Accounting Chapter 11 Homework When Impairment Loss Recognized The Carrying Amount

INTERNATIONAL FINANCIAL REPORTING STANDARDS

Valuation of Intangible Assets. IAS No. 38 allows a company to value an intangible asset

subsequent to initial valuation at (1) cost less accumulated amortization or (2) fair value, if fair value

can be determined by reference to an active market. If revaluation is chosen, all assets within that

class of intangibles must be revalued on a regular basis. Goodwill, however, cannot be revalued.

U.S. GAAP prohibits revaluation of any intangible asset.

Notice that the revaluation option is possible only if fair value can be determined by reference to

an active market, making the option relatively uncommon. However, the option possibly could be

revaluation surplus for that asset.

Consider the following illustration:

Amershan LTD. prepares its financial statements according to IFRS. At the beginning of its 2016

fiscal year, the company purchased a franchise for $500,000. The franchise has a 10-year

contractual life and no residual value, so amortization in 2016 is $50,000. The company does not

use an accumulated amortization account and credits the franchise account directly when

amortization is recorded. At the end of the year, Amershan chooses to revalue the franchise as

permitted by IAS No. 38. Assuming that the fair value of the franchise at year-end, determined by

reference to an active market, is $600,000, Amershan records amortization and the revaluation using

the following journal entries:

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PARTIAL PERIODS

On April 1, 2016, the Hogan Manufacturing Company purchased a machine for

$250,000. The company expects the service life of the machine to be five years and

the anticipated residual value is $40,000. The machine was disposed of after five

Year

Straight line

Sum-of-the-Years’ Digits

Double-Declining Balance

2016

$42,000 x 3/4 = $31,500

$70,000 x 3/4 = $ 52,500

$100,000 x 3/4 = $75,000

2019

$ 42,000

$42,000 x 1/4 = $ 10,500

$ 36,000 x 1/4 = $ 9,000

Illustration 11-14B

CHANGES IN ESTIMATES

➢ Changes in estimates are accounted for prospectively.

➢ When a company revises a previous estimate, prior financial

On January 1, 2014, the Hogan Manufacturing Company purchased office furniture and fixtures

for $250,000. The company expects the service life of the office furniture and fixtures to be five

years and the anticipated residual value to be $40,000. The company’s fiscal year-end is December

31 and the straight-line depreciation method is used for all depreciable assets. During 2016, the

company revised its estimate of service life from five to eight years and also revised estimated

residual value to $22,000.

For 2014 and 2015, depreciation is $42,000 per year [($250,000 – 40,000)  5 years] or $84,000

for the two years. However, with the revised estimate, depreciation for 2016 and subsequent years

is determined by allocating the book value remaining at the beginning of 2016 less the revised

residual value equally over the remaining service life of six years (8 – 2). The remaining book

value at the beginning of 2016 is $166,000 ($250,000 – 84,000) and depreciation for 2016 and

subsequent years is recorded as follows:

Illustration 11-15

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CHANGE IN DEPRECIATION,

AMORTIZATION, OR DEPLETION METHOD

➢ Changes in depreciation, amortization, or depletion method are

accounted for prospectively, in the same way as we account for

changes in estimates.

On January 1, 2014, the Hogan Manufacturing Company purchased office

equipment for $250,000. The company expects the service life of the office

equipment to be five years and its anticipated residual value to be $30,000. The

company’s fiscal year-end is December 31 and the double-declining balance (DDB)

depreciation method is used. During 2016, the company switched from the DDB to

the straight-line method. In 2016, the adjusting entry is:

Depreciation expense (below) ………….. 20,000

Accumulated depreciation ………… 20,000

DDB depreciation:

*Double the straight-line rate for 5 years ([1/5 = 20%] x 2 = 40%)

$250,000 Cost

Illustration 11-17

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ERROR CORRECTIONS

➢ Any previous years’ financial statements that were incorrect

as a result of the error are retrospectively restated to reflect

the correction.

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ERROR CORRECTIONS

(continued)

In 2016, the controller of the Hathaway Corporation discovered an error

in recording $300,000 in legal fees to successfully defend a patent

infringement suit in 2014. The $300,000 was charged to legal fee expense

but should have been capitalized and amortized over the five-year

remaining life of the patent. Straight-line amortization is used by

Hathaway for all intangibles.

Analysis:

($ in thousands)

Correct Incorrect

(Should have been recorded) (as recorded)

Patent is understated by $180 thousand.

To correct incorrect accounts ($ in thousands)

Illustration 11-19

IMPAIRMENT OF VALUE

➢ An asset should be written down if there has been a

significant impairment of value.

Property, Plant, and Equipment and Finite-Life

Intangible Assets

➢ An impairment loss is recognized when the undiscounted sum

of estimated future cash flows from an asset is less than the

asset’s book value.

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IMPAIRMENT OF PROPERTY, PLANT, AND

EQUIPMENT AND FINITE-LIFE INTANGIBLE ASSETS

(continued)

The Dakota Corporation operates several factories that manufacture medical

equipment. Near the end of the company’s 2016 fiscal year, a change in business

climate related to a competitor’s innovative products indicated to management that

the $170 million book value (original cost of $300 million less accumulated

depreciation of $130 million) of the assets of one of Dakota’s factories may not be

recoverable.

