Bio Ltd purchased a piece of equipment in January 2016 for $5,000,000 which had an estimated...

Bio Ltd purchased a piece of equipment in January 2016 for $5,000,000 which had an estimated useful life of 8 years with no residual value. By 31 December 2018, new technology was introduced that would accelerate the obsolescence of this equipment. Bio Ltd estimated that the present value of the expected future net cash flows on this equipment would be $2,600,000 and that the fair value less cost to sell the equipment would be $2,800,000. Bio Ltd intends to continue using the equipment but it is estimated that the remaining useful life is 3 years. Bio Ltd uses straight-line depreciation for this machine.

1) Prepare the accounting journal entries to record the impairment of this machine at 31 December 2018. Show your workings.

2) Suppose that on 31 December 2019, Bio Ltd wants to dispose of this equipment and that it has not yet been disposed of. Prepare the related accounting journal entries. Show your workings.

Expert Solution

1) Impairment of a fixed asset is an abrupt decrease of its fair value due to damage, obsolescence etc. When impairment of a fixed asset occurs, the business has to decrease its value in the balance sheet and recognize a loss in the income statement.

The basic rule to recognize impairment is if the carrying amount exceeds the recoverable amount.

First, we need to determine the carrying amount. The machine has a cost of $5,000,000, useful life of 8 years and is used for 3 years till 31 December 2018. This means that accumulated depreciation is $5,000,000 / 8 * 3 i.e. $1,875,000. Therefore,

Carrying amount = 5,000,000 - 1,875,000 = $3,125,000

Second, we need to determine the recoverable amount. Recoverable amount is the higher of fair value less costs to sell and value in use. Fair value less costs to sell here is $2,800,000. Value in use is the present value of future cash flows which is $2,600,000. Recoverable amount is the higher of $2,800,000 and $2,600,000 which is $2,800,000.

Carrying amount is $3,125,000 while recoverable amount is $2,800,000. Thus an impairment loss of $325,000 (3,125,000 - 2,800,000) is to be recognised. Journal entries on 31st December will be as follows:

2) Journal entries on 31 December 2019 when Bio Ltd wants to dispose of this equipment will be as follows:

ekkarill92 answered 2 years ago

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