The SOO Company has machinery that it acquired a number of years ago at a cost of $812,000. As of December 31, 2012 the company has recorded life-to-date depreciation in the amount of $332,900. Because of changes in their manufacturing processes, the equipment does not function as well as the company originally anticipated. As of December 31, 2012 the company has estimated that the fair value of the machinery is $302,000 and the projected future net cash flows from this machinery will be $426,000.
Instructions:
A. Prepare the journal entry necessary, if any, to record an impairment at December 31, 2012.
B. How should a gain or loss, if any, on the impairment be presented on the income statement?
C. As of December 31, 2013 the fair value of the machinery increased to $326,000. Prepare the journal entry necessary, if any, to record this increase.
A. To determine if there is an impairment, we need to compare the carrying value (original cost minus accumulated depreciation) to the recoverable amount (higher of fair value or present value of future cash flows). In this case, the carrying value of the machinery is ($812,000 - $332,900) $479,100.
Since the fair value of the machinery ($302,000) is lower than the carrying value, we have an impairment loss. The impairment loss is calculated as the carrying value minus the fair value, which is $479,100 - $302,000 = $177,100.
To record the impairment, we make the following journal entry:
Impairment Loss $177,100
Accumulated Depreciation $177,100
B. The gain or loss on impairment should be presented on the income statement as a separate line item before income tax expense. It should be classified as an operating expense since it relates to the impairment of an asset used in the company's operations. In this case, the loss on impairment would be presented as a separate line item on the income statement and deducted from the operating income to arrive at the net income.
C. Since the fair value of the machinery increased to $326,000 as of December 31, 2013, there is no need to record a journal entry for this increase. The increase in fair value will not reverse the impairment loss that was previously recognized. Impairment losses are considered permanent and not reversible, even if the fair value of the asset increases in subsequent periods.