Using the accrual basis of accounting, prepare Majestic Caterers? Income Statement and Balance Sheet for the year ended December 31, 2008.
Majestic Caterers was founded in September 2007 by Barbara Roberts and Lisa Grotto as a catering service in central Arizona. Majestic broke even for the year ended December 31, 2007; however, in 2008, the company experienced a high growth rate. Roberts and Grotto would like to expand their catering enterprise to include a restaurant. Roberts applied for an expansion loan at the local bank, and the bank has requested audited financial statements prepared on the accrual basis. Prior to this loan application, Majestic's financial records have been kept on a cash basis in order to accurately reflect Majestic's priority of cash flow. Roberts and Grotto hired the services of an independent accountant, Paul Maynard, to assist them in converting Majestic's 2008 financial statements, prepared on the cash basis, to 2008 accrual basis. From a review of the company's records and files, as well as discussions with Roberts and Grotto, Maynard has gathered the following data concerning Majestic's transactions during 2008 and the cash basis financial statements. In addition, the company's Statement of Financial Position at December 31, 2007, has been restated to an accrual basis as presented in the next page. Summary of Cash Transactions for 2008 Receipts Cash sales Collections from customers Proceeds from one-year, 12% note, Received January 1, 2008 $464,000 160,000 Disbursements: Payments for supplies Wages paid to employees Payments to the utility company Insurance premiums paid Rent paid to landlord Interest on 12% note, paid on July 1, 2008 Equipment purchased on January 1, 2008 80,000 161,600 248,000 44,000 36,000 72,000 4,800 100,000 Uncollected customers' bills totaled $139,600 at December 31, 2008 On January 1, 2008, a supplier of Majestic advanced the company $80,000 on a one-year, 12 percent note payable with semi-annual interest payments to be made on July 1, 2008 and at maturity on January 1, 2009. Unpaid bills to suppliers totaled $22,400 at December 31, 2008. Supplies costing $16,000 were on hand at December 31, 2008. Wages owed to employees at December 31, 2008 were $11,200. The December utility bill of $3,900 was unpaid at December 31, 2008. The insurance premium was paid for a one-year liability and property damage policy effective February 1, 2008. The rent of $6,000 per month was paid to the landlord on the first of every month. Maynard recommends depreciating the company's equipment, which was purchased January 1, 2008, for $100,000, over its useful life of ten years using the straight-line method of depreciation. The equipment has no estimated residual value. (In its first year of operation, 2007, Majestic leased equipment.) Majestic has an effective income tax rate of 40 percent. There were no differences between financial reporting and income tax reporting for the year ended December 31, 2007. No taxes were paid in 2008. Majestic Caterers Balance Sheet As of December 31, 2007 Assets Cash Accounts receivable Supplies Inventory Total Assets $51,200 48,800 48,000 $148,000 Liabilities and shareholders' equity Accounts payable -- Supplies Common stock Total liabilities and shareholders' equity $56,000 92,000 $148,000 Required: Using the accrual basis of accounting, prepare Majestic Caterers' Income Statement and Balance Sheet for the year ended December 31, 2008. CASE 10-2 Eagle Impairment Loss Intermediate Accounting I Mariah A. Edwards & Kevin Cappel 7/9/2012 Issues: Difference in accounting for impairment under IFRS and USA GAAP. Building (Questions I&2), Goodwill (Questions 3&4) Applicable Literature IAS 36- Impairment of Assets ASC -Impairment and Disposal of Long Lived Asset ASC -Intangibles-Goodwill and Other B uilding Impairment Question 1 Answer Given the facts provided for Eagle in Italy, is the building impaired under IFRS as of December 31, 2010, and if so, what is the amount of the impairment? Under IFRS Amount by which carrying amount of an asset exceeds recoverable amount. (IAS 36-59) Recoverable amount is the higher of an asset's fair value less costs to sell and its value in use (IAS 36-18) The carrying amount is larger than the recoverable amount The impairment amount is $1,000,000 ($ 900,000) $ 200,000 Question 2 Answer Given the facts provided for Eagle