FAR · Select balance sheet accounts · 6 practice questions
Component Replacement: Derecognition and New Depreciation
Capitalize a qualifying replacement and remove the separately identified old component's carrying amount before calculating new depreciation. Below: a worked calculation and free practice on replacements and overhauls.
Try one first
Hint
Focus on whether the expenditure creates additional future benefit and what happens to the carrying amount of the component that was replaced.
Answer B. The replacement extends the asset's useful life and is not routine maintenance, so the cost of the new roof should be capitalized. Because the carrying amount of the replaced component is known, the old component should be derecognized when replaced. Any gain or loss on the retirement/disposal of the old roof would be recorded separately in profit or loss.
Why not A: Candidates may default to expensing post-acquisition costs, but this is not routine repair, it creates additional future benefit (extended useful life). Therefore the cost meets capitalization criteria.
Why not C: This reflects recognizing the new asset but forgetting to remove the replaced component. If the carrying amount of the old component is known, it must be derecognized; leaving it would overstate assets.
Why not D: Netting the amounts is an incorrect presentation. The new roof is recorded at its full cost, and the old roof is removed separately at its carrying amount. Netting understates the cost of the new component and obscures any disposal gain or loss.
Worked example
On January 1, Cedar Co. replaces its machine's engine for $130,000. The machine's $450,000 carrying amount includes the old engine's $125,000 cost and $85,000 accumulated depreciation. The old engine is scrapped for no proceeds. The replacement extends remaining machine life from six to nine years; the new engine also lasts nine years. Use straight-line depreciation and no salvage value.
| 1 | Remove the old engine$125,000 cost - $85,000 accumulated depreciation | $40,000 carrying amount removed |
| 2 | Recognize the disposal loss$40,000 carrying amount - $0 proceeds | $40,000 loss |
| 3 | Capitalize the full replacement cost$450,000 - $40,000 + $130,000 | $540,000 updated carrying amount |
| 4 | Revise the remaining useful life6 remaining years + 3 added years | 9 years |
| 5 | Calculate annual depreciation($540,000 - $0 salvage value) / 9 years | $60,000 |
| 6 | Calculate year-end carrying amount$540,000 - $60,000 | $480,000 |
Cedar reports the machine at $480,000 at year-end, with $60,000 of depreciation and a separate $40,000 disposal loss.
Check: Old out, new in: $450,000 - $40,000 + $130,000 = $540,000; nine remaining years gives $60,000 of annual depreciation.
Key points
- Disposal proceeds affect gain or loss, not the cost capitalized for the new component.
- Expense routine servicing, even when performed during a capitalized replacement or overhaul.
- Apply revised useful lives prospectively. Do not recalculate depreciation already recorded.
How the exam traps you
- Capitalizing only new cost minus the old component's carrying amount. Record the full replacement cost. Remove the old cost and accumulated depreciation, and recognize the disposal gain or loss.
- Keeping the old component on the books after capitalizing its replacement. Remove its cost and accumulated depreciation so only the new component remains.
- Using the original depreciation rate or only the years added by the overhaul. Divide the updated depreciable carrying amount by the full revised remaining useful life.
Question 2
Hint
First decide whether the overhaul should be capitalized or expensed; if capitalized, recompute the carrying amount, subtract the unchanged salvage, and divide by the revised remaining life for a full year (overhaul occurred at the period start).
Answer A. The overhaul is a capital improvement and must be capitalized. NBV at Jan 1, Year 4 before the overhaul = $600,000 − (3 × $54,000) = $438,000; add the $120,000 overhaul → $558,000. New remaining life = 7 + 4 = 11 years; depreciable base = $558,000 − $60,000 = $498,000; annual depreciation = $498,000 ÷ 11 ≈ $45,272.73 → $45,273.
Why not B: Tempting because $54,000 is the original straight-line annual depreciation [(600,000−60,000)÷10]; this would be correct only if the overhaul were treated as a routine repair and expensed. It is wrong here because the overhaul increased future benefits and should be capitalized and depreciated over the revised remaining life.
Why not C: Tempting because this is what results if the $120,000 overhaul is capitalized but the combined carrying amount is incorrectly depreciated over the original remaining 7 years (498,000 ÷ 7 ≈ 71,142.86). It is wrong because the useful life was extended by 4 years, making the revised remaining life 11 years.
Why not D: Tempting because a student might keep the original $54,000 depreciation and also amortize the $120,000 overhaul separately over 11 years (54,000 + 10,909 ≈ 64,909). It is wrong because the correct approach is to add the capitalized cost to the carrying amount and depreciate the combined balance over the revised remaining life (do not double-count depreciation).
Question 3
Hint
Decide whether the expenditure provides additional future benefit (capitalize). If you capitalize, remember to remove the old component's cost and accumulated depreciation, if there are no proceeds, the old component's net book value is recognized as a loss.
Answer A. Because the replacement extends the asset's remaining useful life and increases productive output, the cost of the new turbine is capitalized. Under component-level accounting the old component's cost ($200,000) and accumulated depreciation ($100,000 after 5 years) are removed; with no proceeds the old turbine's net book value ($100,000) is recognized as a loss. The machine's net carrying amount increases by the new turbine cost less the removed NBV (360,000 − 100,000 = 260,000).
