Question

Chrispian Cookies, Inc. is reviewing all available information regarding the future use of its baking equipment, which it intends to use for the foreseeable future. The information indi-cates that this equipment may be obsolete and could be impaired. Chrispian acquired the equipment three years ago at a cost of $ 9,000,000 and depreciated it using the straight- line method with an estimated residual value of $ 1,800,000 and an eight- year useful life.

At the end of the third year, management estimates the following cash flows from the use of the asset:

Future Period Cash Flow Projection Year 1 ………………………………. $ 1,800,000 Year 2 ………………………………. 1,600,000 Year 3 ……………………………… 980,000 Year 4 ……………………………… 890,000 Year 5 ……………………………… 730,000 Total $ 6,000,000 The asset is highly specialized and is not traded in an active market. As a result, the fair value of the asset must be estimated. Chrispian’s cost of capital is 6%.

Required a. Conduct an impairment test for Chrispian’s baking equipment.

b. Prepare the journal entry to record any impairment loss indicated.

c. Compute the amount of the revised depreciation expense at the end of the next year. Assume that management now estimates that there will be no residual value at the end of the asset’s life.

d. The estimated fair value at the end of the next year is $ 4,400,000. The sum of the undiscounted future cash flows exceeds the asset’s carrying value.

Answer 1

Impairment loss can be calculated as access of carrying amount of an asset over its recoverable value. In simpler terms, recoverable value is present value of estimated future cash flows from the underlying asset.

For the present case, the recoverable value of the underlying asset can be calculated as under

W.N. 1 - Calculation of recoverable value

Year	Expected Cash Inflow	Discount Factor @6%	Cash Flow * Discount Factor
1	1,800,000	0.943	1,697,400
2	1,600,000	0.890	1,424,000
3	980,000	0.840	823,200
4	890,000	0.792	704,880
5	730,000	0.747	545,310
	Total (Recoverable Value)		5,194,790

W.N. 2 - Calculation of Carrying Amount

= Purchase Cost - Accumulated depreciation for 3 years

=9,000,000 - {[(9,000,000-1,800,000)/8]*3}

=9,000,000 - 2,700,000

=6,300,000

Based on above calculations, we can understand that the carrying amount of asset is higher than its recoverable amount,

Answer to A.

Amount of impairment loss can be calculated as under

= Carrying amount - Recoverable amount

= 6,300,000 - 5,194,790

= 1,105,210

Answer B.

The journal entry to record the impairment loss shall be as under

Account Description	Debit	Credit
Impairment loss A/c dr	1,105,210
to baking equipment		1,105,210

Answer C.

At the end of the year 3, the carrying value of baking equipment will be decreased to give effect to the impairment loss. Hence, from 4th year onward, the depreciation has to be charged based on the revised carrying value and not the original carrying value. The revised depreciation shall be calculated on the carrying amount of $ 5,194,790, residual value to be nil and remaining useful life of 5 years. Hence, the revised depreciation to be charged at the end of 4th year can be calculated as under:

= (Carrying amount - Salvage Value) / Remaining useful life

= (5,194,790 - 0) / 5

= 1,038,958/-

Answer D.

Carrying amount of equipment at the end of 4th year after providing depreciation will be $ 4,155,832 (5,194,790 - 1,038,958).

Now the estimated fair value is $4,400,000. Also the un-discounted future cash flows exceeded the carrying amount of equipment. As the fair value i.e recoverable value (Assuming that the fair value is higher than the un-discounted future cash flows) of equipment is more then its carrying value, there is no impairment loss to be accounted for.