Question

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 company's prior success, this issue has never arisen in the past, and Matt has been asked to conduct some research on this issue.

Instructions

If your school has a subscription to the FASB Codification, log in and prepare responses to the following. Provide Codification references for your responses.

a.  

What is the authoritative guidance for asset impairments? Briefly discuss the scope of the standard (i.e., explain the types of transactions to which the standard applies).

360-10-05-4 shows that the authoritative guidance for asset impairments provides guidance for :

-recognition and measurement of the impairment of long-lived assets to be held and used.

-measurements of the long lived-asset to be disposed of by sale

-disclosures about the impairment or disposal of long lived assets and disposals of individually significant components of an entity

b.  

Give several examples of events that would cause an asset to be tested for impairment. Does it appear that Klax should perform an impairment test? Explain.

We can find the reasons that an asset would be tested for impairment in 360-10-35-21. They can be tested if:

-there is a large decrease in the market price of the long-lived asset

- if there is a big adverse change in the extent or manner in which a long-lived asset is being used or in its physical condition.

- A large adverse change in legal factors or in the business climate that could affect the value of a long-lived asset , including an adverse action or assessment by a regulator

- An accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of a long-lived asset

- current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of a long-lived asset

- A current expectation that, more likely than not, a long-lived asset will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. The term more likely than not refers to a level of likelihood that is more than 50 percent.

c.  

What is the best evidence of fair value? Describe alternate methods of estimating fair value.

The best evidence of fair value can be found in 360-10-35-36. This states that long-lived assets that are similar in uncertainties dealing with timing amount, an expected present value technique is typically the appropriate technique to estimate fair value.

Answer 1

Answer :

(a) According to FASB ASC 360-10-05 (Property, Plant, and Equipment)

05-2 The guidance in the Overall Subtopic is presented in the following two Subsections:

a. The General Subsections address the accounting and reporting for property, plant, and equipment, including guidance for accumulated depreciation.

b. The Impairment or Disposal of Long-Lived Assets Subsections retain the pervasive guidance for recognizing and measuring the impairment of long-lived assets and for long-lived assets to be disposed of.

05-4 The Impairment of Disposal of Long-Lived Assets Subsections provide guidance for:

a. Recognition and measurement of the impairment of long-lived assets to be held and used

b. Measurement of long-lived assets to be disposed of by sale.

(b) When to Test a Long-Lived Asset for Recoverability is addressed in FASB ASC 360-10-35-21:

35-21 A long-lived asset (asset group) shall be tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. The following are examples of such events or changes in circumstances:

a. A significant decrease in the market price of a long-lived asset (asset group) [FAS 144, paragraph 8, sequence 115]

b. A significant adverse change in the extent or manner in which a long-lived asset (asset group) is being used or in its physical condition

c. A significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset (asset group), including an adverse action or assessment by a regulator

d. An accumulation of costs significantly in excess of the amount originally expected for the acquisition or construc ­tion of a long-lived asset (asset group)

e. A current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of a long-lived asset (asset group)

f. A current expectation that, more likely than not, a long-lived asset (asset group) will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. The term more likely than not refers to a level of likelihood that is more than 50 percent.

(c) According to FASB ASC 360-10-35-36, For long-lived assets (asset groups) that have uncertainties both in timing and amount, an expected present value technique will often be the appropriate technique with which to estimate fair value. According to FASB ASC 820-10-35-37 through 43 (Fair Value Hierarchy):

35-37 To Increase consistency and comparability in fair value measurements and related disclosures, the fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The fair value hierarchy gives the highest priority to quoted prices (unadjusted) in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). In some cases, the inputs used to measure fair value might fall in different levels of the fair value hierarchy. The level in the fair value hierarchy within which the fair value measurement in its entirety falls shall be determined based on the lowest level input that is significant to the fair value measurement in its entirety. Assessing the significance of a particular input to the fair value measurement in its entirety requires judgment, considering factors specific to the asset or liability.

