Question

2. As a result of the decline in crude oil price environment, Mooncor Energy Inc. performed impairment tests on its Oil Sands segment as at December 31, 2015. The long-term assets of the CGU has a net book value of $2.2 billion. The company based its cash flow projections on WTI oil price. Fair value 1,700 M Expected cash flow 2016 400 M Costs to sell 100 M Expected cash flow 2017 500 M Expected cash flow 2018 700 M Expected cash flow 2019 800 M Risk-adjusted cost of capital 12% Based on the above estimates, Mooncor recorded an impairment loss of $440 million (see class notes for calculation). How much more impairment loss would Mooncor need to record if they had used a 1% higher discount rate? What would be the impact of this change on Mooncor's financial statements? What is the implication?

Answer 1

Calculation of Impairment Loss:

Carrying Amount 2,200.00M

Less: Recoverable Amount 1,721.34M

Higher of the following

a) Fair Value less costs to sell ,and 1,600.00M

b) Value in Use 1721.34M   

Impairment Loss to be recognized 478.66M

Impairment loss already recorded 440.00M

Additional impairment loss to be recorded 38.66M

WorkingNotes-

Fair Value less Cost of sale = 1700M -100M = 1600M

Value in use is the present value of future Cash flows

Computation of Value in Use

Year Cash Flow Present Value of @13%[Cash Flow / (1+0.13)^no of year]

2016 400M 353.98

2017 500M 391.57

2018 700M 485.14

2019 800M 490.65

Value in Use = 1721.34

If the asset is being carried at its historical cost then the impairment loss is immediately recognized as an expense, but if it is revalued then impairment loss is treated as revaluation decrease and recognized in other comprehensive income. If impairment loss exceeds the revaluation surplus, the excess is immediately recognized as an expense.

It will impact the profit of the entity in both the cases and result in decline in profit, in both cases either recognized as expense or revaluation decrease.