Question

On January 1, 2014, Borstad Company purchased equipment for $1,150,000. It is depreciating the equipment over 25 years using the straight-line method and a zero residual value. Late in 2019, because of technological changes in the industry and reduced selling prices for its products, Borstad believes that its equipment may be impaired and will have a remaining useful life of 8 years. Borstad estimates that the equipment will produce cash inflows of $450,000 and will incur cash outflows of $341,000 each year for the next 8 years. It is not able to determine the fair value of the equipment based on a current selling price. Borstad’s discount rate is 10%.

	Required:
1.	Prepare schedules to determine whether, at the end of 2019, the equipment is impaired and, if so, the impairment loss to be recognized.
2.	Prepare the journal entry to record the impairment.
3.	Next Level How would your answer to Requirement 1 change if the discount rate was 14% and the cash flows were expected to continue for 6 years?
4.	Next Level How would your answer change if management planned to implement efficiencies that would save $14,000 each year?
5.	Refer to Requirement 1 and assume that the company uses IFRS. It determines that the fair value of the equipment is $630,000 and estimates that it would cost $15,000 to sell the equipment. How much would the company recognize as the impairment loss?

Answer 1

ANSWER

1. Schedules to determine whether the equipment is impaired and amount of impairment

Calculations for recoverability test

Cost of equipment	1150000
Less: Accumulated depreciation for 5 years
( 1150000 / 25 ) * 5	230000
Net value	920000

Cash Inflows ( 450000 * 8 )	3600000
Cash Outflows ( 341000 * 8 )	2728000
Net cash flow	872000

Calculation of impairment loss

Impairment loss = PV of net cash flows - Net Book value of equipment

Net cash flow	872000
PVIF (10%, 8 years)	0.467
PV of net cash flow	406794
Net value	920000
Impairment loss	-513206

2.

Journal entry

Account	Debit	Credit
Impairment loss	513206
Accumulated depreciation	230000
Equipment		743206

3.

Next level discount rate was 14% and the cash flows were expected to continue for 6 years

Calculations for recoverability test

Cost of equipment	1150000
Less: Accumulated depreciation for 5 years
( 1150000 / 25 ) * 5	230000
Net value	920000

Cash Inflows ( 450000 * 6 )	2700000
Cash Outflows ( 341000 * 6 )	2046000
Net cashflow	654000

Calculation of impairment loss

Net cash flow	654000
PVIF (14%, 6 years)	0.456
PV of net cash flow	297954
Net value	920000
Impairment loss	-622046

4.

Next Level management planned to implement efficiencies that would save $14,000 each year

Not: Since it is not mentioned in question whether savings will be applicable for requirements of question 1 question 3, I have assumed it for question 3 that is 6 years

Calculations for recoverability test

Cost of equipment	1150000
Less: Accumulated depreciation for 5 years
( 1150000 / 25 ) * 5	230000
Net value	920000

Cash Inflows ( 450000 * 6 )	2700000
Cash Outflows ( 341000 * 6 )	2046000
Savings ( 14000 * 6 )	84000
Net cash flow (Inflows - Outflows + Savings)	738000

Calculation of impairment loss

Net cash flow	738000
PVIF (14%, 6 years)	0.456
PV of net cash flow	336223
Net value	920000
Impairment loss	-583777

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