35-38 The availability of inputs relevant to the asset or liability and the relative reliability of the inputs might affect the selection of appropriate valuation techniques. However, the fair value hierarchy prioritizes the inputs to valuation techniques, not the valuation techniques. For example, a fair value measurement using a present value technique might fall within Level 2 or Level 3, depending on the inputs that are significant to the measurement in its entirety and the level in the fair value hierarchy within which those inputs fall.

35-39 The remainder of this guidance is organized as follows:

a. Level 1 inputs

b. Level 2 inputs

c. Level 3 inputs

d. Inputs based on bid and ask prices.

e. Investments in certain entities that calculate net asset value per share (or its equivalent, for example, member units or an ownership interest in partners' capital to which a proportionate share of net assets is attributed).

35-40 Level 1 inputs are defined in this Subtopic as quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

35-41 A quoted price in an active market provides the most reliable evidence of fair value and shall be used to measure fair value whenever available, except as discussed in paragraphs 820-10-35-16D, 820-10-35-42, and 820-10-35-43.

35-41A A Level 1 fair value measurement for the liability is a quoted price in an active market for the identical liability at the measurement date. In addition, the quoted price for the identical liability when traded as an asset in an active market also is a Level 1 fair value measurement for that liability when no adjustments to the quoted price of the asset are required. However, a reporting entity needs to determine whether the quoted price for the identical liability when traded as an asset in an active market should be adjusted for factors specific to the liability and the asset (see paragraph 820-10-35-16D). Any adjustment to the quoted price of the asset shall render the fair value measurement of the liability a lower level measurement.

35-42 If the reporting entity holds a large number of similar assets or liabilities (for example, debt securities) that are required to be measured at fair value, a quoted price in an active market might be available but not readily accessible for each of those assets or liabilities individually. In that case, fair value may be measured using an alternative pricing method that does not rely exclusively on quoted prices (for example, matrix pricing) as a practical expedient. However, the use of an alternative pricing method renders the fair value measurement a lower-level measurement.

35-43 In some situations, a quoted price in an active market might not represent fair value at the measurement date. That might be the case if, for example, significant events (principal-to-principal transactions, brokered trades, or announcements) occur after the close of a market but before the measurement date. The reporting entity should establish and consistently apply a policy for identifying those events that might affect fair value measurements. However, if the quoted price is adjusted for new information, the adjustment renders the fair value measurement a lower-level measurement.

Alternative methods for estimating fair value are addressed at FASB ASC 820-10-35-28 through 36:

35-28 Valuation techniques consistent with the market approach, income approach, and/or cost approach shall be used to measure fair value. The definitions and key aspects of those approaches follow.

35-29 The market approach is defined in this Subtopic as a valuation technique that uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities (including a business).

35-30 For example, valuation techniques consistent with the market approach often use market multiples derived from a set of comparables. Multiples might lie in ranges with a different multiple for each comparable. The selection of where within the range the appropriate multiple falls requires judgment, considering factors specific to the measurement (qualitative and quantitative).

35-31 Valuation techniques consistent with the market approach include matrix pricing. Matrix pricing is a mathematical technique used principally to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities' relationship to other benchmark quoted securities.

35-32 The income approach is defined in this Subtopic as an approach that uses valuation techniques to convert future amounts (for example, cash flows or earnings) to a single present amount (discounted). The measurement is based on the value indicated by current market expectations about those future amounts.

35-33 Those valuation techniques include the following:

a. Present value techniques

b. Option-pricing models (which incorporate present value techniques), such as the Black-Scholes-Merton formula (a closed-form model) and a binomial (a lattice model)

c. The multiperiod excess earnings method, which is used to measure the fair value of certain intangible assets.

35-34 The cost approach is defined in this Subtopic as a valuation technique based on the amount that currently would be required to replace the service capacity of an asset (often referred to as current replacement cost).

35-35 From the perspective of a market participant (seller), the price that would be received for the asset is determined based on the cost to a market participant (buyer) to acquire or construct a substitute asset of comparable utility, adjusted for obsolescence.

35-36 Valuation techniques used to measure fair value shall maximize the use of observable inputs and minimize the use of unobservable inputs. Examples of markets in which inputs might be observable for some assets and liabilities (for example, financial instruments) include exchange markets, dealer markets, brokered markets, and principal-to-principal markets.

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