Question

The management of Petro Garcia Inc. was discussing whether certain equipment should be written off as a charge to current operations because of obsolescence. This equipment has a cost of $900,000 with depreciation to date of $400,000 as of December 31, 2020. On December 31, 2020, management projected its future net cash flows from this equipment to be $300,000 and its fair value to be $230,000. The company intends to use this equipment in the future.

1. Where should the gain or loss (if any) on the write-down be reported in the income statement?

2. What accounting issues did management face in accounting for this impairment?

Answer 1

Solution

1) The gain or loss on the write down should be reported under the other operating income and expenses in the income statement.

2) In the given case, the carrying value of the equipment is

$ 900000 - $400000 (Cost less accumulated depreciation)

= $ 500000

Value in use (future benefits or net cashflow from the equipment)is $ 300000 & Fair Value is $ 230000. This means that the recoverable amount is less than the carrying value of the equipment. Therefore the equipment is impaired and the management has to account for the impairment loss. The following issues are confronted by the management while accounting for the impairment loss.

Impairment loss is determined by deducting the recoverable amount from the carrying value. Higher of the value in use and fair value less cost to sell would be taken as the recoverable amount.

Determining value in use requires appropriate estimation of the future cash flows from the equipment. The equipment has become obsolete. This means that there is no active market for the equipment and determining fair value less cost to sell would be difficult.

However in the given case $ 300000, the value in use as determined by the management would be considered as the recoverable amount as it is higher than the fair value. Therefore, an impairment loss of $200000 should be reported in the income statement.