INTERMEDIATE

ACCOUNTING
TENTH CANADIAN EDITION
Kieso Weygandt Warfield Young Wiecek McConomy

CHAPTER 11
Depreciation,
Impairment, and
Disposition

PREPARED BY:

Dragan Stojanovic, CA
Rotman School of Management,
University of Toronto

CHAPTE
11:
R
Depreciation, Impairment, and Disposition
After Studying this chapter you should be able to:
Understand the importance of depreciation, impairment, and disposition from a
business perspective.
Explain the concept of depreciation and identify the factors to consider when
determining
depreciation charges.
Identify how depreciation methods are selected.
Calculate depreciation using the straight-line, decreasing charge, and activity
methods and
recognize the effects of using each.
Explain the accounting issues for depletion of mineral resources.
Explain and apply the accounting procedures for partial periods and a change in
depreciation rate.
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CHAPTE
11:
R
Depreciation, Impairment, and Disposition
After studying this chapter you should be able to (continued):
Explain the issues and apply the accounting standards for capital asset
impairment
under both IFRS and ASPE.
Explain and apply the accounting standards for long-lived assets that are held
for sale.
Account for derecognition of property, plant, and equipment.
Describe the types of disclosures required for property, plant, and equipment.
Analyze a companys investment in assets.
Identify differences in accounting between ASPE and IFRS, and what changes
are expected
in the near future.
Calculate capital cost allowance in straightforward situations.
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Depreciation, Impairment and

Disposition

Depreciation A
Method of
Allocation
Factors
considered
Methods of
allocation
Depreciation
methods of
calculation
Depletion of
mineral
resources
Other
depreciation
issues

Impairment
Indicators of
impairment
Impairment
recognition and
measurement
models
Asset groups and
cash-generating
units

Held for Sale and

Derecognition
Long-lived assets
to be disposed of
by sale
Derecognition

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Presentation,
Disclosure, and
Analysis
Presentation
and disclosure
Analysis

IFRS/ASPE
Comparison
Comparison of
IFRS and
ASPE
Looking ahead

Depreciation Concept
Depreciation (and amortization more
broadly) is a means of cost allocation
It is not a method of valuation
Depreciation involves:
allocating the depreciable amount of property,
plant, and equipment over the periods
expected to benefit from the use of the assets

This allocation is generally recognized as

Depreciation Expense
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Factors in the Depreciation

Process
Questions to be answered to determine the
amount of depreciation expense:
1. What asset components are depreciated
separately?
2. What is the assets depreciable amount?
3. Over what period is the asset depreciated?
4. What pattern best reflects how the assets
economic benefits are used up?
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Components Depreciated Separately

Each significant part of a PP&E asset should be
identified and depreciated as a separate component
Multiple components may be grouped for
calculating depreciation if they have same useful
lives and depreciation methods
Parts of each PP&E asset that are not individually
significant can be grouped and depreciated as a
single component
Application of components for the purpose of
depreciation is required by both ASPE and IFRS.
However, IFRS is more detailed and strict.
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Depreciable Amount
Depreciable amount is initially calculated as:

Original cost of the asset

less estimated residual value (or salvage value)
IFRS does not permit the use of salvage value
Residual value is the net amount expected to be received for
the asset today if it were of the age and in the condition
expected at the end of its useful life
Salvage value is the assets estimated net realizable value at
the end of the assets life
Residual value should be reviewed regularly (at least annually
under IFRS)
Depreciation continues as long as residual value is lower than
assets carrying amount
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Depreciation Period
Depreciation begins when the asset is available for use
Depreciation ends when the asset is derecognized or
classified as held for sale.
An assets useful life and physical life are not the same
(expressed in time or units)
Useful life is sometimes referred to as the economic life
the period of time over which the asset will produce
revenue for the company
Factors affecting useful life are:

economic factors (e.g. obsolescence)

physical factors (e.g. wear and tear)
legal life (e.g. expiration of contract)
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Choice of Depreciation
Method
Depreciation method determines the systematic

allocation of the depreciable amount over the assets

useful life
Depreciation should reflect the pattern of benefits
expected from the use of the asset
Additional considerations for choosing a particular
depreciation method include simplicity, cost, as well as
perceived economic consequences
Depreciation method affects:
The balance sheet
The income statement
The ratios (e.g. return on assets, etc)
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10

Depreciation Methods:
Overview
Depreciation
Methods
Financial Accounting
Depreciation Methods

Straight-Line
Method

Diminishing
Balance
Method
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Tax
Depreciation

Special
methods

Activity
Method

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Comparison of Methods
Straight-Line Method
Simple to use
Based on two broad
assumptions:
Constant usage
Other costs same each
year

Diminishing Balance Method

Best match of some assets
productivity to cost
More depreciation in earlier
years when asset has
greatest benefit

