91Ó°ÊÓ

Sunset Resorts, Inc. owns and manages resort properties. On January 15,2006 , one of its properties was found to be adjacent to a toxic chemical disposal site. As a result of the negative publicity, this property's bookings dropped \(40 \%\) during 2006 . On December 31,2006 , the accounts of the company showed the following details regarding the impaired property: $$\begin{array}{lr} \text { Land } & \$ 25,000,000 \\ \text { Buildings and improvements (net) } & 80,000,000 \\ \text { Equipment (net) } & 15,000,000 \\ \text { Total } & \$ 120,000,000 \\ \hline \hline \end{array}$$ Management decides that closing the resort is the only option. As a result, it is estimated that the buildings and improvements will be written off completely. The land can be sold for other uses for $$\$ 17$$ million, while the equipment can be disposed of for $$\$ 4$$ million, net of disposal costs. a. Provide the journal entry to record the asset impairment on December \(31,2006 .\) b. Provide the note disclosure for the impairment.

Step by step solution

01

Calculate Impairment Loss for Buildings and Improvements

The book value of the buildings and improvements is completely written off. This means the entire amount of $80,000,000 will be removed from the books as an impairment loss.

02

Calculate Impairment Loss for Equipment

The equipment's book value is \(15,000,000. It can be disposed of for \)4,000,000. The impairment loss is calculated by subtracting the disposal value from the book value: \[ 15,000,000 - 4,000,000 = 11,000,000 \] So, the impairment loss on equipment is $11,000,000.

03

No Impairment Loss for Land

The land can be sold for $17,000,000, which is lower than its book value of $25,000,000. However, since land is not impaired, no value is written off here.

04

Create Journal Entry for Impairment Loss

The journal entry to record the impairment loss involves debiting an expense account and crediting the asset accounts. - Debit Impairment Loss: \[ 80,000,000 + 11,000,000 = 91,000,000 \] - Credit Buildings and Improvements: \(80,000,000 - Credit Equipment: \)11,000,000 **Journal Entry:** Debit: Impairment Loss \(91,000,000 Credit: Buildings and Improvements \)80,000,000 Credit: Equipment $11,000,000

05

Provide Note Disclosure for the Impairment

In the note disclosure, you should provide information about the impairment as follows: **Note Disclosure:** "During the year ended December 31, 2006, Sunset Resorts, Inc. recognized an impairment loss of $91,000,000 associated with one of its resort properties. This impairment was due to the decision to close the resort following negative publicity related to its proximity to a toxic chemical disposal site. The buildings and improvements have been fully written off, while the equipment has been assessed for impairment based on its net disposal value."

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Journal Entries

When a company identifies that an asset has become impaired, it must record this loss in its financial statements. This is done through journal entries. These entries adjust the book values of the impaired assets and record the loss as an expense. In our example, Sunset Resorts, Inc. determined that the negative publicity led to the necessity of closing a resort, manifesting in reduced bookings. After calculating the impairment losses, the next step is making a precise journal entry:

• The impairment loss is charged against earnings by debiting an expense account.
• Assets with reduced values, like buildings and equipment that incur impairment, need to be credited to reflect the decrease in the asset's book value.

The journal entry for the impairment made by Sunset Resorts is as follows: - **Debit**: Impairment Loss $91,000,000 - **Credit**: Buildings and Improvements $80,000,000 - **Credit**: Equipment $11,000,000 This entry reflects the total loss due to the impairment and indicates which assets experienced a reduction in book value.

Note Disclosure

Note disclosures are crucial as they offer transparency and additional context behind the numbers present in financial statements. They explain what led to certain financial decisions or figures, providing stakeholders with insights into any unusual or non-recurring items. For Sunset Resorts, the impairment affected significant portions of their assets due to unforeseen negative publicity. The note disclosure for this impairment includes the following information:

• Specifics of assets involved: The buildings and improvements were fully written off, acknowledging a total loss of $80,000,000, while the equipment was impaired by $11,000,000.
• Reason for impairment: The closure decision stemmed from adjacent toxic chemical disposal site issues.
• Total impairment loss: $91,000,000

An example of what the disclosure may look like could be: "During the year ended December 31, 2006, Sunset Resorts, Inc. recognized an impairment loss of $91,000,000 in connection with its resort operations." These disclosures shed light on exceptional circumstances affecting financial results, helping investors and analysts gauge potential long-term impacts.

Impairment Loss Calculation

Calculating the impairment loss is necessary to determine the reduction in asset value accurately. This process involves comparing the book value of an asset against its recoverable amount, essentially how much the asset's market or disposal value is. For Sunset Resorts, the calculations were as follows:

• **Buildings and Improvements: Total Write-off** - The buildings and improvements had a book value of $80,000,000. The entire value was impaired, meaning the asset's recoverable amount was deemed negligible.
• **Equipment: Calculated Impairment Loss** - The equipment had a book value of $15,000,000, but only a net disposal value of $4,000,000. The impairment loss here is the difference: $15,000,000 - $4,000,000 = $11,000,000.

In the context of asset impairment, calculations like these ensure that the asset values recorded in a company's books truly reflect their current worth. This matching of book value to market value is crucial for providing an accurate financial position of the company.