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Chapter 11: Q18E (page 588)

(Impairment) The management of Petro Garcia Inc. was discussing whether certain equipment should be written off as a charge to current operations because of obsolescence. This equipment has a cost of \(900,000 with depreciation to date of \)400,000 as of December 31, 2017. On December 31, 2017, management projected its future net cash flows from this equipment to be \(300,000 and its fair value to be \)230,000. The company intends to use this equipment in the future.

Instructions

  1. Prepare the journal entry (if any) to record the impairment at December 31, 2017.
  2. Where should the gain or loss (if any) on the write-down be reported in the income statement?
  3. At December 31, 2018, the equipment鈥檚 fair value increased to $260,000. Prepare the journal entry (if any) to record this increase in fair value.
  4. What accounting issues did management face in accounting for this impairment?

Short Answer

Expert verified

Answer

  1. Loss on impairment = $270,000
  2. It may be reported in the other expenses and losses section
  3. No entry is necessary
  4. Management should perform a recoverability test

Step by step solution

01

Meaning of Impairment Loss

When an asset's value drops, it will suffer an impairment loss. The value is the sum of its recoverable assets, market value, or maximum amount of undiscounted future cash flows. In addition to legal, economic, and natural factors that can trigger an impairment loss, there are many other factors that can lead to one.

02

(a) Preparing journal entry. 

Date

Particular

Debit ($)

Credit ($)

Loss on Impairment

270,000

Accumulated Depreciation

Equipment

270,000

Working notes:

Calculating the amount of loss on impairment

Cost

$900,000

Less: Accumulated depreciation

400,000

Carrying amount

500,000

Less: Fair value

230,000

Loss on impairment

$270,000

03

(b) Explaining the gain or loss that should be reported in the income statement. 

It might be listed in the other costs and losses section, or it could be marked in a separate part as an unusual item.

The profit or loss might be recorded in the income statement's column for additional costs and losses. It's a unique object that deserves to be emphasized in its own area.

04

(c) Explaining the journal entry 

Restoration of any loss arising out of impairment is not permitted. Therefore, no entry is required to be passed.

A company's assets may be subject to revaluation if they are impaired and incur an impairment loss, and the book value of that asset is periodically adjusted. The revaluation approach may compensate for past losses by adjusting the value of the asset in the future.

05

(d) Explaining the accounting issues that management face in accounting for the impairment 

Management had to first figure out if there was a problem. Management does a recoverability test to assess this phase. The recoverability test calculates the estimated future cash flows from the asset's usage and ultimate disposal.

Impairment occurs when the total of the projected future net cash flows (undiscounted) is less than the asset's carrying value. A loss is calculated if the recoverability test reveals that an impairment has occurred. The impairment loss is the difference between the asset's carrying value and its fair value.

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Most popular questions from this chapter

Some believe that accounting depreciation measures the decline in the value of fixed assets. Do you agree? Explain.

Question: Identify and explain the three types of classifications for investments in debt securities.

(Depreciation and Error Analysis) A depreciation schedule for semi-trucks of Ichiro Manufacturing Company was requested by your auditor soon after December 31, 2018, showing the additions, retirements, depreciation, and other data affecting the income of the company in the 4-year period 2015 to 2018, inclusive. The following data were ascertained.

Balance of Trucks account, Jan. 1, 2015

Truck No. 1 purchased Jan. 1, 2012, cost

\(18,000

Truck No. 2 purchased July 1, 2012, cost

22,000

Truck No. 3 purchased Jan. 1, 2014, cost

30,000

Truck No. 4 purchased July 1, 2014, cost

24,000

Balance, Jan. 1, 2015

\)94,000

The Accumulated Depreciation鈥擳rucks account previously adjusted to January 1, 2015, and entered in the ledger, had a balance on that date of \(30,200 (depreciation on the four trucks from the respective dates of purchase, based on a 5-year life, no salvage value). No charges had been made against the account before January 1, 2015.

Transactions between January 1, 2015, and December 31, 2018, which were recorded in the ledger, are as follows.

July 1, 2015 Truck No. 3 was traded for a larger one (No. 5), the agreed purchase price of which was \)40,000. Ichiro. paid the automobile dealer \(22,000 cash on the transaction. The entry was a debit to Trucks and a credit to Cash, \)22,000. The transaction has commercial substance.

Jan. 1, 2016 Truck No. 1 was sold for \(3,500 cash; entry debited Cash and credited Trucks, \)3,500.

July 1, 2017 A new truck (No. 6) was acquired for \(42,000 cash and was charged at that amount to the Trucks account. (Assume truck No. 2 was not retired.)

July 1, 2017 Truck No. 4 was damaged in a wreck to such an extent that it was sold as junk for \)700 cash. Ichiro received \(2,500 from the insurance company. The entry made by the bookkeeper was a debit to Cash, \)3,200, and credits to Miscellaneous Income, \(700, and Trucks, \)2,500.

Entries for straight-line depreciation had been made at the close of each year as follows: 2015, \(21,000; 2016, \)22,500; 2017, \(25,050; and 2018, \)30,400.

Instructions

  1. For each of the 4 years, compute separately the increase or decrease in net income arising from the company鈥檚 errors in determining or entering depreciation or in recording transactions affecting trucks, ignoring income tax considerations.
  2. Prepare one compound journal entry as of December 31, 2018, for adjustment of the Trucks account to reflect the correct balances as revealed by your schedule, assuming that the books have not been closed for 2018.

(Depreciation Choice鈥擡thics) Jerry Prior, Beeler Corporation鈥檚 controller, is concerned that net income may be lower this year. He is afraid upper-level management might recommend cost reductions by laying off accounting staff, including him.

Prior knows that depreciation is a major expense for Beeler. The company currently uses the double-declining-balance method for both financial reporting and tax purposes, and he鈥檚 thinking of selling equipment that, given its age, is primarily used when there are periodic spikes in demand. The equipment has a carrying value of \(2,000,000 and a fair value of \)2,180,000. The gain on the sale would be reported in the income statement. He doesn鈥檛 want to highlight this method of increasing income. He thinks, 鈥淲hy don鈥檛 I increase the estimated useful lives and the salvage values? That will decrease depreciation expense and require less extensive disclosure, since the changes are accounted for prospectively. I may be able to save my job and those of my staff.鈥�

Instructions

Answer the following questions.

  1. Who are the stakeholders in this situation?
  2. What are the ethical issues involved?
  3. What should Prior do?

(Depreciation Computations鈥擣our Methods) Robert Parish Corporation purchased a new machine for its assembly process on August 1, 2017. The cost of this machine was \(117,900. The company estimated that the machine would have a salvage value of \)12,900 at the end of its service life. Its life is estimated at 5 years, and its working hours are estimated at 21,000 hours. Year-end is December 31.

Instructions

Compute the depreciation expense under the following methods. Each of the following should be considered unrelated.

  1. Straight-line depreciation for 2017.
  2. Activity method for 2017, assuming that machine usage was 800 hours.
  3. Sum-of-the-years鈥�-digits for 2018.
  4. Double-declining balance for 2018.
See all solutions

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