Distorts rate of return

analysis

Activity Method
Only appropriate where usage is not a function of time
Difficult to estimate total number of units over life of asset
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12

Depreciation Methods:
Example
Crane Ltd. buys a crane at the beginning of the current fiscal
year. Information relating to the crane follows:

Cost: $500,000
Estimated useful life: five years (or 30,000 hours)
Residual value (end of five years of use): $50,000
Actual hours used during the current year: 4,000
hours and assume 4,700 in next year

Based on this information, calculate the amortization for the

current year using: straight-line, decreasing charge, and
activity methods
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13

Straight-Line Method
1. Depreciable amount = $500,000 $50,000 = $450,000
2. Annual Depreciation = $450,000 / 5 years = $90,000
3. Depreciation Schedule:
Book Depreciation
Year Value
Expense
1 $500,000 $90,000
2 $410,000 $90,000

Accumulated
Depreciation
$ 90,000
$180,000

Book value
End of year
$410,000
$320,000

Note that the depreciation

expense is the same
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Diminishing Balance Method: DoubleDeclining-Balance Method

Assets residual
value is not
deducted

1. Rate of Depreciation = 2 (1/5) = 40%

Last year
is
2. Depreciation (current)
= $500,000
0.40 = $ 200,000
Rate= (100%
rounded. Book
Depreciation (next)
= ($500,000 - $200,000) Useful
0.40
Life)
value cannot be
= $120,000
x2
less than residual
value.

3. Depreciation Schedule:
Book Depreciation Accumulated
Year Value
Expense Depreciation
1 $500,000 $200,000
$200,000
2 $300,000 $120,000
$320,000
3 $180,000 $ 72,000
$392,000
4 $108,000 $ 43,200
$435,200
5 $ 64,800 $ 14,800
$450,000
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Book value
End of year
$300,000
$180,000
$108,000
$ 64,800
$ 50,000
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Activity Method (unit =

hour)
1. Depreciable amount = $500,000 $50,000 = $450,000
2. Depreciation per hour = $450,000 / 30,000 = $15.00
3. Depreciation (current) = $15.00 4,000 hours = $60,000
Depreciation (next) = $15.00 4,700
hours = $70,500
This same rate
4. Depreciation Schedule:
Book Depreciation
Year Value
Expense
1 $500,000 $60,000
2 $440,000 $70,500

is used each
year

Accumulated
Depreciation
$ 60,000
$130,500

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Book value
End of year
$440,000
$369,500

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Depletion of Natural
Resources
Natural resources are depleted (amortized) over

time as they are removed

Depletion is calculated using an activity method
(such as units-of-production)
The depletion charge is initially debited to Inventory
When the resource is sold, Inventory is credited
and Cost of Goods Sold is debited
Where an equipments useful life is clearly linked to
the life of the resource, it is also amortized using
the units-of-production method
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17

Depletion: Example
Mining Company has right to use land to mine gold:
Lease cost:

Exploration cost:

50,000
$ 100,000

Development cost:

$ 850,000

Total capitalized cost:

$1,000,000

Estimated production (useful life*) = 100,000

ounces of gold
*Note: useful life is the # of units estimated to be in the
resource deposit
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Depletion: Example
Depletion Rate = Total cost residual value
Total estimated units
Depletion Rate = $1,000,000 0 = $10 per ounce
100,000
Entry to record 25,000 ounces mined:
Inventory
250,000
Accumulated depletion
250,000
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Partial Year Depreciation

When an asset is acquired sometime
during the year, a partial depreciation
charge is sometimes taken
The procedure is:

determine depreciation for a full year, and

allocate the amount between the two periods
affected (see upcoming example)

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Depreciation and Partial

Periods
Straight-Line Method
Calculate the amortization for the portion of the year
Generally use the nearest full month
Declining-Balance Method
More complex calculations involved
Units of Production/Use Method
No special calculations required
Calculate the usage rate and apply to actual usage
for the period
Same rate used in subsequent years
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Partial Year Depreciation:

Example
Asset purchased on July 1, 2014. Information
relating to the asset is:

Cost: $10,000
Estimated service life: five years
Residual value end of five years: none
Determine depreciation expense under the doubledeclining-balance method
Determine full year depreciation as follows:
First full year = $10,000 x 40% = $4,000
Second full year = $6,000 x 40% = $2,400
Third full year = $3,600 x 40% = $1,440
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Partial Year Depreciation:

Example
Date of purchase, July 1, 2014
Allocate first full years
depreciation of $4,000
between 2014 and 2015

$2,000

2014

Allocate second full years

depreciation of $2,400
between 2015 and 2016

$2,000 $1,200

$1,200

2015

2016

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Revision of Depreciation
Estimates
Determination of depreciation involves estimates of
useful life, residual value, pattern in which asset
benefits will be received
These estimates need to be reviewed regularly (under
IFRS, at least at the end of every fiscal year end)
When these estimates are revised, depreciation is
recalculated
The revised depreciation is applied prospectively to
the remaining life of the asset, i.e., it is accounted for
in the period of the change and to future periods
The changes do not affect prior periods
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Revision of Depreciation Estimates:

