Question

On July 1, Arcola Company purchases equipment for $330,000. The equipment has an estimated useful life of 10 years and expected salvage value of $40,000. The company uses straight-line depreciation. Four years later, economic factors cause the fair value of the equipment to decline to $160,000. On this date, Arcola examines the equipment for impairment and estimates $185,000 in undiscounted expected cash inflows from this equipment.
Required:
a. Compute the annual depreciation expense relating to this equipment.
b. Compute the equipment's net book value at the end of the fourth year.
c. Apply the test of impairment to this equipment as of the end of the fourth year. Is the equipment impaired?

Answer 1

Answer:

a. $29,000

b. $214,000

c. Yes

Explanation:

a. Annual Depreciation expense:

= (Cost - salvage value)/ Useful life

= (330,000 - 40,000) / 10,000

= $29,000

b. Net book value at end of 4th year:

= Cost - 4 year depreciation

= 330,000 - (4 * 29,000)

= $214,000

c. One test to see if equipment is not impaired is that the Expected Undiscounted cashflows need to be higher than the net book value. This is not the case here as the Net Book value of $214,000 is higher than the expected Undiscounted cash inflows of $185,000. Equipment is therefore impaired.