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Chapter 11: Q17E (page 588)


(Impairment) Assume the same information as E11-16, except that Suarez intends to dispose of the equipment in the coming year. It is expected that the cost of disposal will be \(20,000.

Cost

\)9,000,000

Accumulated depreciation to date

1,000,000

Expected future net cash flows

7,000,000

Fair value

4,800,000

Instructions

  1. Prepare the journal entry (if any) to record the impairment of the asset at December 31, 2017.
  2. Prepare the journal entry (if any) to record depreciation expense for 2018.
  3. The asset was not sold by December 31, 2018. The fair value of the equipment on that date is \(5,300,000. Prepare the journal entry (if any) necessary to record this increase in fair value. It is expected that the cost of disposal is still \)20,000.

Short Answer

Expert verified

Answer

  1. Loss on impairment = $3,220,000
  2. No entry required
  3. Recovery of loss on impairment = $500,000

Step by step solution

01

Meaning of Impairment 

A permanent loss in value of an asset is considered an impairment. This can be a result of permanent damage or technical problems that impede it from delivering the performance it used to deliver.

02

(a) Preparing journal entries

Date

Particular

Debit ($)

Credit ($)

Loss on Impairment

3,220,000

Accumulated Depreciation

Equipment

3,220,000

Working notes:

Calculating the amount of loss on impairment

Cost

$9,000,000

Accumulated depreciation

1,000,000

Carrying amount

8,000,000

Less: Fair value

4,800,000

Plus: Cost of disposal

20,000

Loss on impairment

$3,220,000

03

(b) Explaining the journal entry

Depreciation is not taken on assets intended to be sold. Therefore no entry should be passed.

If the assesses sells, destroys, or demolishes the asset in the same year that it was purchased, they cannot claim the deduction.

04

(c) Preparing journal entry 

Date

Particular

Debit ($)

Credit ($)

Accumulated Depreciation-Equipment

500,000

Recovery of Loss from Impairment

500,000

Working notes:

Calculation of recovery of impairment loss

Fair value $5,300,000

Less: Cost of disposal 20,000

$5,280,000

Less: Carrying amount

4,780,000

Recovery of loss on impairment

$ 500,000

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Most popular questions from this chapter

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.

(Depreciation for Fractional Periods) On March 10, 2019, Lost World Company sells equipment that it purchased for \(192,000 on August 20, 2012. It was originally estimated that the equipment would have a life of 12 years and a salvage value of \)16,800 at the end of that time, and depreciation has been computed on that basis. The company uses the straight line method of depreciation.

Instructions

  1. (a) Compute the depreciation charge on this equipment for 2012, for 2019, and the total charge for the period from 2013 to 2018, inclusive, under each of the six following assumptions with respect to partial periods.
    1. Depreciation is computed for the exact period of time during which the asset is owned. (Use 365 days for base and record depreciation through March 9, 2019.)
    2. Depreciation is computed for the full year on the January 1 balance in the asset account.
    3. Depreciation is computed for the full year on the December 31 balance in the asset account.
    4. Depreciation for one-half year is charged on plant assets acquired or disposed of during the year.
    5. Depreciation is computed on additions from the beginning of the month following acquisition and on disposals to the beginning of the month following disposal.
    6. Depreciation is computed for a full period on all assets in use for over one-half year, and no depreciation is charged on assets in use for less than one-half year. (Use 365 days for base.)
  2. (b) Briefly evaluate the methods above, considering them from the point of view of basic accounting theory as well as simplicity of application.

It has been suggested that plant and equipment could be replaced more quickly if depreciation rates for income tax and accounting purposes were substantially increased. As a result, business operations would receive the benefit of more modern and more efficient plant facilities. Discuss the merits of this proposition.

In its 2014 annual report, Campbell Soup Company reports beginning-of-the-year total assets of \(8,113 million, end-of-the-year total assets of \)8,323 million, total sales of \(8,268 million, and net income of \)807 million. (a) Compute Campbell鈥檚 asset turnover. (b) Compute Campbell鈥檚 profit margin on sales. (c) Compute Campbell鈥檚 return on assets using (1) asset turnover and profit margin and (2) net income. (Round to two decimal places.)

The plant manager of a manufacturing firm suggested in a conference of the company鈥檚 executives that accountants should speed up depreciation on the machinery in the finishing department because improvements were rapidly making those machines obsolete, and a depreciation fund big enough to cover their replacement is needed. Discuss the accounting concept of depreciation and the effect on a business concern of the depreciation recorded for plant assets, paying particular attention to the issues raised by the plant manager.
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