Connect

Close
Skip to eBook contentSkip to Chapter linksSkip to Content links for this ChapterSkip to eBook links

Chapter11: Property, Plant, and Equipment and Intangible Assets: Utilization and Impairment

Group and Composite Depreciation Methods

As you might imagine, depreciation records could become quite cumbersome and costly if a company has hundreds, or maybe thousands, of depreciable assets. However, the burden can be lessened if the company uses the group or composite method to depreciate assets collectively rather than individually. The two methods are the same except for the way the collection of assets is aggregated for depreciation. The group depreciation method collection of assets defined as depreciable assets that share similar service lives and other attributes. defines the collection as depreciable assets that share similar service lives and other attributes. For example, group depreciation could be used for fleets of vehicles or collections of machinery. The composite depreciation method physically dissimilar assets are aggregated to gain the convenience of group depreciation. is used when assets are physically dissimilar but are aggregated anyway to gain the convenience of a collective depreciation calculation. For instance, composite depreciation can be used for all of the depreciable assets in one manufacturing plant, even though individual assets in the composite may have widely diverse service lives.

 

Group and composite depreciation methods aggregate assets to reduce the recordkeeping costs of determining periodic depreciation.

   Both approaches are similar in that they involve applying a single straight-line rate based on the average service lives of the assets in the group or composite.5 The process is demonstrated using Illustration 11-2.

   If there are no changes in the assets contained in the group, depreciation of $52,800 per year (16% × $330,000) will be recorded for 5.15 years. This means the depreciation in the sixth year will be $7,920 (.15 of a full year's depreciation = 15% × $52,800), which depreciates the cost of the group down to its estimated residual value. In other words, the group will be depreciated over the average service life of the assets in the group.

 

The depreciation rate is applied to the total cost of the group or composite for the period.

   In practice, there very likely will be changes in the assets constituting the group as new assets are added and others are retired or sold. Additions are recorded by increasing the group asset account for the cost of the addition. Depreciation is determined by multiplying the group rate by the total cost of assets in the group for that period. Once the group or composite rate and the average service life are determined, they normally are continued despite the addition and disposition of individual assets. This implicitly assumes that the service lives of new assets approximate those of individual assets they replace.

p. 567

ILLUSTRATION 11-2
Group Depreciation
 

The Express Delivery Company began operations in 2011. It will depreciate its fleet of delivery vehicles using the group method. The cost of vehicles purchased early in 2011, along with residual values, estimated lives, and straight-line depreciation per year by type of vehicle, are as follows:

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/pg567_1.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

The group depreciation rate is determined by dividing the depreciation per year by the total cost. The group's average service life is calculated by dividing the depreciable base by the depreciation per year:

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/spi10831_eq1104.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

   Because depreciation records are not kept on an individual asset basis, dispositions are recorded under the assumption that the book value of the disposed item exactly equals any proceeds received and no gain or loss is recorded. For example, if a delivery truck in the above illustration that cost $15,000 is sold for $3,000 in the year 2014, the following journal entry is recorded:

 

No gain or loss is recorded when a group or composite asset is retired or sold.

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/567_1.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

   Any actual gain or loss is included in the accumulated depreciation account. This practice generally will not distort income as the unrecorded gains tend to offset unrecorded losses.

   The group and composite methods simplify the recordkeeping of depreciable assets. This simplification justifies any immaterial errors in income determination. Graphic 11-6 shows a disclosure note accompanying recent financial statements of the El Paso Natural Gas Company (EPNG) describing the use of the group depreciation method for its regulated property.

GRAPHIC 11-6
Disclosure of Depreciation Method—El Paso Natural Gas Company

Real World Financials

 

Summary of Significant Accounting Policies (in part) Property, Plant, and Equipment (in part)

We use the group method to depreciate property, plant, and equipment. Under this method, assets with similar lives and characteristics are grouped and depreciated as one asset. We apply the FERC-accepted depreciation rate to the total cost of the group until its net book value equals its salvage value. For certain general plant and rights-of-way, we depreciate the asset to zero. The majority of our property, plant, and equipment are on our EPNG system which has depreciation rates ranging from one to 20 percent and the depreciable lives ranging from five to 92 years.

   When we retire property, plant, and equipment, we charge accumulated depreciation and amortization for the original cost of the assets in addition to the cost to remove, sell, or dispose of the assets, less their salvage value. We do not recognize a gain or loss unless we sell an entire operating unit.


p. 568

   Additional group-based depreciation methods, the retirement and replacement methods, are discussed in Appendix 11B.

