Depreciation is the accounting process of allocating the cost of tangible assets to expense in a systematic and rational manner to the periods expected to benefit from the use of the asset. For example, in their press releases they will often make a big deal about earnings before interest, tax, depreciation and amortization. Some banks even let companies base their loan terms on EBITDA.
For example, look at Premier Parks, which operates the Six Flags theme park chain. Premier argues that analysts should ignore depreciation for big-ticket items like roller coasters because the rides have a long life. This means that analysts should view the depreciation associated with the costs of maintaining the rides (or buying new ones) as a daily expense.
Of the 147 companies monitored by Moody's that defaulted on their debt, most borrowed on an EBITDA basis. On the other hand, non-financial companies in the S&P 500 generated a substantial EBITA margin of 20.9 percent in 2011.
Depreciation—Method of Cost Allocation
Stanley Coal Mines Facts
Straight-Line Method
Decreasing-Charge Methods
Sum-of-the-Years’-Digits
Declining-Balance Method
Straight-line Method
Sum-of-the-Years’-Digits Method
Double-Declining Balance Method
LEARNING OBJECTIVESLEARNING OBJECTIVES
Depreciation, Impairment, Depreciation, Impairment,
Special Depreciation Methods
Group and Composite Methods
If Mooney retires an asset before or after the average life of the group is reached, it buries the resulting gain or loss in the accumulated depreciation account. If Mooney purchases a new type of asset (eg mopeds), it must calculate a new depreciation rate and apply that rate to subsequent periods.
Hybrid or Combination Methods
How should companies compute depreciation for
Does depreciation provide for the replacement of assets?
How should companies handle revisions in
Special Depreciation Issues
Revision of Depreciation Rates
Questions
First, enter the NBV First, enter the NBV on the change date on the change date. The amount of depreciation expense recorded depends on both the depreciation method used and estimates of the assets' useful lives and salvage values. Changes in these choices and estimates can significantly affect a company's reported results and can make it difficult to compare the depreciation numbers of different companies.
For example, when Willamette Industries extended the estimated life of its machinery and equipment by five years, it increased income by nearly $54 million. An analyst determines the impact of these management choices and judgments on the amount of depreciation expense by examining the notes to the financial statements. During the year, the estimated lifetime of most machinery and equipment has been extended by five years.
The change was based on a study conducted by the company's engineering department, comparisons with typical industry practice and the effect of the company's extensive capital investment, which has resulted in a mix of assets with longer productive lives due to technological advances.
Events leading to an impairment
Impairments
If the sum of the expected future net cash flows from the long-lived asset is less than the carrying amount of the asset, an impairment has occurred. If an impairment is assumed, the impairment loss is the amount by which the carrying amount of the asset exceeds the fair value of the asset. The fair value is the market value or the present value of expected future net cash flows.
Measuring Impairments
Impairment
Alou determines the expected future net cash flows (undiscounted) from the use of the equipment and its eventual disposal to be $580,000.
Impairment Loss
No change in the new cost basis except for depreciation and write-downs in future periods or further write-downs. The rationale is that the new cost base puts the impaired asset on an equal footing with other assets that are not impaired.
Restoration of Impairment Loss
Can write down or depreciate an asset held for sale in future periods, as long as the carrying amount after the write-up never exceeds the carrying amount of the asset before the impairment. Must report losses or gains related to these impaired assets as part of income from continuing operations.
Impairment of Assets to Be Disposed Of
Depletion
Establishing a Depletion Base
Write-off of Resource Cost
Calculation
Estimating Recoverable Reserves
Cuts in oil and natural gas reserve estimates at Royal Dutch Shell, El Paso Corporation, and other energy companies at one point highlighted the importance of reserve disclosure. Investors seemed to believe that this information provides useful information for assessing the future cash flows from a company's oil and gas reserves. For example, when Shell's estimates turned out to be overly optimistic (worth 3.9 billion barrels or 20 percent of reserves), Shell's share price fell.
The experience at Shell and other companies has led the SEC to look at how companies estimate their "proof." Proved reserves are quantities of oil and gas that can be shown “with reasonable certainty to be recoverable in future years. The phrase "reasonable certainty" is crucial to this guidance, but differences in interpretation of what is reasonably certain can result in a wide range of estimates.
WHAT IS YOUR PRINCIPLE WHAT IS YOUR PRINCIPLERAH-RAH SURPRISERAH-RAH SURPRISE In one case, for example, ExxonMobil's estimate was 29 percent higher than an estimate the SEC developed. Exxon-Mobil was more optimistic about the effects of new technology that will allow the industry to recover more of the oil and gas found. Thus, to ensure the continued usefulness of RRA disclosures, the SEC may need to work on a measurement methodology that keeps pace with technological changes in the oil and gas industry.
Bahree, “Big Oil Differs from SEC on Methods for Calculating Industry Reserves,” Wall Street Journal (February, p.
Continuing Controversy
Second, concern about economic consequences puts pressure on the FASB to weigh the economic effects of any required standards. Freedom from bias requires that statements reflect economic reality, even if unintended effects occur. Finally, the oil and gas accounting debate reinforces the need for a conceptual framework with carefully developed guidance on recognition, measurement and reporting so that stakeholders can more easily resolve issues of this nature in the future.
Presentation of Property, Plant, Equipment, and Natural Resources
Presentation and Analysis
Analysis of Property, Plant, and Equipment
Asset Turnover Ratio
Profit Margin on Sales
Rate of Return on Assets
Modified Accelerated Cost Recovery System
Tax Lives (Recovery Periods)
Tax Depreciation Methods
Optional Straight-Line Method
Tax Versus Book Depreciation
The definition of property, plant and equipment is essentially the same under GAAP and IFRS. Accounting for initial costs for the acquisition of natural resources is similar under GAAP and IFRS. GAAP allows the same depreciation methods (straight-line, reducing balance, units of production) as IFRS.
As long as future undiscounted cash flows exceed the carrying amount of the asset, no impairment is recorded. In relation to revaluations, as part of the conceptual framework project, the Boards 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 the basis of measurement in GAAP.
IFRS SELF-TEST QUESTION
Hilo Company decides to use the revaluation method specified in IFRS to account for the land. Hilo Company would report an increase in net income of $150,000 due to the increase in the value of the land.
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