In: Accounting
Computing Impairment of Patent
In January 2017, Idea Company purchased a patent for a new consumer product for $187,000. At the time of purchase, the remaining legal life of the patent was 17 years. However, because of the competitive nature of the market, the patent was estimated to have a useful life of 10 years. During 2021, it was determined that there was a potential health hazard present in the product. As a result, the estimated future cash flows from the patent on December 31, 2021, are estimated to be $88,000 while the fair value of the patent is estimated to be $76,230. Total estimated useful life remains unchanged.
Required
a. Determine annual amortization expense for 2017–2021.
b. Determine the carrying value of the patent on December 31, 2021, before assessing for impairment.
c. What amount should Idea record as an impairment loss (if any) in 2021? What is the adjusted carrying value of the patent on December 31, 2021?
d. Assume that the potential health hazard was resolved in 2022. As a result, the future cash flows from the patent on December 31, 2022, are estimated to be $71,500 while the fair value of the patent is estimated to be $59,400. What amount should Idea record as a loss (or recovery) on impairment (if any) in 2022? What is the adjusted carrying value of the patent on December 31, 2022?
a. | Annual amortization expense | Answer |
b. | Carrying value of patent, Dec. 31, 2021, before impairment testing | Answer |
c. | Impairment loss recognized in 2021 | Answer |
Adjusted carrying value of patent, Dec. 31, 2021 | Answer | |
d. | Impairment loss recognized in 2022 | Answer |
Adjusted carrying value of patent, Dec. 31, 2022 | Answer |
a)Annual amortisation expense for 2017-2021:
Purchase price(Cost) of Patent = $187,000
Estimated Useful Life = 10 years (Ignore legal life of 17 years as useful life is given i.e, 10 years)
Annual amortisation expense = Cost of Patent / Estimated useful life = $187,000 / 10 = $18,700
Therefore, Annual amortisation expense for 2017-2021 = $18,700 per year.
b)Carrying Value of patent before impairment testing as on Dec.31,2021:
= Cost of patent - Accumulated amortisation till Dec.31,2021( i.e, for 5 years)
= $187,000 - $18,700*5 = $93,500
c)Impairment Loss recognised in 2021:
Recoverable Amount = Higher of "Net Selling Price" or "Value in Use"
Impairment Loss = Carrying Value - Recoverable amount
Net Selling Price = Selling Price - Cost of Disposal
( Here, in this question, we are given with the fair value which can be considered as selling price. Cost of disposal is not given and we are assuming it as nil. )
Therefore, Net Selling Price = $76,230 - $0 = $76,230
Value in Use = Present value of estimated future cash flows = $88,000
Recoverable Amount = $88,000 or $76,230 , whichever is higher i.e, $88,000
Impairment Loss to be recognised in 2021 = Carrying Value - Recoverable amount
= $93,500 - $88,000 = $5,500
Adjusted Carrying Value of Patent on Dec.31,2021 = $93,500 - $5,500 = $88,000
d)Impairment loss recognised in 2022:
Carrying Value as on Dec.31,2022 = Carrying Value as on Dec.31,2021 - Amortisation
= $88,000 - ($88,000 / 5) = $70,400
Recoverable Amount = Higher of "Net Selling Price" or "Value in Use"
Impairment Loss = Carrying Value - Recoverable amount
Net Selling Price = Selling Price - Cost of Disposal
( Here, in this question, we are given with the fair value which can be considered as selling price. Cost of disposal is not given and we are assuming it as nil. )
Therefore, Net Selling Price = $59,400 - $0 = $59,400
Value in Use = Present value of estimated future cash flows = $71,500
Recoverable Amount = Higher of $59,400 and $71,500 i.e, $71,500
Here, Carrying Amount($70,400) is less than Recoverable Amount($71,500).
Therefore, there is no impairment loss.
Impairment loss to be reversed/ recovered= Recoverable amount - carrying amount = $71,500 - $70,400 = $1,100
Adjusted carrying value of Patent as on Dec.31,2022 = $70,400 + $1,100 = $71,500.