10.8 Chapter Summary

LO 1: Identify the purpose of depreciation, and discuss the elements that are required to calculate depreciation.

Depreciation is a systematic allocation of an asset’s cost to the accounting periods in which the benefits of the asset are consumed. Depreciation is not an attempt to revalue the asset. To calculate depreciation, one needs to determine the depreciable amount, the useful life, and method of calculation. The depreciable amount is the cost less the residual value. The useful life of an asset will not necessarily be the same as the physical life of the asset. The method should systematically allocate the cost in a manner that reflects the consumption of economic benefits. Significant judgment will be required when applying these three elements.

LO 2: Calculate depreciation using straight-line, diminishing-balance, and units-of-production methods.

Straight-line depreciation assumes that benefits are derived from the asset in equal pro- portions over the asset’s life. The calculation divides the depreciable amount by the useful life and then allocates this equal charge over the life of the asset. The diminishing- balance approach assumes that greater benefits are derived earlier in an asset’s life. This approach charges a constant percentage of the asset’s carrying value each year to depreciation. The units-of-production method charges varying amounts of depreciation based on the asset’s activity. Using output measures is more theoretically correct, but in- put measures may also be used. The calculation requires dividing the depreciable amount by the expected amount of productive output over the asset’s life and then applying the resulting rate to the actual production in the reporting period.

LO 3: Discuss the reasons for separate component accounting and the accounting problems that may arise from this approach.

Component accounting is required because significant asset components may have different useful lives and different economic consumption patterns. By recording components separately, accountants are able to create more meaningful depreciation calculations. Problems that arise in this approach include the inability to measure component costs accurately, the judgment required in identifying significant components, and the additional accounting costs in maintaining component records.

LO 4: Calculate depreciation when partial periods or changes in estimates are required.

The depreciation charge in the period in which an asset is purchased or sold will need to be prorated based on time, except when using the units-of-production method. This proration can be calculated a number of ways but should be consistent from period to period. When changes in estimates regarding useful life, residual value, or pattern of consumption (method) are determined, these changes should be treated prospectively. The new estimate is applied to the current carrying amount, resulting a new depreciation charge for current and future periods. No adjustments are made to past period- depreciation charges.

LO 5: Discuss indicators of impairment and calculate the amount of impairment.

Impairment is indicated when external factors related to the environment in which the business operates or internal factors related to the asset itself indicate that the carrying value may not be ultimately realized. External factors include observable indications of loss of value; technological, market, or legal changes; increases in interest rates; and declines in market capitalization. Internal factors include physical damage, changes in the use of the asset, and declining productivity of the asset. Impairment is calculated as the difference between the carrying amount and the recoverable amount. The recoverable amount is the greater of the value in use or fair value, less costs of disposal. Impairment tests may sometimes be applied to cash-generating units if the effects on individual assets cannot be determined.

LO 6: Identify the criteria required to classify an asset as held for sale.

For an asset to be classified as held for sale, a number of conditions must be present. The asset must be available for immediate sale, and the sale must be highly probable. Management must be committed to the sale and must have an active program to locate a buyer. The asking price must be reasonable in relation to the market. The sale should be expected within one year, and it should be unlikely that the plan will be withdrawn.

LO 7: Prepare journal entries for assets held for sale.

When an asset is classified as held for sale, it must be revalued to the lower of its carrying value or fair value less costs to sell. As well, depreciation of the asset will cease once it is classified as held for sale. This treatment means that either no change in value will occur, or an impairment loss will be reported in the year when the classification occurs. When the asset is subsequently sold in a future period, the resulting gain or loss is not treated as an impairment loss or reversal.

LO 8: Discuss other derecognition issues.

If an asset is expropriated or otherwise disposed, and proceeds are received, this transaction is treated the same as any other asset disposal, with the resulting gain or loss being reported on the income statement. If an asset is simply abandoned or scrapped, then that asset needs to be derecognized, and a loss will be reported equal to the carrying value of the asset. When an asset is donated, the asset needs to be derecognized, and an expense is recognized equal to the fair value of the asset. This means a gain or loss will likely result on this transaction.

LO 9 Identify the presentation and disclosure requirements for property, plant, and equipment.

IFRS requires a significant amount of disclosure regarding PPE assets. Some of these disclosures include details of methods and assumptions that are used in depreciation calculations, the measurement base used, reconciliation of changes during the period, restrictions on and commitments for assets, details of any revaluations, details of changes in estimates, and other factors.

LO 10: Identify key differences between IFRS and ASPE.

IFRS and ASPE share many similarities in the treatment of PPE assets. Some differences include the absence of fair value and revaluation methods under ASPE, a different test and criteria for impairment, different classification rules for held-for-sale assets, different methods of determining the depreciable amount, and greater disclosure requirements under IFRS.