Question

            When reviewing the financial statements for Bent Corp you were surprised by the significant losses they incurred in the previous year. Although not your best investment, they always provided adequate returns. Further investigation identified the two main reasons for the loss. The first was settlement of a significant lawsuit brought against them for patent infringement. As part of the settlement, Bent can continue using the patented process without further cost. The second significant cost was that equipment used in an unrelated business segment was determined to be impaired. The reason given for the impairment was that technological change in the equipment they used in that business segment could be replaced with equipment which cost significantly less than what they paid for the equipment now in use. They claimed continuing to depreciate the equipment based on its original cost distorts their profitability. Evaluate how these two events would affect your calculation of permanent income.

Answer 1

Basically Expenditures can be classified as Recurring and Non Recurring Expenditure ..When Considering Permanent Income which otherwise can be called as Future Maintainable Profits or Cashflows,only those expenses that are recurring will affect the permanent income..

Non Recurring expenses are rare.They may affect the profits but it is temporary.(only for certain period or year).It does not affect Future Profits.

The two reasons claimed in the question for losses are Non Recurring in nature

1) Losing a Case will result in heavy losses but that is Written off in the year it occurs..It doesnot affect the proftability of Future years.It is also stated that even after losing the Company Bent can further continue to use patented process without further costs.So the losses incurred due to losing the case are only for that year,It does not affect the permanent income or earning capability of Bent Corp

2) Impairment loss:Impairment Losses are to be recognised immediately as and when it occurs or found out that asset has been impaired.It should not be deferred.

When assets beome obsolete (impaired)there is no point in calculating depreciation based on original Cost.

True and Fair Financial position cannot be ascertained if impairment losses are not recognised.

Impairment losses will not affect the permanent income..It is a kind of Non recurring expenses.

Technological advancement may lead to assets getting obsolete and using it further may consume much more time and resources which is actually the real hinderance to earn more profits in the long run..It is the thing that affects permanent income and not accounting of impairment losses..Impairment losses are one time expenses unlike recurring.

So these two events will not be considered in calculating permanent income as they are non recurring and kind of sunk costs which has no relevance to future profitability of the Company