Question

SAR Research Associates reports the following intangible assets on its December 31 balance​ sheet:

Intangible Asset	Net Carrying Value	Remaining Life
Franchise	857,000	5 years
Patent	410,000	3 years
Trade Name	3,955,000
Total	5,222,000

It does not use a seperate accumulated amortization account for the intangible assets.

Management provided the following information related to intangible assets it obtained during the current​ year:

-​Franchise: Due to current market​ conditions, products sold under the franchise have experienced significant sales declines from possible obsolescence.

-​Patent: SAR is currently involved in litigation that will determine if the company has the exclusive right to sell the patented product. Legal counsel informed SAR that the value of the patent will likely be reduced.

-Trade​ name: The company is required to test for impairment of its​ indefinite-life intangible assets annually.

SAR's cost of capital is 4 %. Management estimates the following future cash flows to be generated over the next five years from the use of its intangible​ assets:

Future Period	Franchise	Patent	Trade Name
1	360,000	281,000	890,000
2	250,000	92,500	640,000
3	150,000	18,000	690,000
4	46,500		520,000
5	29,000		371,000
Total	835,500	391,500	3,111,000

a.	Compute the impairment loss​ (if any) for each intangible asset.
b.	Prepare the journal entry necessary to record the impairment loss.
c.	Assuming thatSAR amortizes its​ finite-life intangible assets using the​straight-line method, with no scrap​ value, prepare the journal entry to record the annual amortization for the first year subsequent to the impairment​write-down.

Answer 1

A)

=> Assets is said to be impaired when: Carrying Amount of Assets > Recoverable Amount of Assets.

=> Recoverable amount of an assets is heigher of :

i) Net Selling Price

ii) Value in Use

=> Value is use: Present value of future cash flow from use of assets + Residual Price/ Scrap Value at the end of its useful life.

=> Net Selling Price: Amount obtained from the sale of an assets less cost of selling/ disposal of assets. In given question for net selling information is not given so assume it is zero (0). So that result in to value in use become Recoverable amount.

Calculation of Value in Use:

Period	DF@4%	Franchise	Patent	Trade Name	PV@4% of Franchise	PV@4% of Patent	PV@4% of Trade Name
1	0.9615	360000	281000	890000	346140	270182	855735
2	0.9246	250000	92500	640000	231150	85526	591744
3	0.8890	150000	18000	690000	133350	16002	613410
4	0.8548	46500		520000	39748		444496
5	0.8219	29000		371000	23835		304925
Total		835500	391500	3111000	774223	371710	2810310

=> Impairment Loss = Carrying Amount - Recoverable Amount

=> Impairment Loss in case of :

i) Franchise = 857000 - 774223

= 82777

ii) Patent = 410000 - 371710

= 38290

iii) Trade Name = 3955000 - 2810310

= 1144690

B) Journal Entry

i) Impairment Loss Account Dr. 1265757

To Franchise Account 82777

To Patent Account 38290

To Trade Name Account 1144690

(Being amount of Impairment Loss is recorded)

ii) Profit & Loss Account Dr. 1265757

To Impairment Loss Account 1265757

(Being amount trf to profit and loss account)

C) Journal Entry

Amortisation of Assets Account Dr. 278747.93

To Franchise Account ( 774223/5) 154844.60

To Patent Account ( 371710/3) 123903.33

( Being assets amortised after impairment down)

Note : For calculating value in use of Trade we assume that cash flow from trade is only for 5 yrs.