Question

On January 1, 2014, Denn Corporation purchased machinery for $1,300,000, which it installed in a rented factory. The machine has a 12-year useful life and a salvage value of $100,000. The company uses the straight-line method of depreciation for this type of machinery. On December 31, 2018 (after depreciation has been recorded for the year), because of increasing competition in the industry, Denn believes that the asset may be impaired and will have a remaining useful life of five years, over which it estimates the machine will generate $2,000,000 of cash inflows and $1,650,000 of total cash outflows. The cash flows are independent of the company’s other activities and will occur evenly each year. Denn is unable to determine the fair value of the machine. The company’s discount rate is 10%.

               Required: Determine the amount of impairment loss, if any, and prepare the journal entry to               record the impairment loss (if there is one).

Answer 1

Answer:

As per International Accounting Standard (IAS) -36, Para 59, an impairment loss must be recognized whenever a recoverable value is lower than the carrying value. As per IAS-36, Para 6, impairment loss is the amount by which the recoverable value is lower than the carrying value of an asset. Carrying value is the amount at which the given asset is recorded in the balance sheet after adjusting accumulated depreciation and accumulated impairment losses. Recoverable value is the higher of value-in-use and fair value minus costs of disposal. Fair value is the price at which the given asset can be sold in the market to the market participants at the measurement date. Value-in-use is the present value of the future cash flows which are derived from the given asset.

Calculation of Carrying Value of Machinery:

Cost of Machinery	$13,00,000
Less: Salvage Value	($1,00,000)
Depreciable Value	$12,00,000
Useful life (in years)	12
Depreciation each year	$1,00,000

Machinery	$13,00,000
Less: Accumulated depreciation-Machinery (5 years*$100,000 depreciation)	($5,00,000)
Carrying Value of Machinery	$8,00,000

Calculation of Value-in-Use of Machinery:

Total Cash inflows	$20,00,000
Less: Total cash outflows	($16,50,000)
Net cash inflows each year	$3,50,000
Present Value of Annuity for 5 years at 10% Discounting Rate	3.7908
Present Value of cash flows	$13,26,780
Value-in-Value	$13,26,780

Value-in-use is $1,326,780 and Carrying value is $800,000 of the machinery showing higher value-in-use than the carrying value of the machinery so there is no chance of impairment loss in the machinery. Therefore, there is no need to recognize the impairment loss in the machinery.