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Chapter 11: Q11-1AAP (page 599)

Electroboy Enterprises, Inc. operates several stores throughout the western United States. As part of an operational and financial reporting review in a response to a downturn in its markets, the company鈥檚 management has decided to perform an impairment test on five stores (combined). The five stores鈥� sales have declined due to aging facilities and competition from a rival that opened new stores in the same markets. Management has developed the following information concerning the five stores as of the end of fiscal 2016.

Original cost \(36million

Accumulated depreciation \)10 million

Estimated remaining useful life 4 years

Estimated expected future

annual cash flows (not discounted) \(4.0 million per year

Appropriate discount rate 5 percent

Accounting

  1. Determine the amount of impairment loss, if any, that Electroboy should report for fiscal 2016 and the book value at which Electroboy should report the five stores on its fiscal year-end 2016 balance sheet. Assume that the cash flows occur at the end of each year.
  2. Repeat part (a), but instead assume that (1) the estimated remaining useful life is 10 years, (2) the estimated annual cash flows are \)2,720,000 per year, and (3) the appropriate discount rate is 6 percent.

Analysis

Assume that you are a financial analyst and you participate in a conference call with Electroboy management in early 2017 (before Electroboy closes the books on fiscal 2016). During the conference call, you learn that management is considering selling the five stores, but the sale won鈥檛 likely be completed until the second quarter of fiscal 2017. Briefly discuss what implications this would have for Electroboy鈥檚 2016 financial statements. Assume the same facts as in part (b) above.

Principles

Electroboy management would like to know the accounting for the impaired asset in periods subsequent to the impairment. Can the assets be written back up? Briefly discuss the conceptual arguments for this accounting.

Short Answer

Expert verified

Answer

No, an impairment charge is necessary as the undiscounted value is less than the book value when the estimated cash flow is $2,720,000. Electroboy will need to write the stores down to $20,019,445 from $26 million. If the assets are held-for-sale, the assets can be written back up.

Step by step solution

01

Step-by-Step SolutionStep 1: Meaning of depreciation

In financial accounting, depreciation could be a strategy for spreading out the cost of tangible resources over their functional lives. Essentially, it is the disintegration of the value of an asset, which happens over time due to continuous use and abrasion of the asset.

02

(a) Explaining the “accounting” part

Calculating the undiscounted future cash flows

鲍苍诲颈蝉肠辞耻苍迟别诲鈥塮耻迟耻谤别鈥塩补蝉丑鈥塿补濒耻别=贰虫辫别肠迟别诲鈥塮耻迟耻谤别鈥塧苍苍耻补濒鈥塩补蝉丑鈥塮濒辞飞脳贰蝉迟颈尘补迟别诲鈥塺别尘补颈苍颈苍驳鈥塴颈蹿别=$4鈥尘颈濒濒颈辞苍脳4鈥墆别补谤=$16鈥尘颈濒濒颈辞苍

Calculating the book value

叠辞辞办鈥塿补濒耻别=翱谤颈驳颈苍补濒鈥塩辞蝉迟鈭�础肠肠耻尘耻濒补迟别诲鈥塪别辫谤别肠颈补迟颈辞苍=$36鈥尘颈濒濒颈辞苍鈭�$10鈥尘颈濒濒颈辞苍=$26鈥尘颈濒濒颈辞苍

The impairment test suggests that an impairment charge is necessary as the undiscounted value is less than the book value.

Calculating the estimated fair value

贰蝉迟颈尘补迟别诲鈥塮补颈谤鈥塿补濒耻别=贰蝉迟颈尘补迟别诲鈥塭虫辫别肠迟别诲鈥塮耻迟耻谤别鈥塧苍苍耻补濒鈥塩补蝉丑鈥塮濒辞飞脳PVF-OA4,5%=$4鈥尘颈濒濒颈辞苍脳3.54595=$14,183,800

Calculating the impairment charge

滨尘辫补颈谤尘别苍迟鈥塩丑补谤驳别=叠辞辞办鈥塿补濒耻别鈭�贰蝉迟颈尘补迟别诲鈥塮补颈谤鈥塿补濒耻别=$26,000,000鈭�$14,183,800=$11,816,200

Post-impairment book value = $14,183,800

03

(b) Explaining the “accounting” part

Calculating the undiscounted future cash flows

鲍苍诲颈蝉肠辞耻苍迟别诲鈥塮耻迟耻谤别鈥塩补蝉丑鈥塿补濒耻别=贰虫辫别肠迟别诲鈥塮耻迟耻谤别鈥塧苍苍耻补濒鈥塩补蝉丑鈥塮濒辞飞脳贰蝉迟颈尘补迟别诲鈥塺别尘补颈苍颈苍驳鈥塴颈蹿别=$2.72鈥尘颈濒濒颈辞苍脳10鈥墆别补谤=$27.2鈥尘颈濒濒颈辞苍

Calculating the book value

叠辞辞办鈥塿补濒耻别=翱谤颈驳颈苍补濒鈥塩辞蝉迟鈭�础肠肠耻尘耻濒补迟别诲鈥塪别辫谤别肠颈补迟颈辞苍=$36鈥尘颈濒濒颈辞苍鈭�$10鈥尘颈濒濒颈辞苍=$26鈥尘颈濒濒颈辞苍

It is found that the undiscounted future cash flow is greater than the book value; the impairment test suggests that no impairment charge is necessary.

