Question

Suppose a firm buys a machine with a 4 year useful life for $280,000. The machine has a salvage value of $20,000. Do each question separately.

V. Assume the firm uses straight-line depreciation. After two years of depreciation, the firm conducts an impairment test. It concludes the net cash flows from the machine for the remaining two years will be $60,000 per year. Is the machine impaired? Record the journal entry if it is impaired. Assume that the appropriate discount rate is 4%.

VI. Assume the firm uses the units of activity depreciation method where it allocates depreciation expense proportionate to the number of hours the machine is operated. It anticipates operating the machine for 3,000; 3,200; 3,300 and 3,500 hours in the next four years, respectively. Calculate the depreciation expense and net book value for each year.

VII. A steelmaker’s assets will largely consist of tangible assets like inventories and property, plant and equipment. List a firm for which the most valuable things that the firm owns are intangible assets that are not recorded on the balance sheet. Which of the two firms (the steelmaker or the firm you selected) is likely to have the larger market to book ratio? Explain why.

Answer 1

Solution:

V.

Assets are considered impaired when net carrying value (book value) exceeds expected future cash flows. This means a business spent money on an asset, but changing circumstances caused the purchase to be a net loss.

Yes, In the given problem the value of the machine after the period of 2 year is Impaired since the net carrying value of the machine exceeds present value future cash flows.

Working Note 1: Calculation of Net Carrying Value of the Machine

Net Carying Value at the end of 2nd year = Cost of the Machine - Depreciation for the period of 2 year

= $ 280,000 - ($ 65,000 * 2)

= $ 150,000

Working Note 2: Calculation of Present value of Future cash flows

Present Value of Future Cash flow @ Discouting Rate 4% = PV Factor (4,2) * Future cash flow

= ( 1.887 * $ 60,000)

= $ 113,220

VI.

Calculation of Depreciation and Net book value of each year;

(Amount in '$')

Particulars	Year 1	Year 2	Year 3	Year 4
No of Mahine Hours Operation	3000	3200	3300	3500
Book Value in the Begining of the year	280,000	220,000	156,000	90,000
Less: Depreciation (280000 - 20000) i..e $ 260000 in the ration of machine operated hour	60,000	64,000	66,000	70,000
Book Value at the end of the year	220,000	156,000	90,000	20,000

VII.

Intangible Assets are most valuable assets for Service Sector Industries, firm involve in service sector are having intangible assets more valuable than tangible assets. A Financial consultancy Firm (suppose M/s XYZ Ltd) is a good example of a firm having most valuable assets are Intangible like Goodwill, brand name etc.

Market to book ratio is higher in case of the firm having more Intangible Assets. In our example the Financial Consultancy firm i.e. M/s XYZ Ltd is having a larger Market to book ratio as compare to steelmaker this is because of the following reason; namely

Market to book ratio can be calculated using market value devided by the book value and the while calculating the book value only tangible assets are considered. Since in case of a company or firm having more tangible assets than intangible their book value is higher and accordingly while calulating market to book ratio, since the denominator is higher hence the ratio is lower.