000 (with $3,000 estimated selling costs), the following journal entry would be necessary: Building Held for Sale 18,000 Gain on Recovery Value Held for Sale 18,000 ($58,000 $3,000) $37,000 11-85
Asset Retirement by Exchange for Other Nonmonetary Assets When an operating asset is acquired in exchange for another nonmonetary asset, the new asset acquired is generally recorded at its fair market value or the fair value of the nonmonetary asset given in exchange, whichever is more clearly determinable. However, if the exchange has no real commercial substance, the asset received is sometimes recorded at the BOOK value of the asset given. 11-86
Asset Retirement by Exchange for Other Nonmonetary Assets Delivery equipment that cost $83,600 and has accumulated depreciation of $54,780 is exchanged for delivery equipment that has a fair market value of $43,600. Delivery Equipment 43,600 Accumulated Depreciation Machinery 54,780 Machinery 83,600 Gain on Exchange of Machinery 14,780 11-87
Asset Retirement by Exchange for Other Nonmonetary Assets Assume the delivery equipment s fair market value is not determinable, but the machinery has a market value of $25,000. The entry to record the exchange would be as follows: Delivery Equipment 25,000 Accumulated Depreciation Machinery 54,780 Loss on Exchange of Machinery 3,820 Machinery 83,600 11-88
Asset Retirement by Exchange for Other Nonmonetary Assets Assume the delivery equipment s fair market value is not determinable, but the machinery has a market value of $25,000. In addition to the delivery equipment, cash of $3,000 was received. The entry would be as follows: Cash 3,000 Delivery Equipment 22,000 Accumulated Depreciation Mach. 54,780 Loss on Exchange of Machinery 3,820 Machinery 83,600 Fair market value of machine 11-89
Nonmonetary Exchange without Commercial Substance Example 1 No Cash Involved Republic Manufacturing Company owns a molding machine that it decided to exchange for a machine owned by Logan Square Company. The following cost and market data relate to the two machines: 11-90
Nonmonetary Exchange without Commercial Substance The entry on Republic s books to record the exchange will be: Machinery (new) 14,000 Accumulated Depreciation Machinery (old) 32,000 Machinery 46,000 The entry on Logan s books to record the exchange will be: Machinery (new) 16,000 Accumulated Depreciation Machinery (old) 37,700 Loss on Exchange of Machinery 300 Machinery (old) 54,000 11-91
Nonmonetary Exchange without Commercial Substance Example 2 Small Amount of Cash Involved Assume the same facts as Example 1, except that it is agreed that Republic s machine has a market value of $16,000 and Logan s machine is worth $17,000. Republic pays Logan $1,000 cash. 17,000 11-92
Nonmonetary Exchange without Commercial Substance The entry on Republic s books to record the exchange will be: Machinery (new) 15,000 Accumulated Depreciation Machinery (old) 32,000 Machinery (old) 46,000 Cash 1,000 The book value of Logan s machine is less than the fair value, indicating a $700 gain ($17,000 $16,300). A portion of the gain should be recognized as having been earned. 11-93
Nonmonetary Exchange without Commercial Substance The amount to be recognized is computed using the following formula: Recognized gain For Logan: = Cash received Cash received + Fair value of x acquired asset Recognized $1,000 gain = x $700 = $41 $1,000 + $16,000 Total indicated gain 11-94
Nonmonetary Exchange without Commercial Substance The entry on Logan s books to record the exchange is as follows: Cash 1,000 Machinery (new) 15,341 Accumulated Depreciation Machinery (old) 37,700 Machinery (old) 54,000 Gain on Exchange of Machinery 41 11-95
Nonmonetary Exchange without Commercial Substance Example 3 Large Amount of Cash Involved Assume the same facts as in Example 2, except that it is agreed that Republic s machine has a fair value of $12,750 and Logan s machine has a fair value of $17,000. Republic pays Logan $4,250 cash. 11-96
Nonmonetary Exchange without Commercial Substance The entry on Republic s books to record the exchange will be: Machinery (new) 17,000 Accumulated Depreciation Machinery (old) 32,000 Loss on Exchange of Machinery 1,250 Machinery (old) 46,000 Cash 4,250 The entry on Logan s books: Cash 4,250 Machinery (new) 12,750 Accumulated Depreciation Machinery (old) 37,700 Machinery (old) 54,000 Gain on Exchange of Machinery 700 11-97
7. Compute depreciation for partial periods, using both straight-line and accelerated methods Depreciation for Partial Periods 1. Nearest whole month 2. Nearest whole year 3. Half-year convention Makes the most intuitive sense 4. No depreciation in year of acquisition; full year depreciation in year of retirement. 5. Full year depreciation in year of acquisition; no depreciation in year of retirement. 11-98
Depreciation for Partial Periods From this point, each year s depreciation will be $6,333 less than the previous year s depreciation. 11-99
Depreciation for Partial Periods Sum-of-the-Years -Digits Method 11-100
Depreciation for Partial Periods Declining-Balance Method If the asset was purchased three-fourths of the way through the fiscal year and the firm uses the double-declining-balance depreciation, the annual expense for depreciation is shown on the following slide. 11-101
Depreciation for Partial Periods Declining-Balance Method 11-102
8. Understand the depreciation methods underlying the MACRS income tax depreciation system Income Tax Depreciation The term cost recovery was used in the tax regulations to emphasize that ACRS is not a standard depreciation method because the system is not based strictly on asset life or pattern of use. Salvage values are ignored. Depreciate over three to five years. 11-103
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Income Tax Depreciation The MACRS method for personal property also incorporates a half-year convention, meaning that one-half of a year s depreciation is recognized on all assets purchased or sold during the year. 11-105
Income Tax Depreciation Office equipment is purchased for $100,000 on October 1, 2013. It has an estimated residual value of $5,000. 11-106