Question

II. Accounting, Analysis, and Principles

Electroboy Enterprises, Inc. operates several stores throughout northern Belgium and the southern part of the Netherlands. As part of an operational and financial reporting review in a response to a downturn in it markets, the company’s management has decided to perform an impairment test on five stores (combined). The five stores’ sales have declined due to aging facilities and competition from a rival that opened new stores in the same markets. Management has developed the following information concerning the five stores as of the end of fiscal 2015.

Original cost                                                                                                                     €36 million

Accumulated depreciation                                                                                        €10 million                                                                   Estimated remaining useful life                                                                             4 years

Estimated expected future annual cash flows (not discounted)                 €4.0 million per year

Appropriate discount rate                                                                                         5%

Fair value less cost of disposal                                                                                   €23 million                               

Accounting

(a) Determine the amount of impairment loss, if any, that Electroboy should report for fiscal 2015 and the carrying amount at which Electroboy should report the five stores on its fiscal year-end 2015 statement of financial position. Assume that the cash flows occur at the end of each year.

(b) Repeat part (a), but instead assume that (1) the estimated remaining useful life is 10 years, (2) the estimated annual cash flows are €2,720,000 per year, and (3) the appropriate discount rate is 6%.

Analysis

Assume that you are a financial analyst and you participate in a conference call with Electroboy management in early 2016 (before Electroboy closes the books on fiscal 2015). During the conference call, you learn that management is considering selling the five stores, but the sale will not likely be completed until the second quarter of fiscal 2016. Briefly discuss what implications this would have for Electroboy’s 2015 financial statements. Assume the same facts as in part (b) above.

Principles

Electroboy management would like to know the accounting for the impaired asset in periods subsequent to the impairment.

(a) Suppose conditions improve in its markets. Can the assets be written back up? Briefly discuss the conceptual arguments for this accounting.

(b) Briefly describe how accounting for impairment differs from accounting for revaluation.

(c) Define cash generating units and briefly discuss conceptual arguments for accounting of impaired             intangible assets.

Answer 1

Solution a) Book Value of the stores = Original Cost - Accumulated Depreciation

= €36 million - €10 million = €26 million

Sum of expected future values of stores (not discounted) = €4.0 million per year

Estimated useful life = 4 years

Total Sum of expected future values of stores (not discounted) = €4.0 million * 4 = €16.0 million

As the book value is greater than the sum of the expected future values of stores, thus, the company has to report an impairment loss.

Fair value of the stores = PV of future cash flows discounted at the rate of 5%

It is calculated using the NPV formula in excel

= NPV(rate, cash flows from t = 1)

Thus, Fair value of the stores = 14.18 million

Impairment Loss = Book Value - Fair Value = 26 million - 14.18 million = 11.82 million

Solution b) Book Value of the stores = Original Cost - Accumulated Depreciation

= €36 million - €10 million = €26 million

Sum of expected future values of stores (not discounted) = €2.72 million per year

Estimated useful life = 10 years

Total Sum of expected future values of stores (not discounted) = €2.72 million * 10 = €27.2 million

As the book value is less than the sum of the expected future values of stores, thus, the company does not has to report an impairment loss.

Solution c) If the management is considering to sell the five stores in the near terms, then these stores would be treated as an inventory and would not depreciate further. It will be reported at the lower of the book value of assets and fair value less disposal costs.

Fair value less cost of disposal = 23 million

Book Value = 26 million

Hence, the assets will be reported at 23 million.

Solution d) In case the assets are recognized as the inventory held for sale, then the assets will be written back to the fair market value.

If the asset is not recognized as the inventory held for sale, then, the asset would be written back to the fair market value.