On January 1, 2012, Vallahara Company purchased machinery for $650,000, which it
ID: 2585387 • Letter: O
Question
On January 1, 2012, Vallahara Company purchased machinery for $650,000, which it installed in a rented factory. It is depreciating the machinery over 12 years by the straight-line method to a residual value of $50,000. Late in 2016, because of increasing competition in the industry, the company believes that its asset may be impaired and will have a remaining useful life of 5 years, over which it estimates the asset will produce total cash inflows of $1,000,000 and will incur total cash outflows of $825,000. The cash flows are independent of the company’s other activities and will occur evenly each year. Vallahara is not able to determine the fair value based on a current selling price of the machinery. Vallahara’s discount rate is 10%.
Required:
General Journal
1. Prepare schedules to determine whether, at the end of 2016, the machinery is impaired and, if so, the impairment loss to be recognized. 2. If the machinery is impaired, prepare the journal entry to record the impairment. 3. If Vallahara uses IFRS and determines that the fair value of the machinery is $200,000 and that it would cost $10,000 to sell the machine, how much would the company recognize as the impairment loss? 4. Assuming that the recoverable amount of the machinery is determined to be $220,000 at the end of 2017, what entry will Vallahara make to record this increase in value under U.S. GAAP? Under IFRS?Explanation / Answer
1. Calculation of Carrying Value of the asset at the end of 2016
Depreciation each year = (650,000 - 50,000) / 12 = 50,000
Carrying Value of asset at end of 2016 = 650,000 - (50,000 x 4) = 450,000
NOTE: We have ignored depreciation for the year 2016 as the same is not ended till the time of impairment.
Calculation of Fair Value of asset
Fair Value for impairment is the undiscounted cash flows to be received = $1000000 - 825,000 = $175,000
Since the Fair Value of the asset is less than the carrying value. The company is required to book impairment loss.
Calculation of Recoverable amount
Recoverable amount is the present value of net cash flows from asset.
Net Cash flow each year = 175,000 / 5 = $35,000
Recoverable Amount = 35,000 x (1+10%)1+2+3+4+5
= 35,000 x 3.790 = $132,650
Impairment to be booked = $450,000 - 132,650 = $317,350
2. Journal Entry
Impairment Loss on Asset................DR. 117,350
Accumulated Depreciation ...............DR 200,000
TO Asset Account.....................CR. 317,350
3. As per IFRS, recoverable amount of asset should be higher of the fair value less selling cost, if any & Present value of net cash flows.
Net Fair value = Fair Value less selling cost = $190,000
Present Value of cash flows = $132,650
Recoverable Amount = $190,000
Impairment Loss = $450,000 - 190,000 = $260,000
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