Example
Depreciable asset purchased for $90,000

Estimated life was 20 years

Estimated residual value was $10,000
Pattern of benefits received: equal amounts
per period
In year 9, estimates were revised as follows:

Estimated life: total of 30 years

Estimated residual value: $2,000
Determine amortization for 9th year based on the
straight-line method of depreciation
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Revision of Depreciation Estimates:

Example
Book value of the asset at the date of revision of
estimates:

($90,000 $10,000) / 20 years = $4,000 per year

$4,000 8 years = $32,000 of Accumulated
Depreciation
Book value: $90,000 $32,000 = $58,000

Amount to be depreciated (9th to 30th year = 22 years

remaining)

($58,000 $2,000) / 22 years = $2,545 each

year
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Impairment: Overview
Impairment occurs when the carrying amount of the long

lived asset (such as PP&E) is greater than its future

economic benefit to the company
There are many external and internal indicators that
provide evidence of possible impairment
Management needs to regularly evaluate assets for these
indicators of impairment
IFRS requires this at the end of each reporting period
If there is an indicator of possible impairment, then the
asset must be tested for impairment
Two main approaches to measuring impairment losses are:
Cost recovery impairment model
Rational entity impairment model
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Cost Recovery Impairment

Model
Under this model, an asset is impaired only if carrying

amount cannot be recovered from using and eventually

disposing of the asset (recoverability test)
i.e. impaired if carrying amount > undiscounted future

net cash flows

Impairment loss is then measured as assets

carrying amount
less fair value
Fair value of the asset is best measured by quoted

market prices in active markets

It is by its nature a present value or discounted measure

Impairment losses cannot be reversed

Applied by ASPE
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Rational Entity Impairment

Model
Impairment loss is measured by comparing the assets

carrying amount and recoverable amount

Recoverable amount is measured as higher of
1.

Value in use, and

(present value of future net cash flows)

2.

Fair value less cost to sell

If carrying amount < recoverable amount, then there is no

impairment loss
If carrying amount > recoverable amount, then impairment
loss is difference between two values
Impairment losses may be reversed
Applied under IFRS
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Asset Groups and Cash-Generating

Units (CGU)

Many assets do not generate cash flows independently, so

impairment analysis cannot be done at the level of the individual asset
These assets are identified with an asset group or cash-generating
unit (CGU)
i.e. smallest identifiable group of assets that generates cash
inflows that are largely independent of the cash flows from other
assets or groups of assets (IAS 36.6)
Both cost recovery and the rational entity impairment models are then
applied to the groups of assets, instead of the individual asset
Any impairment losses are then allocated to individual assets on a
pro-rata basis
No individual asset should be reduced below its fair value (under cost
recovery model) or recoverable amount (under rational entity model)
if these amounts are known
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Held for Sale

Long-lived asset is classified as held for sale if the

company intends on disposing the asset by sale and

meets strict criteria (described in Ch. 4)
Held for sale assets are
Reported separately on the balance sheet
Not depreciated
Measured at the lower of
Carrying amount, and
Fair value less costs to sell

Subsequent increases in net realizable value may be

recognized as gains, but only to the extent they

offset previously recognized losses
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Derecognition
Plant assets may be:

retired voluntarily, or disposed of by sale,

exchange, involuntary conversion, donation
Depreciation is recorded up to the date of disposal
before determining gain or loss
Gains or losses from disposal are normally shown
with Other revenues and expenses in the income
statement

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Presentation and
Disclosure
There are many significant disclosures required
for property, plant, and equipment
Types of disclosures include the following:
cost and the accumulated depreciation
depreciation method and rate or period
assumptions surrounding fair-value-related
measurements
carry amounts of assets held for sale
outstanding contingencies

Specific standards under IFRS generally have

more extensive disclosure requirements
compared to ASPE
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Analysis of Property, Plant, and

Equipment
1. Activity analysis
(efficiency in using assets to generate revenues)
Total Asset Turnover =

Net Revenue
Average Total Assets

2. Profitability analysis
(net income earned from each sales dollar):
Profit Margin =
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Net Income
Net Revenue
34

Analysis of Property, Plant, and

Equipment
Return on Assets
(effect long-lived assets have on profitability):
= Asset Turnover

Profit Margin

= Net Revenue
Average Total Assets

Net Income
Net Revenue

= Net Income
Average Total Assets
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IFRS and ASPE

ASPE and IFRS are consistent in many
areas of accounting for depreciation and
disposition
Most significant difference between the
two standards relates to measurement of
impairment losses
There are no major changes expected in
this area
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36

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