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# ACC 211 Ch. 11

## Terms

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What does depreciation account for?
Depreciation is not a matter of valuation but a means of cost allocation.
Define depreciation
Depreciation is defined as the accounting process of allocating 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.
What three questions need to be answered to set up a depreciation cycle for an asset?
1. What depreciable base is to be used for the asset?
2. What is the assetâ€™s useful life?
3. What method of cost apportionment is best for this asset?
Define salvage value
It is the estimated amount that will be received at the time the asset is sold or removed from service.
Assets are retired for what two reasons?
physical factors and economic factors
Define physical factors
Physical factors are the wear and tear, decay, and casualties that make it difficult for the asset to perform indefinitely.
What are the 3 categories of economic factors?
inadequacy, supersession, and obsolescence.
define inadequacy
It results when an asset ceases to be useful to a give enterprise because the demands of the firm have increased.
define supersession
Supersession is the replacement of one asset with another more efficient and economical asset.
define obsolescence
Obsolescence is the catchall for situations not involving inadequacy and supersession.
What are the 3 major methods of depreciation?
1. Activity method
2. Straight-line method
3. Decreasing-charge method
What are the major decreasing-charge methods?
1. Sum-of-the-yearsâ€™ digits
2. Declining-balance method.
Define the activity method of depreciation
The activity method (also called the variable charge approach) assumes that depreciation is a function of use or productivity instead of the passage of time. It considers either the input or the output measures.
What is the equation for the activity method?
[(Cost â€“ salvage)*units] / total estimated units
What is the recording of depreciation an attempt to do?
Depreciation is an attempt to match the cost of an asset to the periods that benefit from the use of that asset.
What is the assumption of the straight-line method?
The straight-line method considers depreciation a function of time rather than a function of usage.
What is the equation for the straight-line method?
(Cost â€“ salvage) / estimated service life
What is the assumption of the sum-of-the-year's-digits method?
depreciation occurs the most when the asset is the most new
What is the equation for the denominator in the sum-of-the-year's-digits method?
[N(N+1)]/2
What is the equation for the double declining balance method?
depreciation = (book value)*[2*(1/estimated service life)]
What's the difference between a group and a composite?
The term â€œgroupâ€ refers to a collection of assets that are similar in nature.
â€œCompositeâ€ refers to a collection of assets that are dissimilar in nature.
What is the equation for the group or composite depreciation method?
Sum individual depreciation rates in order to find the composite depreciation amount. Divide this into total depreciable base in order to find the time left.
How is an individual asset in a composite treated if it is retired before, or after, the average service life of the group is reached?
The resulting gain or loss is put into the Accumulated Depreciation account.
Why use the group or composite method?
The group or composite method simplifies the bookkeeping process and tends to average out errors caused by over- or under-depreciation.
How should you depreciate for partial periods?
In computing depreciation expense for partial periods, it is necessary to determine the depreciation expense for the full year and then to prorate this depreciation expense between the two periods involved. This process should continue throughout the useful life of the asset.
In what way must a company depreciate its assets?
A company is at liberty to adopt any one of these several factional-year policies in allocating cost to the first and last years of an assetâ€™s life so long as the method is applied consistently. However, unless otherwise stipulated, depreciation is normally computed on the basis of the nearest full month.
How are changes in depreciation estimates handled?
Changes in estimate should be handled in the current and prospective periods. No entry is made at the time the change in estimate occurs, and charges for depreciation in subsequent periods (assuming use of the straight-line method) are based on dividing the remaining book value less any salvage value by the remaining estimated life.
How is the lower of cost or market rule applied to property, plant, and equipment?
It isn't.
What is an impairment?
Impairment occurs when the carrying amount of an asset is not recoverable, and therefore a write-off is needed.
What are some examples of events that might lead to an impairment?
1. A significant decrease in the market value of an asset.
2. A significant change in the extent or manner in which an asset is used.
3. A significant adverse change in legal factors or in the business climate that affects the value of an asset.
4. An accumulation of costs significantly in excess of the amount originally expected to acquire or construct an asset.
5. A projection or forecast that demonstrates continuing losses associated with an asset.
Explain the "recoverability test"
It is used to determine whether an impairment has occurred. First, estimate the future net cash flows expected from the use of that asset and its eventual disposition. If the sum of the expected future net cash flows (undiscounted) is less than the carrying amount of the asset, the asset is considered impaired.
How is the "loss on impairment" measured?
The impairment loss is the amount by which the carrying amount of the asset exceeds its fair value. The fair value of an asset is measured by its market value if an active market for it exists. If no active market exists, the present value of expected future net cash flows should be used.
How is a loss on impairment recorded?
Debit "Loss on Impairment."
Credit "Accumulated Depreciation."
How is impairment loss recorded in the income statement?
The impairment loss is reported as part of income from continuing operations, generally in the â€œother expenses and lossesâ€ section.
When does the lower of cost or market apply to an asset?
Assets held for disposal are like inventory and should be reported at the lower of cost or net realizable value.
How should losses or gains related to impaired assets be recorded in the income statement?
continuing operations
The computation of the depletion base involves what four factors?
1. acquistion cost of the deposit
2. exploration cost
3. development costs
4. restoration costs
What are exploration costs?
As soon as a company has the right to use the property, exploration costs are often needed to find the resource.
How are exploration costs recorded?
In most cases, these costs are expensed as incurred. When these costs are substantial and the risks of finding the resource uncertain, capitalization may occur.
What are the two elements of development costs?
1. tangible equipment costs
2. intangible development costs
define tangible equipment costs
tangible equipment costs include all of the transportation and other heavy equipment necessary to extract the resource and get it ready for production or shipment.
How are tangible equipment costs treated?
tangible assets that can be moved-- expensed...
tangible assets that cannot be moved-- added to depletion base
What are intangible development costs?
Intangible development costs are for such items as drilling costs, tunnels, shafts, and wells.
How are intangible development costs treated?
Intangible development costs are considered part of the deplation base.
What are restoration costs, and how should they be treated?
substantial costs to restore property to its natural state after extraction has occurred; should be added to the depletion base
What is the full cost concept as it is applied to the exploration costs of oil and gas?
it states that unsuccessful ventures should be treated as a cost of the successful ones
what is the successful efforts concept as it is applied to the exploration costs of oil and gas?
it states that only the costs of successful projects should be capitalized
what is reserve recognition accounting?
a current value approach that states that as soon as a company discovers oil, it should report the value of the oil on the balance sheet and in the income statement
How are changes in estimates or recoverable reserves treated?
revise the depletion rate on a prospective basis by dividing the remaining cost by the new estimate of the recoverable reserves
define asset turnover ratio; how is it found
this ratio shows how efficiently a company uses its assets to generate sales; determined by dividing net sales by average total assets for the period
define the "profit margin on sales ratio"
it is simply the rate of return on sales, calculated by dividing net income by net sales
define the rate of return on assets (ROA)
determines how profitably assets have been used, computed by dividing net income by average total assets

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