Property, Plant & Equipment (PPE): Depreciation and Impairment — In-Depth Q&A

1) What account is debited and what account is credited to record depreciation on trucks?

Typical journal entry (for any depreciable PPE, including trucks):

• Debit: Depreciation Expense—Trucks (or Depreciation Expense if not separated by asset type)

• Credit: Accumulated Depreciation—Trucks (a contra-asset account that reduces the truck’s carrying amount on the balance sheet)

Why this is the entry:

• Depreciation is the systematic allocation of an asset’s cost (less residual value) over its useful life.

• The expense belongs on the income statement for the period benefiting from the asset’s use (matching principle).

• The truck asset account (Trucks) is usually not credited directly under GAAP; instead, Accumulated Depreciation is credited so users can see the following:

  • the original cost (historical cost) of trucks, and

  • the total depreciation taken to date.

Example: If monthly depreciation for trucks is $1,200:

• Dr Depreciation Expense—Trucks ............. 1,200

• Cr Accumulated Depreciation—Trucks ... 1,200

Key presentation point: On the balance sheet, you’ll often see:

• Trucks (at cost) ............................................. XXX

• Less: Accumulated Depreciation—Trucks .... (XXX)

• Net book value (carrying amount) .................... XXX

2) How would the sum-of-the-years’-digits (SYD) method be applied to an asset with a life of six years?

Sum-of-the-years’-digits (SYD) is an accelerated depreciation method: it records higher depreciation early and lower depreciation later.

Step-by-step application for a 6-year life

1. Compute depreciable base:

   • Depreciable base = Cost − Residual (salvage) value

2. Compute the SYD denominator:

   • For 6 years, the sum of digits = 6 + 5 + 4 + 3 + 2 + 1 = 21

   • In general, for n years: SYD = n(n+1)/2

   • For 6: 6×7/2 = 21

3. Assign a fraction to each year:

   • Year 1 fraction = 6/21

   • Year 2 fraction = 5/21

   • Year 3 fraction = 4/21

   • Year 4 fraction = 3/21

   • Year 5 fraction = 2/21

   • Year 6 fraction = 1/21

4. Compute depreciation each year:

   • Depreciation for a given year = (Depreciable base) × (that year’s fraction)

Mini-example breakdown (Asset Schedule)

Assuming a cost of $100,000, a residual value of $10,000, and a depreciable base of $90,000 (denominator = 21):

• Year 1:

  • Fraction: 6/21

  • Depreciation: $90,000 × 6/21 = $25,714

  • Ending Book Value: $74,286

• Year 2:

  • Fraction: 5/21

  • Depreciation: $21,429

  • Ending Book Value: $52,857

• Year 3:

  • Fraction: 4/21

  • Depreciation: $17,143

  • Ending Book Value: $35,714

• Year 4:

  • Fraction: 3/21

  • Depreciation: $12,857

  • Ending Book Value: $22,857

• Year 5:

  • Fraction: 2/21

  • Depreciation: $8,571

  • Ending Book Value: $14,286

• Year 6:

  • Fraction: 1/21

  • Depreciation: $4,286

  • Ending Book Value: $10,000 (residual)

What to notice:

• Depreciation is front-loaded.

• Ending book value reaches the residual value at the end of life (subject to rounding).

3) Is MACRS used for federal income tax rules acceptable under GAAP?

MACRS (Modified Accelerated Cost Recovery System) is a tax depreciation system used in the United States for federal income tax reporting.

GAAP acceptability

• MACRS is generally not considered a GAAP depreciation method for financial reporting because

  • it is designed to meet tax policy objectives, and

  • It uses prescribed recovery periods and conventions that may not reflect economic useful life or the pattern of benefits.

What companies typically do in practice

• Many companies maintain two depreciation schedules:

  1. Book depreciation (GAAP): straight-line, declining-balance, SYD, units-of-production—based on estimated useful life and expected benefit pattern.

  2. Tax depreciation (IRS/MACRS): based on tax rules.

How differences are handled

• If tax depreciation differs from book depreciation, the company recognizes deferred tax assets/liabilities under ASC 740 (Income Taxes) for temporary differences.

Bottom line:

• MACRS is acceptable for tax reporting.

• For GAAP financial statements, depreciation should reflect management’s estimates of useful life, residual value, and pattern of economic benefit—so MACRS is usually not used for book depreciation.

4) Which method gives higher depreciation expense in the later years of an asset’s life: straight-line or declining-balance?

Straight-line depreciation typically gives a higher depreciation expense in the earlier years compared to declining-balance.

Why

• Declining-balance (accelerated) methods record more depreciation early and less later.

• Straight-line records the same depreciation amount each year.

Intuition

• Under declining balance, the depreciation base each year is the beginning book value (which shrinks rapidly early on). As book value falls, depreciation becomes smaller.

• Under straight-line, the company keeps charging the same annual expense, which eventually becomes larger than the declining-balance amount in later years.

Extra nuance (common in practice)

• Many accelerated systems (e.g., double-declining-balance) are implemented with a switch to straight-line when straight-line produces a higher remaining annual expense, ensuring the asset reaches residual value by the end of its life.

• Conclusion:

• In the later years, straight-line is usually higher than declining balance.

5) What is the basic test for determining whether impairment exists?

The basic impairment test asks:

Is the asset’s carrying amount (book value) greater than its recoverable amount?