INTERNATIONAL FINANCIAL REPORTING STANDARDS

 

Valuation of Property, Plant, and Equipment. As we've discussed, under U.S. GAAP a company reports property, plant, and equipment (PP&E) in the balance sheet at cost less accumulated depreciation (book value). IAS No. 166 allows a company to report property, plant, and equipment at that amount or, alternatively, at its fair value (revaluation). If a company chooses revaluation, all assets within a class of PP&E must be revalued on a regular basis. U.S. GAAP prohibits revaluation.

   If the revaluation option is chosen, the way the company reports the difference between fair value and book value depends on which amount is higher:

  

If fair value is higher than book value, the difference is reported as other comprehensive income (OCI) which then accumulates in a “revaluation surplus” (sometimes called revaluation reserve) account in equity.

  

If book value is higher than fair value, the difference is reported as an expense in the income statement. An exception is when a revaluation surplus account relating to the same asset has a balance from a previous increase in fair value, that balance is eliminated before debiting revaluation expense.

   Consider the following illustration:

Candless Corporation prepares its financial statements according to IFRS. At the beginning of its 2011 fiscal year, the company purchased equipment for $100,000. The equipment is expected to have a five-year useful life with no residual value, so depreciation for 2011 is $20,000. At the end of the year, Candless chooses to revalue the equipment as permitted by IAS No. 16. Assuming that the fair value of the equipment at year-end is $84,000, Candless records depreciation and the revaluation using the following journal entries:

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/pg568_1.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

   After this entry, the book value of the equipment is $80,000; the fair value is $84,000. We use the ratio of the two amounts to adjust both the equipment and the accumulated depreciation accounts (and thus the book value) to fair value ($ in thousands):

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/pg568_2.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

The entries to revalue the equipment and the accumulated depreciation accounts (and thus the book value) are:

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/pg568_3.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

   The new basis for the equipment is its fair value of $84,000 ($105,000 −21,000), and the following years' depreciation is based on that amount. Thus, 2012 depreciation would be $84,000 divided by the four remaining years, or $21,000:7

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/pg568_4.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

p. 569

   After this entry, the book value of the equipment is $63,000. Let's say the fair value now is $57,000. We use the ratio of the two amounts to adjust both the equipment and the accumulated depreciation accounts (and thus the book value) to fair value ($ in thousands):

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/pg569_1.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

   The entries to revalue the equipment and the accumulated depreciation accounts (and thus the book value) are:

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/pg569_2.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (K)</a>

   A decrease in fair value, as occurred in 2012, is expensed unless it reverses a revaluation surplus account relating to the same asset, as in this illustration. So, of the $6,000 decrease in value ($63,000 book value less $57,000 fair value), $4,000 is debited to the previously created revaluation surplus and the remaining $2,000 is recorded as revaluation expense in the income statement.

   Investcorp, a provider and manager of alternative investment products headquartered in London, prepares its financial statements according to IFRS. The following disclosure note included in a recent annual report discusses the company's decision to change its method of valuing its premises and equipment.

      

Change in Accounting Policy
During the current period, the Group changed its policy with respect of carrying value of premises and equipment. These assets have been revalued to their fair value in the current period and shall be carried at their revalued amount less any accumulated depreciation and cumulative impairment losses. The revaluation surplus has been recognized in other comprehensive income and included as separate component of equity as revaluation surplus.

      

 <a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/premium/0077328787/student/820130/globe.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (14.0K)</a>
 
 
 

 LO10

 
 
 
 
 
 
 
 
 
 
 
 
 

IFRS ILLUSTRATION

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

To record the revaluation of equipment to its fair value.

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Real World Financials




5A declining balance method could also be used with either the group or composite method by applying a multiple (e.g., 200%) to the straight-line group or composite rate.

6“Property, Plant and Equipment,” International Accounting Standard No. 16 (IASCF), as amended effective January 1, 2009.

7IAS No. 16 allows companies to choose between the method illustrated here and an alternative. The second method eliminates the entire accumulated depreciation account and adjusts the asset account (equipment in this illustration) to fair value. Using either method, the revaluation surplus (or expense) would be the same.

2011 McGraw-Hill Higher Education
Any use is subject to the Terms of Use and Privacy Notice.
McGraw-Hill Higher Education is one of the many fine businesses of The McGraw-Hill Companies.