Question

(Impairment) 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, 2017. On December 31, 2017, 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.

Instructions

1. Prepare the journal entry (if any) to record the impairment at December 31, 2017.
2. Where should the gain or loss (if any) on the write-down be reported in the income statement?
3. At December 31, 2018, the equipment’s fair value increased to $260,000. Prepare the journal entry (if any) to record this increase in fair value.
4. What accounting issues did management face in accounting for this impairment?

Short answer

Answer

1. Loss on impairment = $270,000
2. It may be reported in the other expenses and losses section
3. No entry is necessary
4. Management should perform a recoverability test

Step-by-step solution

Meaning of Impairment Loss

When an asset's value drops, it will suffer an impairment loss. The value is the sum of its recoverable assets, market value, or maximum amount of undiscounted future cash flows. In addition to legal, economic, and natural factors that can trigger an impairment loss, there are many other factors that can lead to one.

(a) Preparing journal entry. 

Date	Particular	Debit ($)	Credit ($)
	Loss on Impairment	270,000
	Accumulated Depreciation Equipment		270,000

Working notes:

Calculating the amount of loss on impairment

Cost	$900,000
Less: Accumulated depreciation	400,000
Carrying amount	500,000
Less: Fair value	230,000
Loss on impairment	$270,000

(b) Explaining the gain or loss that should be reported in the income statement. 

It might be listed in the other costs and losses section, or it could be marked in a separate part as an unusual item.

The profit or loss might be recorded in the income statement's column for additional costs and losses. It's a unique object that deserves to be emphasized in its own area.

(c) Explaining the journal entry 

Restoration of any loss arising out of impairment is not permitted. Therefore, no entry is required to be passed.

A company's assets may be subject to revaluation if they are impaired and incur an impairment loss, and the book value of that asset is periodically adjusted. The revaluation approach may compensate for past losses by adjusting the value of the asset in the future.

(d) Explaining the accounting issues that management face in accounting for the impairment 

Management had to first figure out if there was a problem. Management does a recoverability test to assess this phase. The recoverability test calculates the estimated future cash flows from the asset's usage and ultimate disposal.

Impairment occurs when the total of the projected future net cash flows (undiscounted) is less than the asset's carrying value. A loss is calculated if the recoverability test reveals that an impairment has occurred. The impairment loss is the difference between the asset's carrying value and its fair value.