Assume U.S. GAAP (generally accepted accounting principles) applies unless other

Question

Assume U.S. GAAP (generally accepted accounting principles) applies unless
otherwise noted.

A company has equipment with an original cost of $850,000, accumulated
amortization of $300,000 and 5 years of estimated remaining useful life. Due to a
change in market conditions the company now estimates that the equipment will
only generate cash flows of $80,000 per year over its remaining useful life. The
company’s incremental borrowing rate is 8 percent. Which of the following
statements concerning impairment and future return on assets (ROA) is most
accurate? The asset is:

A. impaired and future ROA increases.
B. impaired and future ROA decreases.
C. not impaired and future ROA increases.

Explanation / Answer

The equipment is impaired. NBV = $550,000 which is greater than the sum of the

undiscounted cash flows 5 yrs x $80,000 = $400,000. The company’s future ROA

will increase. Once the asset is written down, there will be lower depreciation

charges, which will increase net income, and a lower carrying value of assets,

which decreases total assets. Both factors would increase any future ROA.

A is right

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