FINANCIAL
ACCOUNTING AND REPORTING
DEPRECIATION AND DEPLETION
Carrying amount
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The
amount at which an asset is recognized after deducting any accumulated
depreciation and accumulated impairment losses.
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Cost
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The
amount of cash or cash equivalents paid or the fair value of the other
consideration given to acquire an asset at the time of its acquisition or
construction or, where applicable, the amount attributed to that asset when
initially recognized in accordance with the specific requirements of other
IFRS.
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Depreciable amount
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The
cost of an asset, or other amount substituted for cost, less its residual
value.
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Depreciation
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The
systematic allocation of the depreciable amount of an asset over its useful
life.
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Residual value
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The
estimated amount that an entity would currently obtain from disposal of the
asset, after deducting the estimated costs of disposal, if the asset were
already of the age and in the condition expected at the end of its useful
life.
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Useful life
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(a) The period over which an asset is expected
to be available for use by an entity; or
(b) The number of production or similar units
expected to be obtained from the asset by an entity.
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Depreciation
Ø Each
part of an item of property, plant and equipment with a cost that is
significant in relation to the total cost of the item shall be depreciated
separately.
Ø The
depreciation charge for each period shall be recognized in profit or loss
unless it is included in the carrying amount of another asset for example
depreciation on factory equipment which shall be included as overhead and cost
of inventories.
Ø The
residual value and the useful life of an asset shall be reviewed at least at
each financial year-end and, if expectations differ from previous estimates,
the change(s) shall be accounted for as a change in an accounting estimate
Ø Depreciation is recognized even if the fair value of
the asset exceeds its carrying amount; as long as the asset’s residual value
does not exceed its carrying amount.
Repair and maintenance of an asset do not negate the need to depreciate
it.
Ø
The residual value
of an asset may increase to an amount equal to or greater than the asset’s
carrying amount. If it does, the asset’s
depreciation charge is zero unless and until its residual value subsequently
decreases to an amount below the asset’s carrying amount.
Ø
Depreciation of
an asset begins when it is available for use.
Depreciation of an asset ceases at the earlier of the date that the
asset is classified as held for sale and the date that the asset is derecognized.
Therefore, depreciation does not
cease when the asset becomes idle or is retired from active use unless
the asset is fully depreciated. However,
under usage methods of depreciation the depreciation charge can be zero while
there is no production.
(a) Expected
usage of the asset. Usage is assessed by
reference to the asset’s expected capacity or physical output.
(b) Expected
physical wear and tear, which depends on operational factors such as the number
of shifts for which the asset is to be used and the repair and maintenance
programme, and the care and maintenance of the asset while idle.
(c) Technical or
commercial obsolescence arising from changes or improvements in production, or
from a change in the market demand for the product or service output of the
asset.
(d) Legal or
similar limits on the use of the asset, such as the expiry dates of related
leases.
Ø The
depreciation method used shall reflect the pattern in which the asset’s future
economic benefits are expected to be consumed by the entity.
Ø The
depreciation method applied to an asset shall be reviewed at least at each
financial year-end and, if there has been a significant change in the expected
pattern of consumption of the future economic benefits embodied in the asset,
the method shall be changed to reflect the changed pattern. Such a change shall be accounted for as a
change in an accounting estimate
Ø A variety of depreciation methods can be used to
allocate the depreciable amount of an asset on a systematic basis over its
useful life. These methods include the straightline method, the diminishing balance method and
the units of production method.
Example: Let us assume an asset acquired for 2,200,000
with a residual value of 400,000 at the
end of its 5 year useful life and is expected to produce 100,000 units of
output at 15,000 (year 1), 20,000 (Y2), 30,000 (Y3), 25,000 (Y4) and 10,000
(Y5). Depreciation each year shall be
computed as follows:
Straight-line
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SYD
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Double-Declining
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Production
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DA divided by UL
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SYD = 1+2+3+4+5
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Cost x 2 over Life
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Rate = DA / Total output
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Or DA x SL Rate
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DA x (RL/SYD)
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BV x 2 over Life
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Current output x rate
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BV less RV (final year)
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1.8M / 100,000 = 18
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Y1
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1.8M / 5 = 360,000
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1.8M x 5/15 = 600,000
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2.2M x 40% = 880,000
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15,000 x 18 = 270,000
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Y2
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1.8M / 5 = 360,000
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1.8M x 4/15 = 480,000
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1.32M x 40% = 528,000
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20,000 x 18 = 360,000
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Y3
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1.8M / 5 = 360,000
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1.8M x 3/15 = 360,000
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792K x 40% = 316,800
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30,000 x 18 = 540,000
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Y4
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1.8M / 5 = 360,000
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1.8M x 2/15 = 240,000
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475.2K – .4M = 75,200
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25,000 x 18 = 450,000
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Y5
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1.8M / 5 = 360,000
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1.8M x 1/15 = 120,000
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No Depreciation
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10,000 x 18 = 180,000
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KEY
OBSERVATIONS
Ø SL provides uniform depreciation, SYD and
Double-declining provides accelerated and declining depreciation while
production provides variable amount of depreciation.
Ø SL, SYD and Production method uses depreciable
amount from beginning to end. Double
declining ignores the residual value in the initial year and depreciates the
book value after that, but still adheres to the depreciation of the depreciable
amount only that’s why the depreciation in year 4 is only the difference
between the book value and residual value.
Year four is also the final year of depreciation because at this point
the asset is fully depreciated.