Book value at fiscal year-end = $26 million.

04

Explaining the “analysis” part

If the stores are being sold, they will very certainly be classified as 鈥渉eld-for-sale鈥� for financial reporting purposes. The impairment test is based on discounted cash flows rather than undiscounted cash flows if they are held-for-sale. It's essentially a lower-of-cost-or-market strategy.

Calculating the estimated fair value

贰蝉迟颈尘补迟别诲鈥塮补颈谤鈥塿补濒耻别=贰蝉迟颈尘补迟别诲鈥塭虫辫别肠迟别诲鈥塮耻迟耻谤别鈥塧苍苍耻补濒鈥塩补蝉丑鈥塮濒辞飞脳PVF-OA4,5%=$2.72鈥尘颈濒濒颈辞苍脳7.36009=$20,019,445

As a result, Electroboy will have to write down the stores from $26 million to $20,019,445. When management wants to sell the assets, fixed asset write-downs are more likely.

05

Explaining the “principles” part

Once an asset has been written down to an impairment value, it cannot be written up again under GAAP. This provision is based on a combination of caution and concerns about the accuracy of measures for upward revaluations of the respective impairment.

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Most popular questions from this chapter

A building that was purchased on December 31, 2003, for $2,500,000 was originally estimated to have a life of 50 years with no salvage value at the end of that time. Depreciation has been recorded through 2017. During 2018, an examination of the building by an engineering firm discloses that its estimated useful life is 15 years after 2017. What should be the amount of depreciation for 2018?

Walkin Inc. is considering the write-down of its long-term plant because of a lack of profitability. Explain to the management of Walkin how to determine whether a write-down is permitted.

(Depletion Computations鈥擳imber) Forda Lumber Company owns a 7,000-acre tract of timber purchased in 2003 at a cost of \(1,300 per acre. At the time of purchase, the land was estimated to have a value of \)300 per acre without the timber. Forda Lumber Company has not logged this tract since it was purchased. In 2017, Forda had the timber cruised. The cruise (appraiser) estimated that each acre contained 8,000 board feet of timber. In 2017, Forda built 10 miles of roads at a cost of \(7,840 per mile. After the roads were completed, Forda logged and sold 3,500 trees containing 850,000 board feet.

Instructions

  1. Determine the cost of timber sold related to depletion for 2017.
  2. If Forda depreciates the logging roads on the basis of timber cut, determine the depreciation expense for 2017.
  3. If Forda plants five seedlings at a cost of \)4 per seedling for each tree cut, how should Forda treat the reforestation?

Cominsky Company purchased a machine on July 1, 2018, for \(28,000. Cominsky paid \)200 in title fees and county property tax of \(125 on the machine. In addition, Cominsky paid \)500 shipping charges for delivery, and \(475 was paid to a local contractor to build and wire a platform for the machine on the plant floor. The machine has an estimated useful life of 6 years with a salvage value of \)3,000. Determine the depreciation base of Cominsky鈥檚 new machine. Cominsky uses straightline depreciation.

(Depreciation Computation鈥擜ddition, Change in Estimate) In 1990, Herman Moore Company completed the construction of a building at a cost of \(2,000,000 and first occupied it in January 1991. It was estimated that the building will have a useful life of 40 years and a salvage value of \)60,000 at the end of that time.

Early in 2001, an addition to the building was constructed at a cost of \(500,000. At that time, it was estimated that the remaining life of the building would be, as originally estimated, an additional 30 years and that the addition would have a life of 30 years and a salvage value of \)20,000.

In 2019, it is determined that the probable life of the building and addition will extend to the end of 2050, or 20 years beyond the original estimate.

Instructions

  1. Using the straight-line method, compute the annual depreciation that would have been charged from 1991 through 2000.
  2. Compute the annual depreciation that would have been charged from 2001 through 2018.
  3. Prepare the entry, if necessary, to adjust the account balances because of the revision of the estimated life in 2019.
  4. Compute the annual depreciation to be charged, beginning with 2019.
See all solutions

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