Concepts of Microeconomics

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1. Distinguish among depreciation, depletion, and amortization expenses.

Depreciation refers to the cost allocation of tangible long-term assets; depletion refers to the cost allocation of natural resources; and amortization refers to the cost allocation of intangible assets. All three terms have similar underlying principles governing their use.

2. What factors must be considered in determining the periodic deprecation charges that should be made for a company’s depreciable assets?

Four separate factors must be considered in determining the periodic depreciation charges that should be made for a company’s assets. They are (1) asset cost, (2) residual or salvage value, (3) useful life, and (4) pattern of use. These factors, when considered together, help determine which of the common methods are most appropriate for the circumstances.

3.What role does residual, or salvage, and value play in the various methods of time-factor deprecation?

Residual or salvage value is included in the formulas for all time-factor depreciation methods except for the declining-balance methods. In practice, residual value is often ignored if it is the practice of a company to retain assets for most of their useful lives. In the case of declining-balance methods, although residual value is not included in the formulas, it is considered when an asset is near the end of its useful life. Generally, the book value should not be reduced below its expected residual value.

4.Distinguish between the functional and physical factors affecting the useful life of an tangible noncurrent operating assets.

Functional factors include inadequacy and obsolescence that reduce the usefulness of the asset. Physical factors include wear and tear, deterioration and decay, and damage or destruction reducing the usefulness of the asset.

5. Distinguish between time-factor and use-factor methods of depreciation.

Time-factor methods of depreciation base cost allocation on time according to either straight-line or accelerated depreciation. In theory, the pattern selected should be related to the pattern of benefits expected from the asset. Because the pattern of benefits is very subjective, the selection of a specific time-factor method is usually an arbitrary decision.

Use-factor methods of depreciation base cost allocation on some measure that relates more directly to the use of the asset. Most commonly, the allocation is based on productive output or service hours. In theory, the use-factor methods provide a much better matching of costs against revenues than do time-factor methods. However, because use-factor methods require more extensive accounting records, they are not as common as the time-factor methods.

6. Briefly describe group deprecation, and describe how asset retirements are recorded under this method.

With group depreciation, periodic depreciation expense is computed on a whole group of assets as if the group were one single asset. The weighted-average life of the group is used to determine how much of the aggregate asset cost should be depreciated each year. No gains or losses are recognized at the time of the retirement of individual assets; accumulated depreciation is reduced for the difference between the asset cost and the cash retirement proceeds.

7.Describe the component approach to computing depreciation.

Some items of property, plant, and equipment are composed of identifiable sub-items, or components, with substantially different useful lives or usage patterns. The component approach to depreciation is to depreciate each component, separately. The component approach is allowed in the United States and is required under IAS 16.

8. How does the recognition of an asset retirement obligation impact periodic depreciation expense? Interest expense?

The amount of an asset retirement obligation is added to the cost of the associated asset. Accordingly, the asset retirement...
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