Asset Impairment Stearns Inc. owns plant and equipment on the island of Lagos. T

Question

Asset Impairment

Stearns Inc. owns plant and equipment on the island of Lagos. The cost and carrying amount of the
building are $2,800,000 and $2,400,000, respectively. Until this year, the market value of the factory
was $7 million. However, a new dictator just came to power and declared martial law. As a
result of the changed political status, the future cash inflows from the use of the factory are expected
to be greatly reduced. Stearns now believes that the output from the factory will generate cash inflow for the next 20 years,

as measured by the value in use of $2,000,000. In addition, the market value of the factory building

is now just $1,300,000. Stearns is not sure how to account for the sudden impairment in value.
Required:
1. Explain how to decide whether an impairment loss is to be recognized.
2. Prepare the necessary journal entry, if any, to account for an impairment in the value of
the factory.

Explanation / Answer

1. There is a need to account for impairment loss when the carrying amount of the asset exceeds the recoverable amount. Such a scenario can arise due to both internal (like wear and tear, damage to asset, etc) and external factors (change in technology, change in economic conditions, change in law, etc). In the given case due to introduction of martial law in the country, the future cash flows stand greatly reduced; due to which the recoverable amount has declined.

We know that carrying amount is 2,400,000

Recoverable amount is higher of fair market value (less cost of disposal if any) or value in use.

Fair market value = 1,300,000

Value in Use = 2,000,000

Thus, Recoverable Amount = 2,000,000

Since Recoverable Amount < Carrying Amount, imapirment loss is to be recognized.

2. Journal Entry will be:

Impairment loss A/c Dr. 400,000

To Accumulated Impairment loss A/c 400,000

Alternatively, the asset account can be credited to account for impairment.

Impairment loss = Carrying Amount - Recoverable Amount = 2,400,000 - 2,000,000 = $ 400,000

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