Chapter 10: Depreciation, Impairments, and Depletion

The foundational concept presented is the historical cost principle, which establishes that PP&E must be initially recorded at its total acquisition cost, encompassing not only the purchase price but also all ancillary expenditures required to place the asset in service, such as installation fees, testing costs, professional services, and transportation charges. The chapter distinguishes between three primary acquisition methods: direct purchase, construction by the company, and acquisition through nonmonetary exchange, each requiring different accounting treatments to ensure accurate asset valuation. When companies construct assets internally, the chapter addresses the capitalization of overhead allocations and the treatment of interest incurred during the construction period, establishing rules for determining which financing costs should be added to the asset's carrying value versus expensed immediately. For lump-sum purchases where multiple assets are acquired for a single consideration, the chapter demonstrates allocation methods based on proportional fair values. The discussion of nonmonetary exchanges emphasizes the application of commercial substance tests to determine whether transactions should be recorded at fair value or book value. Subsequent expenditures present a critical distinction: costs that enhance the asset's utility or extend its useful life are capitalized as additions to the asset's basis, while ordinary maintenance and repairs are expensed in the current period. The chapter then addresses the opposite end of the asset lifecycle, explaining how to account for PP&E dispositions through sales, retirements, or involuntary conversions such as theft or casualty loss, including proper computation and recording of realized gains and losses. Throughout, the chapter emphasizes adherence to generally accepted accounting principles and appropriate disclosure requirements to ensure financial statement users receive transparent information about the company's investment in operational assets and how these transactions affect both profitability and financial position.