Ø Depreciation for SYD and Double-Declining for a
portion of a year is computed by multiplying the amount of depreciation by the
number of month’s outstanding divided by 12.
For example depreciation in the second year of the useful life for 9
months shall be 360,000 (480,000 x 9/12) for SYD and 396,000 (528,000 x 9/12)
for Double-Declining.
WASTING
ASSETS are natural
resources property in the form of land containing mineral deposits, precious
stones and metals or trees to be harvested as logs and lumber with a limited
life and will be subject to depletion using the production method.
The total cost of the wasting asset shall be:
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(a) Acquisition cost -
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Purchase price of the property.
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(b) Exploration cost-
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Cost incurred to locate the minerals and other resources
beneath the surface of the property.
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(c) Development cost -
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Cost incurred for the actual production or
extraction of the minerals and other resources. Development cost is naturally incurred
multiple number of times during the period of production and will usually
cause the recomputation of the rate.
Development cost related to other tangible assets should not be
capitalized as part of the wasting asset rather as other items of PPE and
depreciated separately, like equipment, machinery and processing facilities.
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(d) Restoration cost -
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Future cost to be paid to restore the property
back to its original condition but recorded as a provision (liability that is
estimated) at its present value.
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Example:
Land containing iron ore is
acquired at 50,000,000 with an expected residual value of 4,000,000 at the end
of its useful life of 5 years.
Geological estimates after exploration activities expect that 2,000,000
tons of iron ore can be produced. The
following information has been gathered for two years of mining activities.
Year 1
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Year 2
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Exploration cost
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5,000,000
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-
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Development cost
related
to extraction
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7,000,000
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3,000,000
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Expected restoration cost
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3,000,000
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PV of restoration cost
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1,800,000
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Tons produced
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300,000
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400,000
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Tons remaining
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1,700,000
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1,000,000
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Tons sold
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100,000
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500,000
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Development cost
related
to equipment
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5,000,000
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Residual value of equipment
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500,000
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KEY
VARIABLES
Ø The total cost of the wasting asset is 63,800,000
and the depletable base is 59,800,000. The
equipment shall be recorded as a separate asset and depreciated using specific
rules that will be discussed later. LET
US ASSUME THAT THE EQUIPMENT HAS A 10 YEAR LIFE.
Ø The rate for year 1 is 29.9 per ton (59,800,000
divided by 2,000,000)
Ø The rate for year 2 is much more complicated to
compute. First, the depletion in year 1
shall be deducted from 59,800,000. Then
the additional development cost of 3,000,000 shall be added to the
balance. The total amount will then be
divided by the new expected output from the beginning of the year which is
1,400,000 (400,000 + 1,000,000). There
is a change in accounting estimate in the expected output since the original
estimate was 2,000,000 and 300,000 in year 1 and 400,000 in year 2 would
indicate that 1,300,000 should still be remaining after year 2.
Ø The year 2 rate is:
Year 1 Depletion base
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59,800,000
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Less: Year 1 depletion (29.90 x 300,000)
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8,970,000
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Depletion base balance
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50,830,000
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Year 2 Development cost
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3,000,000
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Total
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53,830,000
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Divided by: Estimated output (revised)
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1,400,000
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Year 2 rate
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38.45 per
ton
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Year 1
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Year 2
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Total depletion is
rate x actual production:
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(300,000 x 29.90) and (400,000 x 38.45)
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8,970,000
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15,380,000
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Depletion
in cost of sales is rate x units sold:
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Year 1 (100,000 x 29.90)
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2,990,000
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Year 2 (200,000 x 29.90) + (300,000 x
38.45)
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17,515,000
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WASTING
ASSET DOCTRINE: Wasting
asset corporations are allowed to declare dividends in excess of the retained
earnings balance but the ceiling or upper limit is the amount of realized
depletion or the depletion already recognized in cost of sales amounting to 20,505,000
(2,990,000 + 17,515,000). If let’s say
that the entity has retained earning amounting to P10,000,000. It may declare dividends up to 30,505,000 otherwise
known as maximum dividends.
DEPRECIATION
OF ASSETS USED IN THE WASTING ASSET
Ø If the depreciable asset has a
future use, the asset is depreciated using its own useful life under the same
depreciation methods for similar assets, for example our asset above shall be
depreciated at 450,000 annually (5M – 500,000) divided by 10 years.
Ø If the depreciable asset has no
future use, but the useful life is shorter than the life of the asset, the
asset will again be depreciated using its own useful life under the same
depreciation methods for similar assets. Depreciation will be 1,125,000
annually (5M – 500,000) divided by 4 years if we assume that it is shorter than
the 5 year useful life of the wasting asset.
Ø If the life of the wasting
asset, the production method shall be used.
Therefore the rate of 2.25 per ton shall be used (4,500,000 / 2,000,000)
and depreciation for the first year shall be 675,000 (2.25 x 300,000).
Ø A problem shall arise if there
is a shutdown because depreciation
on an asset shall not cease because it is idle.
Let’s assume that there is a shutdown in the second year but production
resumes in Year 3 and the estimated output is unchanged at 1,700,000 tons and
200,000 tons is extracted in Year 3. We
will also be using the 10 year life originally stated above.
Year 1 depreciation (2.25 x 300,000)
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675,000
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Year 2 depreciation (4,500,000 – 675,000) / 9
years
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425,000
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Year 3 rate = (4,500,000 – 675,000 – 425,000) /
1,700,000
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2 per ton
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Year 3 depreciation (2 x 200,000)
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400,000
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