in Italy, is the building impaired under U.S. GAAP as of December 31, 2010, and if so, what is the amount of the impairment? Under GAAP Step 1. The asset carrying amount is compared with the expected undiscounted cashflows Step 2. An impairment loss is measured as the difference between the carrying amount and fair value (ASC 360-10-35-17) The undiscounted future cash flows ($1,150,000) exceeds the carrying amount ($1,100,000) by $50,000, therefore the building is not impaired G oodwill Impairment Question 3 Answer Using the information given for Eagle's CGU in Serbia, including the present value of discontinued cash flow calculation, determine the following: 1. Is there an impairment loss under IFRS and U.S. GAAP as of December 31, 2010. Assume that the fair value of PP&E is 1 million and the fair value of all other identifiable assets and liabilities, excluding goodwill, equal their carrying amounts when testing for impairment. 2. Assume that the value in use calculation is appropriate. Are management's assumptions in calculating the value in use appropriate? 3. Calculate the new carrying value of assets and CGU under IFRSs. As noted above, assume that the fair value of PP&E is 1 million and the fair value of all individual assets and liabilities, excluding goodwill, equal carrying amounts. Q3 #1 Under IFRS Impairment of goodwill occurs if the carrying value is greater than the recoverable amount (IAS 36-90) To find impairment, take the greater of value in use and fair value (the recoverable amount) and subtract it from the carrying value (IAS 36-104) Take the greater of value in use and fair value (in this case it is the value in use at $1,050,000), and subtract it from the carrying value This results in a $350,000 difference from the $1,400,000 Goodwill is impaired $300,000 and PP&E is impaired $50,000 (IAS 36-90 and IAS 36104-105) Under GAAP Goodwill is tested for impairment on a reporting unit level Step 1. Perform recoverability test by comparing the sum of the undiscontinued future cash flows with the carrying amount of the CGU Step 2. If the carrying amount is greater than the undiscontinued future cash flows, impairment exists (ASC 350-20-35) The undiscontinued future cash flows of $1,600,000 exceed the carrying amount of $1,400,000 by $200,000 Therefore, there is no impairment of goodwill Q3 #2 Management's Assumptions: Question projected growth of sales -External Industry Reports -Reasons for projected growth Q3 #3 New Carrying Value: Due to the $350,000 impairment under IFRS, the new carrying value is computed New carrying value of assets: $1,600,000-$350,000= $1,250,000 Question 4 Answer Assume that during 2011, the effects of the export laws on Eagle's production in Serbia are less dramatic than initially expected by management. As a result, management estimates that the recoverable amount of its Serbian CGU at the end of 2011 increased to $1,200. On the basis of this information and the information from 1-3 above, calculate the reversal of loss, if any, under IFRSs and the carrying values as of December 31, 2011. The remaining useful life of PP&E is seven years at the beginning of 2011. Assume there have been no other changes in the carrying value of other assets or liabilities during 2011. Is there a reversal of loss under IFRS? IFRS does not allow reversal of loss on goodwill (IAS 36-110) Therefore, the carrying value of the CGU as of December 31, 2011 is equal to the carrying value of $1,050,000 less depreciation of PP&E of $150,000 and add back the reversal of loss of $50,000 The carrying value of the CGU= $950,000 Case 10-2 Eagle Impairment Loss Eagle Company (Eagle) is a manufacturing company with operations in Italy and Serbia. Eagle in Italy: In addition to other assets, Eagle owns and operates a commercial building in Italy that is carried at its cost less any accumulated depreciation and any accumulated impairment losses. The building represents a cash-generating unit (CGU) for which the following information is available as of December 31, 2010: 12/31/10 in thousands Carrying amount $1,100 Value in use 900 Fair market value less costs to sell 800 Fair market value 850 Undiscounted future cash flows 1,150 Building Eagle in Serbia: In Serbia, in 2008, Eagle acquired a smaller competing company and goodwill was allocated to the CGU shown below. Activities in Serbia represent the lowest level