Why not B: This is tempting because the machine's net carrying amount does increase by $260,000, but GAAP requires recording the full cost of the new component and removing the old component's cost and accumulated depreciation. Removing the old component with no proceeds produces a $100,000 loss, so simply capitalizing a net amount without recognizing the disposal loss is incorrect.
Why not C: This distractor appeals if a student treats all replacements as routine maintenance. However, because the replacement extends useful life and increases productive output, the expenditure provides future economic benefit and must be capitalized rather than expensed.
Why not D: Some may think adding the new part without removing the old avoids recognizing a loss, but that double-counts the old component. Proper accounting requires removal of the old component's gross cost and accumulated depreciation (and recognition of any gain or loss) when it is retired or replaced.
Question 4
Hint
Separate the shutdown costs into components: a new inspection component, recurring maintenance, and the old inspection component already on the books.
Answer B. Under U.S. GAAP, costs of a major inspection that are a condition of continuing to operate PPE may be capitalized when recognition criteria are met, and the carrying amount of the prior inspection component is derecognized. The original $800,000 inspection component had 3 years of depreciation through January 1, Year 4 (800,000 × 3/4 = 600,000 accumulated depreciation), leaving a $200,000 carrying amount that is removed on derecognition. The $1,050,000 new inspection cost is capitalized as a separate component; the $140,000 routine lubrication and minor parts work is recurring maintenance and is expensed.
Why not A: Tempting because the inspection is required to return the asset to service, but routine lubrication, filter changes, and minor parts are recurring maintenance and should be expensed. This choice also ignores that the prior inspection component must be derecognized rather than simply netted into the new cost.
Why not C: This reflects the common but incorrect shortcut that only improvements that increase capacity or extend overall life are capitalizable. A major inspection required for continued operation can be capitalized when it meets asset recognition criteria; only the routine maintenance portion is expensed.
Why not D: Plausible because candidates often net the undepreciated balance against the new cost, but GAAP requires derecognition of the old component and capitalization of the full cost of the new inspection. The $200,000 remaining carrying amount of the original inspection is removed (recognized as a loss on derecognition), not deducted from the new component's recorded cost.
Question 5
Hint
Compute the old pump's carrying amount (cost less accumulated depreciation after 3 years), then apply derecognition rules for replaced components and capitalize the cost of the new pump to find the net PP&E effect.
Answer C. The pump was separately tracked. Annual depreciation = $100,000 ÷ 4 = $25,000, so after 3 years accumulated depreciation = $75,000 and carrying amount = $25,000. Derecognize the old pump's cost ($100,000) and its accumulated depreciation ($75,000), recognizing the $25,000 difference as a loss; capitalize the $90,000 cost of the new pump. Net PP&E change = +$90,000 − $25,000 = +$65,000.
Why not A: This mechanically manipulates the contra-asset without removing the old asset cost, which overstates net PP&E. Proper accounting derecognizes the old component's cost and related accumulated depreciation and records any gain or loss.
Why not B: Tempting because routine repairs are expensed, but this is the replacement of a separately tracked major component. GAAP requires derecognition of the old component and capitalization of the new component rather than expensing the entire cost.
Why not D: Even if the balance sheet amounts are adjusted, when an asset with a nonzero carrying amount is disposed of with no proceeds the difference between cost and accumulated depreciation must be recognized in earnings as a loss. Omitting the loss misstates income.
Question 6
Hint
First decide which costs are capitalized (the overhaul) versus expensed (routine maintenance). If the life is extended, recalculate depreciation prospectively over the revised remaining life and then compute accumulated depreciation.
Answer C. The $24,000 overhaul is capitalized and added to cost (240,000 + 24,000 = 264,000). Year1 depreciation = 240,000/8 = 30,000, so the carrying amount at Jan 1, Year2 before the overhaul is 210,000; after the overhaul the depreciable base is 234,000 and the remaining life is revised to 9 years (7 remaining + 2 extension), so Year2 depreciation = 234,000/9 = 26,000. Accumulated depreciation = 30,000 + 26,000 = 56,000, and net PP&E = 264,000 - 56,000 = 208,000.
Why not A: This capitalizes the overhaul but incorrectly depreciates the $24,000 addition over the original 8-year life (or otherwise continues the original depreciation pattern), producing Year2 depreciation of $33,000. When an improvement extends remaining life, the new carrying amount should be depreciated prospectively over the revised remaining life.
Why not B: This treats the $24,000 overhaul as an expense so gross PP&E remains $240,000 and Year2 depreciation stays at $30,000 (accumulated = 30,000 + 30,000 = 60,000). It's wrong because an overhaul that improves the asset and extends its life should be capitalized and depreciated prospectively.
Why not D: This reflects capitalizing the overhaul but failing to record the proper Year2 depreciation on the improved asset (recording only the original $30,000). It's wrong because an improvement placed in service at the start of the period should be depreciated in that period, yielding $26,000 for Year2.
Common questions
Do you remove the old component when capitalizing its replacement?
Yes, when the replaced component is separately identified, remove its historical cost and accumulated depreciation. Compare disposal proceeds with its carrying amount to determine the gain or loss.
Do you expense or capitalize a major overhaul?
Capitalize an overhaul that extends useful life or increases capacity. Expense routine maintenance performed at the same time.
How do I calculate depreciation after a component replacement?
For straight-line depreciation, divide updated carrying amount less salvage value by revised remaining life. Depreciate components separately when lives differ, but cap each period at the host asset's remaining life unless the component will remain in use independently afterward.
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