Chapter11: Property, Plant, and Equipment and Intangible Assets: Utilization and Impairment
Change in Depreciation, Amortization, or Depletion Method
Recall from our discussion in Chapter 4 that generally accepted accounting principles require that a change in depreciation, amortization, or depletion method be considered a change in accounting estimate that is achieved by a change in accounting principle. We account for these changes prospectively, exactly as we would any other change in estimate. One difference is that most changes in estimate do not require a company to justify the change. However, this change in estimate is a result of changing an accounting principle and therefore requires a clear justification as to why the new method is preferable. Consider the example in Illustration 11-7.
Graphic 11-11 provides an example of a disclosure describing a recent change in depreciation method by Performed Line Products (PLP), a worldwide manufacturer of cable hardware and fiber optics connection devices.
Frequently, when a company changes depreciation method, the change will be effective only for assets placed in service after that date. Of course, that means depreciation schedules do not require revision because the change does not affect assets depreciated in prior periods. A disclosure note still is required to provide justification for the change and to report the effect of the change in the current year's income.
Changes in depreciation, amortization, or depletion methods are accounted for the same way as a change in accounting estimate.
Change in Depreciation Method
On January 1, 2009, the Hogan Manufacturing Company purchased a machine for $250,000. The company expects the service life of the machine to be five years and its anticipated residual value to be $30,000. The company's fiscal year-end is December 31 and the double-declining-balance (DDB) depreciation method is used. During 2011, the company switched from the DDB to the straight-line method. In 2011, the adjusting entry is:
A disclosure note reports the effect of the change on net income and earnings per share along with clear justification for changing depreciation methods.
Change in Depreciation Method—Performed Line Products
Real World Financials
Property and Equipment—Net (in part)
Effective January 1, 2009, the Company changed its method of computing depreciation from accelerated methods to the straight-line method for the Company's PLP-USA assets. Based on Statement of Financial Accounting Standards (SFAS) No. 154, “Accounting Changes and Error Corrections” [FASB ASC 250], the Company determined that the change in depreciation method from an accelerated method to a straight-line method is a change in accounting estimate affected by a change in accounting principle. Per SFAS 154 [FASB ASC 250], a change in accounting estimate affected by a change in accounting principle is to be applied prospectively. The change is considered preferable because the straight-line method will more accurately reflect the pattern of usage and the expected benefits of such assets and provide greater consistency with the depreciation methods used by other companies in the Company's industry. The net book value of assets acquired prior to January 1, 2009 with useful lives remaining will be depreciated using the straight-line method prospectively. As a result of the change to the straight-line method of depreciating PLP-USA's assets, depreciation expense decreased $.1 million for the three month period ended March 31, 2009 and the decrease is expected to approximate such amount in each of the remaining quarters in 2009.