at which internal management monitors goodwill. At the end of 2008 and 2009, the value in use of the CGU including goodwill exceeded its carrying amount. Therefore the activities of Eagle in Serbia and the goodwill allocated to those activities were regarded as not impaired. However, at the end of 2010, the newly elected government passed legislation significantly restricting exports of Eagle's main product. The information below relates to the CGU (which includes goodwill) of Eagle's operations in Serbia before the impairment analysis is performed. For this case, assume the basis of segmentation for CGUs and reporting units (RU) is the same under IFRSs and U.S. GAAP. Copyright 2009 Deloitte Development LLC All Rights Reserved. Case 10-2: Eagle Impairment Loss Page 2 Eagle's Serbian CGU carrying value 12/31/10 in thousands Cash Property, plant, and equipment (PP&E) Land Goodwill Total assets Liabilities Carrying value $50 1,100 150 300 $1,600 (200) $1,400 As a result of the change in legislation, Eagle's production will be significantly affected for the foreseeable future. In addition, external industry reports estimate no growth rate for the foreseeable future. The significant export restriction and the resulting production decrease are impairment indicators that require Eagle to estimate the recoverable amount of its operations at the end of 2010. Eagle's management prepared the cash flow analysis shown below: Discounted cash flows in thousands: Total revenue Growth Cost of goods sold Gross profit Selling, general, and administrative (SG&A) Earnings before interest, taxes, depreciation & amortization (EBITDA) 2011 2012 2013 $5,649 $6,045 $6,528 6% 7% 8% 3,389 3,627 3,917 2,260 2,418 2,611 2014 $7,181 10% 4,309 2,872 2015 $8,043 12% 4,826 3,217 847 906 979 1,077 1,206 1,413 1,512 1,632 1,795 2,011 Depreciation and amortization Earnings before interest and taxes (EBIT) Available tax-loss carryforwards Net taxable earnings 564 604 652 718 804 849 0 849 908 0 908 980 0 980 1,077 0 1,077 1,207 0 1,207 Income taxes Net operating profit after-tax 296 553 317 591 342 638 377 700 422 785 564 (848) 0 $269 235 604 (903) 0 $292 222 Add back depreciation and amortization Subtract capital expenditures Subtract new net working cap. Free cash flow Present value of free cash flows at 15% Total present value as of 12/31/10 652 718 804 (980) (1,077) (1,201) 0 0 0 $310 $341 $388 205 195 193 $1,050 Copyright 2009 Deloitte Development LLC All Rights Reserved. Case 10-2: Eagle Impairment Loss Page 3 Assume the $1.05 million above is the appropriate fair value under U.S. GAAP and the recoverable amount under IFRS. Further assume management estimates no costs to sell would be incurred. The five-year business forecast prepared by management reflects an increase in the amount of capital expenditures in order to modify Eagle's main product, which, when modified, will not be subject to legislation restrictions. The additional capital expenditure estimates for these investments are $450,000 and $470,000, for 2011 and 2012, respectively (included in the capital expenditures line in the calculation of present value of discounted cash flows). The amounts of capital expenditures for 2013 and 2014 also include $50,000 and $70,000, respectively for future financing outflows Eagle may incur when borrowing funds for capital expenditures. The remaining useful life of Eagle's identifiable assets is eight years at the beginning of 2010. Eagle uses straight-line depreciation and anticipates no residual value. Management determined the discount rate used in the calculation of present value is a pre-tax discount rate of 15 percent using the weighted average cost of capital (WACC) of Eagle. Required: Question 1 Given the facts provided for Eagle in Italy, is the building impaired under IFRSs as of December 31, 2010, and if so, what is the amount of the impairment? Question 2 Given the facts provided for Eagle in Italy, is the building impaired under U.S. GAAP as of December 31, 2010, and if so, what is the amount of the impairment? Question 3 Using the information given for Eagle's CGU in Serbia, including the present value of discounted cash flow calculation, determine the following: 1. Is there an impairment loss on goodwill? If so, determine the amount of the impairment loss under IFRS and U.S. GAAP as of December 31, 2010. Assume that the fair value of PP&E is 1 million and the fair value of all other identifiable assets and liabilities, excluding goodwill, equal their carrying amounts when testing for impairment. 