Couple of questions pertaining to depreciation

CFA Level II
#1

Dear all,

Schweser 2015 Page 47 - 48, Study Session 5, Reading #16

Impact of Impairments on Financial Statements & Ratios

…In subsequent periods, ROA & ROE will increase due to higher earnings (due to lower depreciation)…

Question 1: Impairment will reduce the carrying value - Why will depreciation be lower after impairments in the previous period? Doesn’t depreciation expense remain the same (e.g. straight line depreciation already give u the annual depreciation at the start already?)? The only depreciation method I can think of is Double Declining Balance (“DDB”) as book value is one of the components of the equation. Am I right to say that everytime when an asset is being impaired, depreciation expenses will be recomputed? Just like the same treatement when management re-estimate cost/salvage value of the asset?

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Question 2: Treatment of SOFTWARE DEVELOPMET costs, am I right in the below:

Own Use:

IFRS- Capitalize

U.S. GAAP- Capitalize

For Sale:

IFRS- Capitalize

U.S. GAAP- Capitalize after technological feasibility reached, prior to that is expense off

Thank you.

Cheers,

Ernest

#2

anyone?

#3

Suppose that you have a machine with a book value of $100,000, salvage value of $10,000, and 5 years of useful life left. Using straight-line depreciation, you depreciate $18,000/year.

Now you find it’s impaired, worth only $60,000. You have a $40,000 impairment loss this year. But now the remaining depreciable value is only $50,000 (= $60,000 − $10,000), so the annual depreciation would be $10,000.

#4

Thanks for the explanation, Bill!

You mentioned that the book value of the machine is 100k. Can i say that prior to this amount of 100k, the machine has already some balance of depreciation?

Apology for asking but my understanding of straight line depreciation is that it gives you a constant amount of depreciation from the inception of the asset (e.g. i purchase a machine for 100k with salvage value of 10k and the machine has a useful life of 5 years. Then depreciation expenses for thenext 5 years will be 18k each.).

Am I right to say that if during one particular year of the useful life (years) of the asset, the asset has been tested for impairment and the impairment amount will reduce the existing carrying value (which is the original cost less accd depreciation) of the asset?

Thank you!

#5

Absolutely correct.

Under straight line depreciation you get the same depreciation each (full) year, _ unless something changes _.

The stuff that can change includes:

  • Impairment
  • Estimated useful life
  • Estimated salvage value
#6

Absolutely Awesome!

Noted and Thank You Bill!

#7

You’re most welcome.