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Chapter 11: Q9P (page 594)

(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.

Short Answer

Expert verified
  1. Accumulated depreciation = $1,900,000
  2. Accumulated depreciation = $1,400,000
  3. Recovery of loss from impairment = $300,000

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

Carrying value=Equipment cost−Equipment costUseful life×2=$10,000,000−$10,000,0008×2=$10,000,000−$2,500,000=$7,500,000

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

Calculating Accumulated depreciation

Accumulated depreciation=Carrying value−Fair value of equipment=$7,500,000−$5,600,000=$1,900,000

03

(b) Preparing journal entry

Date

Particular

Debit ($)

Credit ($)

Depreciation Expense

1,400,000

Accumulated Depreciation

Equipment

1,400,000

Working notes:

Accumulated depreciation=Fair value of euipmentRemaining useful life=$5,600,0004=$1,400,000

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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Most popular questions from this chapter

(Depreciation Computations, SYD) Five Satins Company purchased a piece of equipment at the beginning of 2014. The equipment cost \(430,000. It has an estimated service life of 8 years and an expected salvage value of \)70,000. The sum of-the-years’-digits method of depreciation is being used. Someone has already correctly prepared a depreciation schedule for this asset. This schedule shows that \(60,000 will be depreciated for a particular calendar year.

Instructions

Show calculations to determine for what particular year the depreciation amount for this asset will be \)60,000.

(Comprehensive Fixed-Asset Problem) Darby Sporting Goods Inc. has been experiencing growth in the demand for its products over the last several years. The last two Olympic Games greatly increased the popularity of basketball around the world. As a result, a European sports retailing consortium entered into an agreement with Darby’s Roundball Division to purchase basketballs and other accessories on an increasing basis over the next 5 years.

To be able to meet the quantity commitments of this agreement, Darby had to obtain additional manufacturing capacity. A real estate firm located an available factory in close proximity to Darby’s Roundball manufacturing facility, and Darby agreed to purchase the factory and used machinery from Encino Athletic Equipment Company on October 1, 2016. Renovations were necessary to convert the factory for Darby’s manufacturing use.

The terms of the agreement required Darby to pay Encino \(50,000 when renovations started on January 1, 2017, with the balance to be paid as renovations were completed. The overall purchase price for the factory and machinery was \)400,000. The building renovations were contracted to Malone Construction at \(100,000. The payments made, as renovations progressed during 2017, are shown below. The factory was placed in service on January 1, 2018.

1/1

4/1

10/1

12/31

Encino

\)50,000

\(90,000

\)110,000

\(150,000

Malone

30,000

30,000

40,000

On January 1, 2017, Darby secured a \)500,000 line-of-credit with a 12% interest rate to finance the purchase cost of the factory and machinery, and the renovation costs. Darby drew down on the line-of-credit to meet the payment schedule shown above; this was Darby’s only outstanding loan during 2017.

Bob Sprague, Darby’s controller, will capitalize the maximum allowable interest costs for this project. Darby’s policy regarding purchases of this nature is to use the appraisal value of the land for book purposes and prorate the balance of the purchase price over the remaining items. The building had originally cost Encino \(300,000 and had a net book value of \)50,000, while the machinery originally cost \(125,000 and had a net book value of \)40,000 on the date of sale. The land was recorded on Encino’s books at \(40,000. An appraisal, conducted by independent appraisers at the time of acquisition, valued the land at \)290,000, the building at \(105,000, and the machinery at \)45,000.

Angie Justice, chief engineer, estimated that the renovated plant would be used for 15 years, with an estimated salvage value of \(30,000. Justice estimated that the productive machinery would have a remaining useful life of 5 years and a salvage value of \)3,000. Darby’s depreciation policy specifies the 200% declining-balance method for machinery and the 150% decliningbalance method for the

plant. One-half year’s depreciation is taken in the year the plant is placed in service, and one-half year is allowed when the property is disposed of or retired. Darby uses a 360-day year for calculating interest costs.

Instructions

  1. Determine the amounts to be recorded on the books of Darby Sporting Goods Inc. as of December 31, 2017, for each of the following properties acquired from Encino Athletic Equipment Company.
    1. Land.
    2. Buildings.
    3. Machinery.
  2. Calculate Darby Sporting Goods Inc.’s 2018 depreciation expense, for book purposes, for each of the properties acquired from Encino Athletic Equipment Company.
  3. Discuss the arguments for and against the capitalization of interest costs.

Lockard Company purchased machinery on January 1, 2017, for \(80,000. The machinery is estimated to have a salvage value of \)8,000 after a useful life of 8 years. (a) Compute 2017 depreciation expense using the straight-line method. (b) Compute 2017 depreciation expense using the straight-line method assuming the machinery was purchased on September 1, 2017.

(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’s 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?

Last year, Wyeth Company recorded an impairment on an asset held for use. Recent appraisals indicate that the asset has increased in value. Should Wyeth record this recovery in value?
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