Question

In: Accounting

After graduating from QCCUNY, you recently joined as a staff accountant in the controller’s office at...

After graduating from QCCUNY, you recently joined as a staff accountant in the controller’s office at Klax Company that provides warehousing services for companies in several Midwestern cities. The location, Dubuque, Iowa, has not been performing well due to increased competition and loss of several customers that have recently gone out of business. Your controller suspect that the plant and equipment may be impaired and wonder those assets should be written down. Given the company’s prior success, this issue has never arisen in the past, you have been asked to conduct some research on this issue with respect to the following by May 18, 2020. You believe this is a great opportunity for you to impress her with the knowledge of asset impairment that you acquired in your intermediate accounting course, and make your alma-mater and the professor proud of you by doing a great job and providing codification references for your responses.
1. What is the definition of impairment and what is the authoritative guidance for asset impairment? Briefly describe the scope of the standards (i.e., explain what types of transactions to which the standards applies).
2. Give several examples of events that would cause an asset to be tested for impairment.
3. Does it appear that Klax should perform impairment test? Explain.
4. What is the recoverable amount and what is the best evidence of fair value? Describe the alternative methods of estimating fair value.

Solutions

Expert Solution

Answer : Impairment: In accounting, impairment describes a permanent reduction in the value of a company's asset, typically a fixed asset or an intangible asset. When testing an asset for impairment, the total profit, cash flow, or other benefit expected to be generated by that specific asset is periodically compared with its current book value. If it is determined that the book value of the asset exceeds the future cash flow or benefit of the asset, the difference between the two is written off and the value of the asset declines on the company's balance sheet

Business assets should be tested for impairment when a situation occurs that causes the asset to lose value. An impairment loss is recognized and accrued to record the asset’s revaluation. Once an asset has been revalued, fluctuations in market value are calculated periodically. Certain intangible assets, such as goodwill, are tested for impairment on an annual basis. Impairment losses can occur for a variety of reasons:

  • when an asset is badly damaged (negative change in physical condition)
  • the asset’s market price has been significantly reduced
  • legal issues have had a negative impact on the asset
  • the asset is set for disposal before the end of its useful life A loss on impairment is recognized as a debit to Loss on Impairment (the difference between the new fair market value and current book value of the asset) and a credit to the asset. The loss will reduce income in the income statement and reduce total assets on the balance sheet.

A loss on impairment is recognized as a debit to Loss on Impairment (the difference between the new fair market value and current book value of the asset) and a credit to the asset.The loss will reduce income in the income statement and reduce total assets on the balance sheet.

Answer 3. Yes. Klax should perform impairment test given the scenario.

Under generally accepted accounting principles (GAAP), assets are considered tobe impaired when the fair value falls below the book value. Any write-off due to an impairment loss can have adverse affects on a company's balance sheet and its resulting financial ratios. It is, therefore, very important for a company to test its assets for impairment periodically. Certain assets, such as the intangible goodwill, must be tested for impairment on an annual basis in order to ensure the value of assets are not inflated on the balance sheet.

GAAP also recommends that companies take into consideration events and economic circumstances that occur between annual impairment tests in order to determine if it is "more likely than not" that the fair value of an asset has dropped below its carrying value. Specific situations where an asset might become impaired and unrecoverable include when there is a significant change to an asset's intended use, decrease in consumer demand, damage to the asset, or adverse changes to legal factors that affect the asset. If these types of situations arise mid-year, it's important to test for impairment immediately.\

Answer 4. Recoverable Amount

In simple terms, the recoverable amount is the highest value that can be obtained from an asset. We can think of two general ways we can obtain value from an asset: (a) from using that asset in the business or (b) by selling it to someone else. The value of (a) is the present value of expected future cash flows from using the asset. The value of (b) is the fair value of the asset less costs to sell the asset. The higher amount from these two alternatives is the recoverable amount.

The recoverable amount is used in the test for impairment. The reason that the recoverable amount is the higher figure from the two alternative estimates is that we presume that the company’s management will choose the best (value-maximizing) option.

Fair value is an asset's purchase or sale price in a current transaction between willing parties. The best evidence of fair value is prices quoted in active markets, such as the price for a stock listed on a stock market.

Alternative Methods of Estimating Fair Value

  • Market approach. Uses the prices associated with actual market transactions for similar or identical assets and liabilities to derive a fair value. For example, the prices of securities held can be obtained from a national exchange on which these securities are routinely bought and sold.

  • Income approach. Uses estimated future cash flows or earnings, adjusted by a discount rate that represents the time value of money and the risk of cash flows not being achieved, to derive a discounted present value. An alternative way to incorporate risk into this approach is to develop a probability-weighted-average set of possible future cash flows.

