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RSM220H1 (54)
Chapter 11

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Rotman Commerce
Dragan Stojanovic

Chapter 11: Depreciation, Impairment, & Disposition DEPRECIATION- A METHOD OF ALLOCATION  Depreciation/amortization is a means of cost allocation; not valuation o Process of allocating the depreciable amount of a PPE asset to expense in a systematic manner to those periods expected to benefit from its use  The assets cost – residual amount  Amortization: general process of allocating the CA of any long lived asset to the accounting periods that benefit from its use  Deprecation: for PPE  Depletion: use only with natural resource assets o Will always be estimates ^ Factors Considered in the Deprecation Process  Asset components o The guide the componentization decision  Identify each part of a PPE asset whose cost is a significant portion of the total asset cost as a sep component  Group together significant components with similar useful lives and patterns of providing economic benefits  Add together the costs of the remaining parts of the asset, none of which are individually signif  Group together similar individual minor assets to dep as one component o Both IFRS and GAAP require to reco sep components for purpose of dep  Depreciable amount o The amount of an asset that is to be depreciated  Diff btwn the assets cost and its residual value  The estimated amount a company would receive today on disposal of asset – any related disposal costs  If RV is more than the CA, then no dep taken until this reverses  Under GAAP; the dep charge is based on the higher of the 2  The cost – SV over the life of asset  The cost – RV over assets useful life  Depreciation period o Useful life of the asset o Dep begins when asset is available for use o Dep ends when the asset is derecognized (removed from accounts) or when it is classified as held for sale o Dep continues even if the asset is idle or has been taken out of service, unless it is fully dep o Useful life and service life are not the same  Legal life may also limit the useful life (eg leasehold improvements) Methods of Allocation (Depreciation)  Basis for the Choice o Resulting dep should reflect the pattern in which the asset benefits are expected to be used up by the entity o The choice of dep affects the BS (CA of PPE) and IS (dep exp)  Ratios affected are  ROTA  DTTA  TAT o The 3 models are  SL Dep  Decreasing charge method  Activity method  Straight line method o Cost – RV /est life o Assumptions  The asset delivers equal economic benefits each year  Maintenance exp is about the same each period o Issue with distortion in rate of return  Decreasing charge method o Called DB or accelerated amortization o Creates higher dep exp in the earlier years and lower charge in later periods  Declining balance method  Uses dep rate that stays constant throughout the asset life  Rate is applied each year to the declining book value (cost – accum dep + accum impairment losses)  RV not deducted in calc dep  Activity method o Called units of production method or variable charge approach o Calc dep according to usage or productivity o Life is defined in terms of the output it provides or input required o Cost – RV /total est hours (eg)  Depletion  Activity method relevant in extractive industries  Depletion exp is a product exp and is therefore a part of direct cost of inventory produced  Pattern of depletion  Usually use activity method for calculating depletion  Total cost – RV /total est units available  Estimating recoverable reserves  Change est of useful life  Need to revise the depletion rate by dividing the costs remaining on the book – RV by the new est of the recoverable reserves o Past depletion not adjusted  Liquidating dividends  Distribute their capital investment by paying a dividend greater than the amount of accum NI  Equal the accum amount of NI (after depletion) + the amount of depletion that has been charged  Other methods Other Depreciation Issues  Depreciation and Partial Periods o Can take no dep in year of acquisition and a full years dep in the year of disposal o Or can charge a full years dep on assets o Can charge a full years dep in the year of acquisition  Revision of Depreciation Rates o Estimates need to be reviewed at least each fiscal year under IFRS o Account for change prospectively (in the period of change) and in the future  Not go back and correct the records IMPAIRMENT  If FV model then remeasurement of asset automatically recognizes reduction and the associated loss is reco in income  If CM or RM not automatically adjusted to FV o Cost – a
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