Question

ACCOUNTING INTERMEDIATE 2 On 1st January 2014 Alex company dealers of electronic products purchased a building for $8,000,000. Its estimated useful life at that date was 20 years and the company applies straight line depreciation method. On 31st December 2018, the government launched a plan to construct a flyover adjacent to the building and the related construction reduced the access to the building due to the inability to park and enter to the building. Due to this reason the value for the building decreased. The company estimated that they can sell the building for $4,700,000 but it has to incur a cost of $205,000. Alternatively, if it continues to use it the present value of the net cash flows that the building would generate is $5,200,000. In 2019 the government constructed a service road parallel to the highway which improved the recoverable amount to $6,000,000. The depreciation for the year 2019 is $440,000 Calculate the carrying amount, recoverable amount and the necessary journal entries for the above scenario. You are required to:

A.Calculate accumulated depreciation & carrying value as at 31st Dec 2018, applying IAS 36.

B. Calculated recoverable amount & Impairment loss as at 31st Dec 2018 applying IAS 36.

C. Record relevant journal entries as at 31st Dec 2018 applying IAS 36 and amount to be recognized in statement of financial position.

D. Calculated carrying amount and amount of appreciation in building as at 31st Dec 2019 applying IAS 36.

E. Record relevant journal entry for regain in the value of impaired asset as at 31st Dec 2019 applying IAS 36.

F. A customer has made a claim against Alex Company for injury suffered following the purchases and use of a defective electronic product. Legal advisers have confirmed that Alex Company will probably have to pay financial compensation of $50,000 to the customers. In turn, Alex Company has made a counter claim against the suppliers of the defective products for $50,000 and believes it is probable that its claim against the supplier will be successful. Justify with reasons what adjustments, if any, should be made by Alex Company in the financial statements.

Answer 1

Background :

1.IAS 36 (Impairment of Assets) ensures that Assets are not carried more than its recoverable amount where the recoverable amount is higher of Value in Use and Net Selling Price(NSP)  

2. Value in Use is the PV of future outflows from the Asset

3. Net Selling Price is Selling Price of the asset after deducting the selling cost(SP- Selling Cost)

4.The entity will test for impairment when it has encountered any external and internal indicator which indicates that Asset has fallen from its carrying amount.

5. Impairment loss can be reversed but only to the extent of its carrying value as if there was no impairment OR  we can say this in simple terms "that the increased carring amount due to reversal should not be more than what the depreciated historical cost would have been if there was no impairment"

Solution:

Given Data : Asset Purchased on 1st January, 2014 | Cost of Asset- $8000000 | Useful Life- 20 years |

Part A: Carrying Amount and Accumulated Depreciation on 31-Dec-2018
Cost of Asset	$       8,000,000
Less: Accumulated Depreciation till 31-Dec-2018 (8000000/20)*5	$      2,000,000
Carrying Value on 31-Dec-2018 (c)	$      6,000,000

Part B: Calculation of Recoverable Amount & Impairment Loss(2018)
Value in Use(Given)	$       5,200,000
Net Selling Price($4700000-$205000)	$      4,495,000
Recoverable Amount(r) (Higher of Value in Use & NSP)	$      5,200,000
Impairment Loss ( c)-(r )	$          800,000

Part C : Journal Entries 31 Dec 2018
1	Depreciation(expense)	400000
	To Asset		400000
	(Being, Depreciation charged for the asset)
2	Impairment Loss(expense)	800000
	To Asset		800000
	(Being, Asset Impaired)

Part D :Calculation of Recoverable Amount & Impairment Loss(2019)
Carrying Value of Asset as on 1-Jan-2019	5200000
Less: Depreciation(Given)	440000
Carrying Value of Asset as on 31-Dec-2019	4760000
Calculation of Impairment reversal
Carrying Amount of Asset as on 01-Jan-2014	8000000
Less: Accumulated Depreciation till 31-Dec-2019 (8000000/20)*6	2400000
Carrying Amount of Asset as on 31-12-2019 (as if there was no Impairment previously)	5600000
Impairment Reversal allowed (5600000-4760000)	840000
Impairment Expensed previously	800000
Maximum Impairment Reveral (Lower of above)	800000

Revised Carrying Value of Asset as on 31-Dec-2019(476000+800000)

5560000

Part E : Journal Entries 31 Dec 2019
1	Depreciation(expense)	440000
	To Asset		440000
	(Being, Depreciation charged for the asset)
2	Asset	800000
	To Impairment Reversal		800000
	(Being, Impairment reversed)

PART F: IAS 37: Provision, Contingent Assets & Contingent Liability

Background :

1. IAS 37 requires that entities should not recognise contingent liabilities but should disclose them, unless the possibility of an outflow of economic resources is remote.

2. Contingent assets should not be recognised but should be disclosed if inflow of economic benefits is probable. When the realisation of income is virtually certain, then the related asset is not a contingent asset and its recognition is appropriate.

In the given case, Alex should disclose in the financial statements regarding the financial compensation of $50000 to the customer as contingent Liability.

Also, Alex should disclose $50000 claim against the supplier as a contingent asset as it probable that it will be successful

Please note:

1. In Part D, Depreciation of 2019 is already given in the Question and the same is mentioned in the solution

2. In Part D, The asset was valued to Rs. 6000000 by the management which has no relevance as the asset can be maximum regained upto the carrying value as if there was no impairment previously. Also Maximum Impairment cannot exceed previous impairment.

Thanks!