Question

Blue Company uses special strapping equipment in its packaging business. The equipment was purchased in January 2019 for $12,200,000 and had an estimated useful life of 8 years with no salvage value. At December 31, 2020, new technology was introduced that would accelerate the obsolescence of Blue’s equipment. Blue’s controller estimates that expected future net cash flows on the equipment will be $7,686,000 and that the fair value of the equipment is $6,832,000. Blue intends to continue using the equipment, but it is estimated that the remaining useful life is 4 years. Blue uses straight-line depreciation.
(a) Prepare the journal entry (if any) to record the impairment at December 31, 2020.

(b) Prepare the journal entry for the equipment at December 31, 2021.

Answer 1

Answer:

Journal Entry - Impairment

Debit : Impairment Loss, $854,000

Credit: Accumulated Impairment Loss, $854,000

Journal entry - Depreciation

Debit : Depreciation expense, $2,135,000

Credit : Accumulated Depreciation, $2,135,000

Explanation:

Impairment loss is the excess of the Carrying Amount of an Asset over its Recoverable Amount.

Carrying Amount

Carrying Amount = Cost - Accumulated Depreciation

Depreciation Calculation (Straight line) : (Cost - Salvage Value) / Number of Useful life

2019 = ($12,200,000 - $0) / 8

        = $1,525,000

2020 = $12,200,000 - $1,525,000 / 5

         = $2,135,000

Note the change in useful life is applied from beginning of the year hence (4+1) years.Also the adjustment is only made in 2019 not retrospectively.

Carrying Amount = $12,200,000 - $1,525,000 - $2,135,000

                            = $ 8,540,000

Recoverable Amount

Is the higher of :

1. Fair Value less Cost to sell : $6,832,000 or,
2. Value in use : $7,686,000

Therefore Recoverable amount is $7,686,000

Impairment test

Carrying Amount : $ 8,540,000 > Recoverable amount : $7,686,000

The equipment is impaired.

Impairment loss is $ 8,540,000 - $7,686,000 = $854,000

Journal Entry - Impairment

Debit : Impairment Loss, $854,000

Credit: Accumulated Impairment Loss, $854,000

Journal entry - Depreciation

Debit : Depreciation expense, $2,135,000

Credit : Accumulated Depreciation, $2,135,000