(Impairment) Roland Company uses special strapping equipment in its packaging business. The equipment was purchased in January 2016 for \(10,000,000 and had an estimated useful life of 8 years with no salvage value. At December 31, 2017, new technology was introduced that would accelerate the obsolescence of Roland’s equipment. Roland’s controller estimates that expected future net cash flows on the equipment will be \)6,300,000 and that the fair value of the equipment is \(5,600,000. Roland intends to continue using the equipment, but it is estimated that the remaining useful life is 4 years. Roland uses straight-line depreciation.

Instructions

1. Prepare the journal entry (if any) to record the impairment at December 31, 2017.
2. Prepare any journal entries for the equipment at December 31, 2018. The fair value of the equipment at December 31, 2018, is estimated to be \)5,900,000.
3. Repeat the requirements for (a) and (b), assuming that Roland intends to dispose of the equipment and that it has not been disposed of as of December 31, 2018.

Step by step solution

01

Step-by-Step SolutionStep 1: 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 a business's financial statements above the maximum amount that could be recouped through its sale.

02

(a) Preparing journal entry

Date	Particular	Debit ($)	Credit ($)
	Loss on Impairment	1,900,000
	Accumulated Depreciation Equipment		1,900,000

Working notes:

Calculating carrying value

$$\begin{gathered} \text{Carrying\hspace{0.17em}value}=\text{Equipment\hspace{0.17em}cost}-\left(\frac{\text{Equipment\hspace{0.17em}cost}}{\text{Useful\hspace{0.17em}life}}\right)\times 2 \\ =\mathrm{\$}10,000,000-\left(\frac{\mathrm{\$}10,000,000}{8}\times 2\right) \\ =\mathrm{\$}10,000,000-\mathrm{\$}2,500,000 \\ =\mathrm{\$}7,500,000 \end{gathered}$$

Note: Future cash flow ($6,300,000) < Carrying value ($7,500,000)

Calculating Accumulated depreciation

$$\begin{gathered} \text{Accumulated\hspace{0.17em}depreciation}=\text{Carrying\hspace{0.17em}value}-\text{Fair\hspace{0.17em}value\hspace{0.17em}of\hspace{0.17em}equipment} \\ =\mathrm{\$}7,500,000-\mathrm{\$}5,600,000 \\ =\mathrm{\$}1,900,000 \end{gathered}$$

03

(b) Preparing journal entry

Date	Particular	Debit ($)	Credit ($)
	Depreciation Expense	1,400,000
	Accumulated Depreciation Equipment		1,400,000

Working notes:

$$\begin{gathered} \text{Accumulated\hspace{0.17em}depreciation}=\frac{\text{Fair\hspace{0.17em}value\hspace{0.17em}of\hspace{0.17em}euipment}}{\text{Remaining\hspace{0.17em}useful\hspace{0.17em}life}} \\ =\frac{\mathrm{\$}5,600,000}{4} \\ =\mathrm{\$}1,400,000 \end{gathered}$$

04

(c) Preparing journal entry

No depreciation is recorded on impaired assets to be disposed of. Recovery of impairment losses is recorded.

Date	Particular	Debit ($)	Credit ($)
12/31/17	Loss on Impairment	1,900,000
	Accumulated Depreciation Equipment		1,900,000
12/31/18	Accumulated Depreciation Equipment	300,000
	Recovery of Loss from Impairment		300,000

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