  • Cost approach. Uses the estimated cost to replace an asset, adjusted for the obsolescence of the existing asset.


Related Solutions

Matt Holmes recently joined Klax Company as a staff accountant in the controller’s office. Klax Company...
Matt Holmes recently joined Klax Company as a staff accountant in the controller’s office. Klax Company provides warehousing services for companies in several European cities. The location in Koblenz, Germany, has not been performing well due to increased competition and the loss of several customers that have recently gone out of business. Matt’s department manager suspects that the plant and equipment may be impaired and wonders whether those assets should be written down. Given the company’s prior success, this issue...
Matt Jones recently joined Kind Company as a staff accountant in the controller's office. Kind Company...
Matt Jones recently joined Kind Company as a staff accountant in the controller's office. Kind Company provides warehousing services for companies in several East Coast cities. The location in Philadelphia, PA, has not been performing well due to increased competition and the loss of several customers that have recently gone out of business. Matt's department manager suspects that the plant and equipment may be impaired and wonders whether those assets should be written down. Given the company's prior success, this...
Struggling with the bolded questions Matt Holmes recently joined Klax Company as a staff accountant in...
Struggling with the bolded questions Matt Holmes recently joined Klax Company as a staff accountant in the controller's office. Klax Company provides warehousing services for companies in several midwestern cities. The location in Dubuque, Iowa, has not been performing well due to increased competition and the loss of several customers that have recently gone out of business. Matt's department manager suspects that the plant and equipment may be impaired and wonders whether those assets should be written down. Given the...
You have just joined a company as a new staff accountant. Your company is in an...
You have just joined a company as a new staff accountant. Your company is in an acquisition mode (acquiring 5 to 10 smaller companies each of the last 4 years). You are excited to hear that you are going with an acquisition team to facilitate another acquisition (Company X). You have been instructed to sit down with Company X’s controller and explain some pre-acquisition (before the acquisition is finalized) accounting expectations. Expectations for Company X before the acquisition is finalized....
Question text You just joined a firm after graduating from PSU. The firm management has a...
Question text You just joined a firm after graduating from PSU. The firm management has a strong favor for the IRR rule, except in specific cases or for specific reasons. You have been assigned to evaluate the following project (cash flows are shown below) at the required rate of return of 17.35 percent. What would be your recommendation? Show and explain.   Year 0 1 2 3 4 CF ($) -374,358 133,499 -34,449 244,710 270,123
You were recently hired to work in the controller’s office of the Balboa Lumber Company. Your...
You were recently hired to work in the controller’s office of the Balboa Lumber Company. Your boss, Alfred Eagleton, took you to lunch during your first week and asked a favor. “Things have been a little slow lately, and we need to borrow a little cash to tide us over. Our inventory has been building up and the CFO wants to pledge the inventory as collateral for a short-term loan. But I have a better idea.” Mr. Eagleton went on...
You recently joined the staff of Bombay Corporation, a multi-national retail business. You have been asked to review the income statement and balance sheet prepared by the previous staff accountant.
You recently joined the staff of Bombay Corporation, a multi-national retail business. You have been asked to review the income statement and balance sheet prepared by the previous staff accountant. The statements and additional information are found on pages 2-3. Required:1. Discuss the purpose of a classified balance sheet.2. Discuss the purpose of a multi-step income statement.
The Scenario: After recently graduating from KSU, you begin a career as an product investment analyst...
The Scenario: After recently graduating from KSU, you begin a career as an product investment analyst with Hormel Foods. As the newest Skippy P.B. analyst, your first assignment is to evaluate the following enterprise. The Skippy P.B. Fruit Bites machine will initially cost $200,000. Hormel expects to use the machine for 10 years. After 10 years, the machine will be worth $20,000 in today’s prices. The machine will be depreciated using straight‐line depreciation over 8 years and the salvage value...
You have been hired as a staff accountant by a small company that recently completed an...
You have been hired as a staff accountant by a small company that recently completed an initial public offering (IPO) of its common stock. At its inception, the company had been financed by Pegasus, an investment group. Pegasus had bought a significant amount of the company’s debt (equal to a third of its total assets) in the form of convertible bonds. The stock price has appreciated significant since the IPO, and Pegasus has decided to convert its debt securities into...
You are recently hired as a staff accountant for a small finished goods manufacturing company. Part...
You are recently hired as a staff accountant for a small finished goods manufacturing company. Part of your duties include doing the month end inventory of finished goods. After a few months you do not look forward to this as the amount of inventory seems to be increasing. In order to satisfy your thoughts on this increase of inventory you decide to review the financial information for the last few months. Looking over the Income Statement you see the profits...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT