Question

Stenberg plc is preparing its financial statements for the year ended 30 November 2020.
On 1 May 2020, the company purchased a factory for the manufacture of optical disks,
paying £24,000,000. The factory will be depreciated over its estimated life of 10 years
using the straight line method on a full year basis with no residual value.
The asking price for the factory had been £30,000,000. However, Stenberg plc estimated
the net present value of the factory’s future expected net cash flows at £28,500,000 and
the price eventually agreed with the vendor was £24,000,000.
During October 2020 a rival company announced that it had patented a new technology
which has been enthusiastically greeted by the major players in the industry. Stenberg
plc now feels that it may be necessary to revise downwards its expectations for the
factory. It now believes that the net present value of the expected net cash flows from the
factory as at 30 November 2020 was £20,500,000. The net realisable value of the factory
was estimated at £14,000,000 as at 30 November 2020.
Required:
Discuss whether or not there is evidence of impairment and describe how the factory
should be treated in the financial statements for the year ended 30 November 2020.

Answer 1

Answer:

• Depreciation for the year to 30 November 2020 is £2,400,000, so the asset's carrying amount at that date is £21,600,000 (£24,000,000 – £2,400,000).

• Value in use is £20,500,000. Fair value less costs of disposal is £14,000,000. Recoverable amount is the higher of these two figures i.e. £20,500,000.

• There is an impairment loss of £1,100,000 (£21,600,000 – £20,500,000). This should be recognised as an expense when calculating the company's profit or loss for the year to 30 November 2020.

• The asset's carrying amount at 30 November 2020 is reduced to £20,500,000. Assuming that the previous estimates of useful life and residual value remain unchanged, this amount should be written off in the form of depreciation charges over the following nine years. However, the asset is clearly being used in an area of manufacturing which is subject to rapid technological change and the company should be alert to the possibility of further impairment losses in the future.