Endor has lots of coal. Big Coal, and American Company purchases the rights to m
ID: 2587126 • Letter: E
Question
Endor has lots of coal. Big Coal, and American Company purchases the rights to mine the Far-Moon-of-Endor from the Endorian government for $100,000,000. At the time, Big Coal expected to generate $30,000,000 annually for 20 years from this coal mine, thus making it a great investment. Unfortunately, the next year Earth passes strict new pollution laws which greatly reduces the demand for Big Coal’s coal. Big Coal correctly determines that its mining rights are impaired and writes it down to $12,000,000. Two years later, Yoda Company releases to the market a new device which permits the burning of coal with NO POLLUTION! Earthlings now want your coal again and you expect to generate $30,000,000 per year for the remaining years. The present value of this new income stream is $500,000,000. Under GAAP what do you do when the Yoda device is acquired and you start selling lots of coal again? Under IFRS what do you do when Yoda’s device is acquired and you start selling lots of coal again? Which approach GAAP or IFRS gives us investors more relevant information? Defend your answer.
Explanation / Answer
1. Reversal of impairment loss under US GAAP.
As per ASC 360-10-35-20 under US GAAP, reversal of impairment loss booked in an asset in earlier years is prohibited. An asset is considered to have a new cost basis after an impairment loss is recorded and the reversal of a previously recognized impairment loss is prohibited. In the given case, Big coal has booked impairment loss in previous, and the same is prohibited to be reversed after the acquistion of device.
2. Under IFRS, paragraphs 110–116 of IAS 36 at each reporting period, entity is required to check whether the conditions on the basis of which impairment was booked exists or not. In the given case, the economic condition of the coal has improved and after the acquisition, there will increase in the cash flows from selling of coal. Thus Big Coal is required to reverse the impairment loss booked earlier but upto the amount of original carrying value as adjusted for the depreciation till date.
Amortization of Rights = $100,000,000 / 20 = $5,000,000
Calculation of Impairment loss booked in second year
Book value = 100,000,000 - 5,000,000 = $95,000,000
Impairment Loss = $95,000,000 - 12,000,000 = $83,000,000
Present Value of income stream = $500,000,000
Carrying Value of asset if impairment not happen = 100,000,000 - (5000000 x 4) = $80,000,000
Since the carrying value is less than the impairment loss booked, company can reverse impairment loss maximum upto the carrying vallue of $80,000,000.
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