Management is able to identify cash flows from this factory and estimates that

future cash flows over the remaining useful life of the factory will be $150 million.

The fair value of the factory’s assets is not readily available but is estimated to be

$135 million.

Change in circumstances. –The change in business climate related to a

competitor’s innovative products requires Dakota to investigate for possible

impairment.

Step 1. Recoverability. Because book value of $170 million exceeds the $150

million undiscounted future cash flows, an impairment loss is indicated.

Step 2. Measurement of impairment loss. The impairment loss is $35 million,

determined as follows:

Illustration 11-20

IMPAIRMENT OF PROPERTY, PLANT, AND

EQUIPMENT AND FINITE-LIFE INTANGIBLE ASSETS

(continued)

Asset Impairment Disclosure – Sears Holding Corporation

Impairment of Long-lived Assets (in part)

In accordance with accounting standards governing the impairment or disposal of long-lived assets, the

carrying value of long-lived assets, including property and equipment and definite-lived intangible assets, is

evaluated whenever events or changes in circumstances indicate that a potential impairment has occurred

relative to a given asset or assets. Factors that could result in an impairment review include, but are not

Note 13—Store Closing Charges, Severance Costs and Impairments (in part)

Long-Lived Assets

In accordance with accounting standards governing the impairment or disposal of long-lived assets, we

Illustration 11-21

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INTERNATIONAL FINANCIAL REPORTING STANDARDS

Impairment of Value: Property, Plant, and Equipment and Finite-Life Intangible Assets.

Highlighted below are some important differences in accounting for impairment of value for

property, plant, and equipment and finite-life intangible assets between U.S. GAAP and IAS No. 36.

U.S. GAAP IFRS

When to Test When events or changes in Assets must be assessed for indicators of

circumstances indicate that impairment at the end of each reporting

book value may not be period. Indicators of impairment are similar

recoverable. to U.S. GAAP.

Let’s look at an illustration highlighting the important differences described above.

The Jasmine Tea Company has a factory that has significantly decreased in value due to

technological innovations in the industry. Below are data related to the factory’s assets:

($ in millions)

Book value $18.5

What amount of impairment loss should Jasmine Tea recognize, if any, under U.S. GAAP? Under

IFRS?

U.S. GAAP There is no impairment loss. The sum of undiscounted estimated future cash flows

exceeds the book value.

IFRS Jasmine should recognize an impairment loss of $2.5 million. Indicators of

impairment are present and book value exceeds both value-in-use (present value of

Nokia, a Finnish company, prepares its financial statements according to IFRS. The following

disclosure note describes the company’s impairment policy:

Assessment of the recoverability of long-lived assets, and intangible assets, and goodwill (in part)

The carrying value of identifiable intangible assets and long-lived assets is assessed if events or

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INTERNATIONAL FINANCIAL REPORTING STANDARDS

Impairment of Value: Indefinite-Life Intangible Assets Other than

Goodwill. Similar to U.S. GAAP, IFRS requires indefinite-life intangible

assets other than goodwill to be tested for impairment at least annually.

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IMPAIRMENT OF VALUE – GOODWILL

➢ A goodwill impairment loss is indicated when the fair value of the reporting unit is

less than its book value.

➢ A goodwill impairment loss is measured as the excess of the book value of the

Step 2. – Measurement of impairment loss. The impairment loss is $75 million, determined as

follows:

Determination of implied fair value of goodwill:

Fair value of Pharmacopia $360 million

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IMPAIRMENT OF VALUE – GOODWILL

(continued)

Goodwill Impairment Disclosure – Alcoa Inc.

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INTERNATIONAL FINANCIAL REPORTING STANDARDS

Impairment of Value: Goodwill. Highlighted below are some important differences in accounting

1. Compare the fair value Compare the recoverable amount of the CGU

of the reporting unit with to book value. If the recoverable amount is

2. The impairment loss is (present value of estimated future cash flows).

the excess of book value

over implied fair value.

IAS No. 36 requires goodwill to be tested for impairment at least annually. U.S. GAAP allows a

company to avoid annual testing by making qualitative evaluations of the likelihood of goodwill

impairment to determine if step one is necessary. Both U.S. GAAP and IAS No. 36 prohibit the

reversal of goodwill impairment losses.

Let’s look at an illustration highlighting these differences.

Canterbury LTD. has $38 million of goodwill in its balance sheet from the 2014 acquisition of

Denton, Inc. At the end of 2016, Canterbury’s management provided the following information for

the year-end goodwill impairment test ($ in millions):

Fair value of Denton (determined by appraisal) $132

Fair value of Denton’s net assets (excluding goodwill) 120

Book value of Denton’s net assets (including goodwill) 150

Present value of Denton’s estimated future cash flows 135

Assume that Denton is considered a reporting unit under U.S. GAAP and a cash-generating unit

under IFRS, and that its fair value approximates fair value less costs to sell. Determine the amount of

goodwill impairment loss that Canterbury should recognize, if any, under U.S. GAAP? Under

IFRS?

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