On January 1, 2014, Borstad Company purchased equipment for $1,150,000. It is depreciating the equipment over...
On January 1, 2014, Borstad Company purchased equipment for $1,150,000. It is depreciating the equipment over 25 years using the straight-line method and a zero residual value. Late in 2019, because of technological changes in the industry and reduced selling prices for its products, Borstad believes that its equipment may be impaired and will have a remaining useful life of 8 years. Borstad estimates that the equipment will produce cash inflows of $450,000 and will incur cash outflows of $341,000 each year for the next 8 years. It is not able to determine the fair value of the equipment based on a current selling price. Borstad’s discount rate is 10%. Required: 1. Prepare schedules to determine whether, at the end of 2019, the equipment is impaired and, if so, the impairment loss to be recognized. 2. Prepare the journal entry to record the impairment. 3. Next Level How would your answer to Requirement 1 change if the discount rate was 14% and the cash flows were expected to continue for 6 years? 4. Next Level How would your answer change if management planned to implement efficiencies that would save $14,000 each year? 5. Refer to Requirement 1 and assume that the company uses IFRS. It determines that the fair value of the equipment is $630,000 and estimates that it would cost $15,000 to sell the equipment. How much would the company recognize as the impairment loss?
Homework Answers
1. Schedules to determine whether the equipment is impaired and amount of impairment
Calculations for recoverability test
| Cost of equipment | 1150000 |
| Less: Accumulated depreciation for 5 years | |
| ( 1150000 / 25 ) * 5 | 230000 |
| Net value | 920000 |
| Cash Inflows ( 450000 * 8 ) | 3600000 |
| Cash Outflows ( 341000 * 8 ) | 2728000 |
| Net cash flow | 872000 |
Calculation of impairment loss
Impairment loss = PV of net cash flows - Net Book value of equipment
| Net cash flow | 872000 |
| PVIF (10%, 8 years) | 0.467 |
| PV of net cash flow | 406794 |
| Net value | 920000 |
| Impairment loss | -513206 |
2. Journal entry
| Account | Debit | Credit |
| Impairment loss | 513206 | |
| Accumulated depreciation | 230000 | |
| Equipment | 743206 |
3. Next level discount rate was 14% and the cash flows were expected to continue for 6 years
Calculations for recoverability test
| Cost of equipment | 1150000 |
| Less: Accumulated depreciation for 5 years | |
| ( 1150000 / 25 ) * 5 | 230000 |
| Net value | 920000 |
| Cash Inflows ( 450000 * 6 ) | 2700000 |
| Cash Outflows ( 341000 * 6 ) | 2046000 |
| Net cashflow | 654000 |
Calculation of impairment loss
| Net cash flow | 654000 |
| PVIF (14%, 6 years) | 0.456 |
| PV of net cash flow | 297954 |
| Net value | 920000 |
| Impairment loss | -622046 |
4. Next Level management planned to implement efficiencies that would save $14,000 each year
Not: Since it is not mentioned in question whether savings will be applicable for requirements of question 1 question 3, I have assumed it for question 3 that is 6 years
Calculations for recoverability test
| Cost of equipment | 1150000 |
| Less: Accumulated depreciation for 5 years | |
| ( 1150000 / 25 ) * 5 | 230000 |
| Net value | 920000 |
| Cash Inflows ( 450000 * 6 ) | 2700000 |
| Cash Outflows ( 341000 * 6 ) | 2046000 |
| Savings ( 14000 * 6 ) | 84000 |
| Net cash flow (Inflows - Outflows + Savings) | 738000 |
Calculation of impairment loss
| Net cash flow | 738000 |
| PVIF (14%, 6 years) | 0.456 |
| PV of net cash flow | 336223 |
| Net value | 920000 |
| Impairment loss | -583777 |
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