2. Assume that the value in use calculation is appropriate. Are management's assumptions in calculating the value in use appropriate? 3. Calculate the new carrying value of assets and CGU under IFRSs. As noted above, assume that the fair value of PP&E is 1 million and the fair value of all individual assets and liabilities, excluding goodwill, equal their carrying amounts. Question 4 Assume that during 2011, the effects of the export laws on Eagle's production in Serbia are less dramatic than initially expected by management. As Copyright 2009 Deloitte Development LLC All Rights Reserved. Case 10-2: Eagle Impairment Loss Page 4 a result, management estimates that the recoverable amount of its Serbian CGU at the end of 2011 increased to $1,200. On the basis of this information and the information from 1-3 above, calculate the reversal of loss, if any, under IFRSs and the carrying value as of December 31, 2011. The remaining useful life of PP&E is seven years at the beginning of 2011. Assume there have been no other changes in the carrying value of other assets or liabilities during 2011. Copyright 2009 Deloitte Development LLC All Rights Reserved. CASE 10-2 Eagle Impairment Loss Intermediate Accounting I Mariah A. Edwards & Kevin Cappel 7/9/2012 Issues: Difference in accounting for impairment under IFRS and USA GAAP. Building (Questions I&2), Goodwill (Questions 3&4) Applicable Literature IAS 36- Impairment of Assets ASC -Impairment and Disposal of Long Lived Asset ASC -Intangibles-Goodwill and Other B uilding Impairment Question 1 Answer Given the facts provided for Eagle in Italy, is the building impaired under IFRS as of December 31, 2010, and if so, what is the amount of the impairment? Under IFRS Amount by which carrying amount of an asset exceeds recoverable amount. (IAS 36-59) Recoverable amount is the higher of an asset's fair value less costs to sell and its value in use (IAS 36-18) The carrying amount is larger than the recoverable amount The impairment amount is $1,000,000 ($ 900,000) $ 200,000 Question 2 Answer Given the facts provided for Eagle in Italy, is the building impaired under U.S. GAAP as of December 31, 2010, and if so, what is the amount of the impairment? Under GAAP Step 1. The asset carrying amount is compared with the expected undiscounted cashflows Step 2. An impairment loss is measured as the difference between the carrying amount and fair value (ASC 360-10-35-17) The undiscounted future cash flows ($1,150,000) exceeds the carrying amount ($1,100,000) by $50,000, therefore the building is not impaired G oodwill Impairment Question 3 Answer Using the information given for Eagle's CGU in Serbia, including the present value of discontinued cash flow calculation, determine the following: 1. Is there an impairment loss under IFRS and U.S. GAAP as of December 31, 2010. Assume that the fair value of PP&E is 1 million and the fair value of all other identifiable assets and liabilities, excluding goodwill, equal their carrying amounts when testing for impairment. 2. Assume that the value in use calculation is appropriate. Are management's assumptions in calculating the value in use appropriate? 3. Calculate the new carrying value of assets and CGU under IFRSs. As noted above, assume that the fair value of PP&E is 1 million and the fair value of all individual assets and liabilities, excluding goodwill, equal carrying amounts. Q3 #1 Under IFRS Impairment of goodwill occurs if the carrying value is greater than the recoverable amount (IAS 36-90) To find impairment, take the greater of value in use and fair value (the recoverable amount) and subtract it from the carrying value (IAS 36-104) Take the greater of value in use and fair value (in this case it is the value in use at $1,050,000), and subtract it from the carrying value This results in a $350,000 difference from the $1,400,000 Goodwill is impaired $300,000 and PP&E is impaired $50,000 (IAS 36-90 and IAS 36104-105) Under GAAP Goodwill is tested for impairment on a reporting unit level Step 1. Perform recoverability test by comparing the sum of the undiscontinued future cash flows with the carrying amount of the CGU Step 2. If the carrying amount is greater than the undiscontinued