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Chapter 11: Q16E (page 588)

(Impairment) Presented below is information related to equipment owned by Suarez Company at December 31, 2017.

Cost

\(9,000,000

Accumulated depreciation to date

1,000,000

Expected future net cash flows

7,000,000

Fair value

4,800,000

Assume that Suarez will continue to use this asset in the future. As of December 31, 2017, the equipment has a remaining useful life of 4 years.

Instructions

  1. Prepare the journal entry (if any) to record the impairment of the asset at December 31, 2017.
  2. Prepare the journal entry to record depreciation expense for 2018.
  3. The fair value of the equipment at December 31, 2018, is \)5,100,000. Prepare the journal entry (if any) necessary to record this increase in fair value.

Short Answer

Expert verified

Answer

  1. Loss on impairment = $3,200,000
  2. Depreciation = $1,200,000
  3. No entry required

Step by step solution

01

Meaning of Impairment

The term "impairment" refers to a reduction of the market value of fixed or intangible assets, indicative of a reduction in the quantity, quality, or market value of an asset. The idea is that an asset should never be reported in your business's financial statements above the maximum amount that could be recouped through its sale.

02

(a) Preparing journal entry

Date

Particular

Debit ($)

Credit ($)

Dec. 31, 2017

Loss on Impairment

3,200,000

Accumulated Depreciation

Equipment

3,200,000

Working Notes:

Calculating loss on impairment

Cost

$9,000,000

Less: Accumulated depreciation

1,000,000

Carrying amount

8,000,000

Less: Fair value

4,800,000

Loss on impairment

$3,200,000

03

(b) Preparing journal entry

Date

Particular

Debit ($)

Credit ($)

Dec. 31, 2018

Depreciation Expense

1,200,000

Accumulated Depreciation

Equipment

1,200,000

Working notes:

Calculating depreciation expense

Depreciation=NewcarryingamountUsefullife=$4,800,0004=$1,200,000

04

(c) Explaining the journal entry 

It is not possible to restore any impairment loss. Therefore, no entry should be passed.

Profit or loss is instantly adjusted to reflect an impairment loss. The asset's (or cash-generating units) carrying amount is decreased. Goodwill is lowered first in a cash-generating unit, followed by other assets on a pro-rata basis. In future periods, the depreciation (amortization) charge is adjusted to allocate the asset's revised carrying amount over the asset's remaining useful life.

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Most popular questions from this chapter

(Depreciation Computations鈥擣ive Methods, Partial Periods) Muggsy Bogues Company purchased equipment for \(212,000 on October 1, 2017. It is estimated that the equipment will have a useful life of 8 years and a salvage value of \)12,000. Estimated production is 40,000 units and estimated working hours are 20,000. During 2017, Bogues uses the equipment for 525 hours and the equipment produces 1,000 units.

Instructions

Compute depreciation expense under each of the following methods. Bogues is on a calendar-year basis ending December 31.

  1. Straight-line method for 2017.
  2. Activity method (units of output) for 2017.
  3. Activity method (working hours) for 2017.
  4. Sum-of-the-years鈥�-digits method for 2019.
  5. Double-declining-balance method for 2018.

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.

Why might a company choose not to use revaluation accounting?

Francis Corporation purchased an asset at a cost of \(50,000 on March 1, 2017. The asset has a useful life of 8 years and a salvage value of \)4,000. For tax purposes, the MACRS class life is 5 years. Compute tax depreciation for each year 2017鈥�2022.

Use the information for Lockard Company given in BE11-2. (a) Compute 2017 depreciation expense using the double-declining-balance method. (b) Compute 2017 depreciation expense using the double-declining-balance method, assuming the machinery was purchased on October 1, 2017.
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