Under U.S. GAAP (ASC 360) for long-lived assets held and used

Impairment is approached in two conceptual steps:

1. Recoverability test (screening test):

   • Compare carrying amount to the sum of undiscounted expected future cash flows from use and eventual disposition.

   • If carrying amount > undiscounted cash flows, the asset is not recoverable → impairment exists.

2. Measurement of impairment loss:

   • Impairment loss = Carrying amount − Fair value (often estimated using discounted cash flows, market prices, or appraisals).

Under IFRS (IAS 36)

IFRS uses a one-step model:

• Impairment exists if:

  • Carrying amount > recoverable amount, where the recoverable amount is the higher of the following:

    • fair value less costs of disposal, and

    • value in use (discounted future cash flows).

In plain terms:

• If the asset can’t generate enough economic benefit to justify its recorded amount, it’s impaired.

6) Under what circumstances is the units-of-production method especially desirable?

Units-of-production (UOP) depreciation is especially desirable when an asset’s wear and tear and consumption of benefits are driven more by usage than by the passage of time.

Best-fit circumstances

• Output-based assets where productivity varies significantly by period:

  • manufacturing equipment (machine hours, units produced)

  • mining equipment (tons extracted)

  • transportation equipment (miles driven)

• When the asset is used heavily in some periods and lightly in others, and management wants depreciation to match actual usage.

Why UOP can be more faithful

• It often better matches the expense with revenue:

  • High production period → higher depreciation expense

  • Low production period → lower depreciation expense

Common requirements to apply UOP well

• The company can reliably measure activity (units, hours, miles).

• The expected total productive capacity (total units over life) can be reasonably estimated.

Formula:

• Depreciation per unit = (Cost − Residual value) ÷ Estimated total units

• Period depreciation = Depreciation per unit × Units produced in the period

7) What property, plant, and equipment information must be presented in the financial statements and notes?

GAAP disclosure requirements vary by jurisdiction and company type, but commonly required PPE information includes:

A) On the face of the financial statements (balance sheet)

• PPE reported at cost (or revalued amount under IFRS), often by major class:

  • land, buildings, machinery, vehicles, furniture/fixtures, leasehold improvements, construction in progress

• Accumulated depreciation (and accumulated impairment, if applicable)

• Net PPE (carrying amount)

B) In the notes (typical disclosures)

1. Depreciation methods used (straight-line, accelerated, UOP)

2. Useful lives or depreciation rates for major asset classes

3. Capitalization policies (e.g., threshold for capitalization vs expensing, treatment of repairs vs improvements)

4. Reconciliation/roll-forward of PPE balances by class (often):

   • beginning balance

   • additions (purchases, capitalized interest, asset retirement cost, internally constructed assets)

   • disposals

   • depreciation expense

   • impairment losses (and sometimes reversals under IFRS)

   • ending balance

5. Impairment disclosures (if recognized):

   • events leading to impairment

   • amount of loss

   • how fair value was determined (market, income approach, appraisals)

6. Commitments (e.g., capital commitments for construction or major equipment purchases)

7. Asset retirement obligations (if significant): nature, amounts, and accounting policy

8. Leased assets (if applicable), including right-of-use assets under ASC 842/IFRS 16 (often presented separately)

9. Collateral/pledges: PPE pledged as security for debt

Goal of these disclosures:

• Help users assess the age, replacement needs, capital intensity, and earnings impact of depreciation and impairment.

8) What events, developments, or situations indicate that impairment of PPE may exist?

Indicators of impairment are signals that carrying amounts may not be recoverable. Common examples include:

A) Significant adverse changes in the business or market

• A decline in market price of the asset or the products it produces

• New competition reducing sales volume or pricing power

• Loss of a major customer or contract

• Adverse regulatory changes (environmental rules, safety requirements)

B) Physical damage or obsolescence

• Physical damage (fire, flood, accident) not fully insured

• Technological obsolescence (new technology makes equipment less efficient or unsellable)

• Asset becomes idle or is used far below planned capacity

C) Internal performance issues

• Operating losses or negative cash flows related to the asset or asset group

• Worse-than-expected profitability or cost overruns

• A plan to restructure, shut down, or sell a facility or product line

D) Changes in how the asset is used

• Management decides to change use (e.g., from production to held-for-sale)

• Shortening of expected useful life due to strategic shifts

• Decisions to abandon the asset before end of life

E) Macroeconomic/financial factors

• Significant increases in interest rates (which can reduce fair value / present value)

• Economic downturn affecting demand

Important note:

• The presence of indicators doesn’t automatically mean impairment must be recorded, but it generally triggers a need to test recoverability (GAAP) or compare to the recoverable amount (IFRS).

Quick study recap (one-liners)

• Depreciation entry: Dr Depreciation Expense; Cr Accumulated Depreciation.

• SYD (6 years): denominator 21; fractions 6/21 down to 1/21.

• MACRS: tax-only; not typically GAAP for books, creates deferred taxes.

• Later years higher: straight-line > declining balance.

• Impairment basic idea: carrying amount exceeds recoverable amount.

• UOP is best when usage drives wear/benefit.

• PPE disclosures: methods, liabilities, roll-forward, impairments, commitments, and collateral.

• Impairment indicators: market declines, obsolescence, damage, losses, restructuring, underuse.