Concept Review Solutions

CHAPTER 10: DEPRECIATION, AMORTIZATION, AND IMPAIRMENT

Page 532

1. The main causes of declines in value or usefulness of capital assets are physical factors such as wear and tear (e.g., usage of assets), and obsolescence by advances in technology (e.g., passage of time).

2. Amortization or depreciation is not an accurate measure of the decline in the value of assets as it is not concerned with, nor does it attempt to make, a determination of value. Amortization is merely the allocation of capital (historical) cost over the useful life of the asset.

3. Six asset categories that do not have to be amortized are land, biological assets, held for sale assets, investment property, intangible capital assets with an indefinite life, and goodwill. These are not amortized since their useful life is assumed to be indefinite or there are unique accounting standards for these assets.

Page 533

1. When an asset is viewed as a whole, it does not reflect the pattern of consumption since some parts or components will be used up faster than others. The effect of this is lower depreciation than if the asset was viewed as components.

2. Separation into components requires significant professional judgement. Parts that would have a similar useful life and depreciation method can be grouped together. The remainder of insignificant parts would be grouped together and depreciated. Separation into components should be accomplished when the asset is first acquired, even though not all events are known at purchase. . Some of these components may be physical and others may be non-physical. Each of those components would be depreciated separately

3. If there are insignificant parts, these would be grouped together and depreciated.

Page 537

1. The most popular method of amortization in Canada is the straightline method.

2. Factors affecting management’s choice of amortization policies include nature and use of asset, corporate reporting objectives, industry norms, parent company preferences, simplified reporting, and accounting information system costs (i.e., complexity and flexibility of system). (Any 3 of these would be acceptable.)

3. Estimates required prior to amortizing a capital asset include the acquisition costs (pre and post acquisition costs), the useful life of the asset (e.g., number of years, or production output), and the residual value of the asset.

Page 542

1. A company is most likely to use a usagebased amortization method when obsolescence is not a significant factor in the useful life of an asset (i.e., when decline in usefulness or value of an asset is driven primarily by wear and tear through usage), the asset’s utilization varies significantly from period to period, and when it is possible to capture the annual usage data needed to apply the method.

2. Under the doubledeclining balance amortization method, the amortization rate used is double the normal straightline rate; the result is an aggressive amortization rate.

3. By using an amortization method that coincides with the capital cost allowance method required for tax purposes, a company may reduce the record-keeping expenses otherwise required to maintain two sets of records for fixed assets. The company will also be able to avoid future (deferred) income tax balances arising from differences between the accounting book value and the tax value of capital assets.

Page 545

1. When a new asset is required, its company will need to determine the following information:

• Identification of significant major parts or components

• For each significant major part or component

– Acquisition cost

– Residual value

– Useful life

– Depreciation method and period.

2. With decommissioning costs related to land, the amount of the obligation is added to the value of the land. This is often referred to as a bump-up to the related asset. The initial land value is not depreciated, but the additional value added to the land for the obligation is depreciated.

3. Group and composite systems of amortization may be useful for large companies as they simplify record keeping. There is no need to maintain detailed cost and amortization records for each asset. As well, there is no need to figure out when an asset is scrapped or sold, exactly which asset it was, and its initial cost and accumulated depreciation amounts.

Page 558

1. Assets should be tested for impairment when events or circumstances indicate that the carrying value may not be recoverable. Examples of such circumstances include:

▫ Significant change in business environment (new products from competitors that makes your company’s products obsolete)

▫ Physical damage to the asset

▫ History of operating losses/cash flow losses that indicate the cost of the asset may not be recoverable

▫ A probability (>50%) that company will retire/dispose of the assets earlier than planned

▫ Loss of a lawsuit that significantly effects overall operations (e.g. patent infringement)

The value is written down to the amount that can be recovered through sale or use.

2. In an impairment test, the carrying value of property, plant, and equipment is compared to its fair value in use. If the asset’s fair value is less than its carrying value on the company’s books, the asset has suffered impairment and must be written down. The asset is written down to the fair value as estimated on the basis of discounted cash flows.

In completing the impairment testing, the following steps are taken:

1. Identification of cash-generating units (CGU)

2. Review of external and internal impairment indicators

3. If required annual impairment testing or if indication of impairment, then measurement of the recoverable amount

4. If impairment, write down to recoverable amount and allocate the impairment loss

3. Reversal is allowed for all long-lived assets with the exception of goodwill. Impairment losses may be reinstated if the fair value of the asset has recovered and should be recognized in income immediately.

In order to guard against manipulation, the international standard provides guidelines on how to ascertain that an impairment loss has occurred and when the value has recovered.

Concept Review Solutions Intermediate Accounting, 6e, Volume 1