future cash flows, impairment exists (ASC 350-20-35) The undiscontinued future cash flows of $1,600,000 exceed the carrying amount of $1,400,000 by $200,000 Therefore, there is no impairment of goodwill Q3 #2 Management's Assumptions: Question projected growth of sales -External Industry Reports -Reasons for projected growth Q3 #3 New Carrying Value: Due to the $350,000 impairment under IFRS, the new carrying value is computed New carrying value of assets: $1,600,000-$350,000= $1,250,000 Question 4 Answer Assume that during 2011, the effects of the export laws on Eagle's production in Serbia are less dramatic than initially expected by management. As a result, management estimates that the recoverable amount of its Serbian CGU at the end of 2011 increased to $1,200. On the basis of this information and the information from 1-3 above, calculate the reversal of loss, if any, under IFRSs and the carrying values as of December 31, 2011. The remaining useful life of PP&E is seven years at the beginning of 2011. Assume there have been no other changes in the carrying value of other assets or liabilities during 2011. Is there a reversal of loss under IFRS? IFRS does not allow reversal of loss on goodwill (IAS 36-110) Therefore, the carrying value of the CGU as of December 31, 2011 is equal to the carrying value of $1,050,000 less depreciation of PP&E of $150,000 and add back the reversal of loss of $50,000 The carrying value of the CGU= $950,000 Case 10-2 Eagle Impairment Loss Eagle Company (Eagle) is a manufacturing company with operations in Italy and Serbia. Eagle in Italy: In addition to other assets, Eagle owns and operates a commercial building in Italy that is carried at its cost less any accumulated depreciation and any accumulated impairment losses. The building represents a cash-generating unit (CGU) for which the following information is available as of December 31, 2010: 12/31/10 in thousands Carrying amount $1,100 Value in use 900 Fair market value less costs to sell 800 Fair market value 850 Undiscounted future cash flows 1,150 Building Eagle in Serbia: In Serbia, in 2008, Eagle acquired a smaller competing company and goodwill was allocated to the CGU shown below. Activities in Serbia represent the lowest level at which internal management monitors goodwill. At the end of 2008 and 2009, the value in use of the CGU including goodwill exceeded its carrying amount. Therefore the activities of Eagle in Serbia and the goodwill allocated to those activities were regarded as not impaired. However, at the end of 2010, the newly elected government passed legislation significantly restricting exports of Eagle's main product. The information below relates to the CGU (which includes goodwill) of Eagle's operations in Serbia before the impairment analysis is performed. For this case, assume the basis of segmentation for CGUs and reporting units (RU) is the same under IFRSs and U.S. GAAP. Copyright 2009 Deloitte Development LLC All Rights Reserved. Case 10-2: Eagle Impairment Loss Page 2 Eagle's Serbian CGU carrying value 12/31/10 in thousands Cash Property, plant, and equipment (PP&E) Land Goodwill Total assets Liabilities Carrying value $50 1,100 150 300 $1,600 (200) $1,400 As a result of the change in legislation, Eagle's production will be significantly affected for the foreseeable future. In addition, external industry reports estimate no growth rate for the foreseeable future. The significant export restriction and the resulting production decrease are impairment indicators that require Eagle to estimate the recoverable amount of its operations at the end of 2010. Eagle's management prepared the cash flow analysis shown below: Discounted cash flows in thousands: Total revenue Growth Cost of goods sold Gross profit Selling, general, and administrative (SG&A) Earnings before interest, taxes, depreciation & amortization (EBITDA) 2011 2012 2013 $5,649 $6,045 $6,528 6% 7% 8% 3,389 3,627 3,917 2,260 2,418 2,611 2014 $7,181 10% 4,309 2,872 2015 $8,043 12% 4,826 3,217 847 906 979 1,077 1,206 1,413 1,512 1,632 1,795 2,011 Depreciation and amortization Earnings before interest and taxes (EBIT) Available tax-loss carryforwards Net taxable earnings 564 604 652 718 804 849 0 849 908 0 908 980 0 980 1,077 0 1,077 1,207 0 1,207 Income taxes Net operating profit after-tax 296 553 317 591 342 638 377 700 422 785 564 (848) 0 $269 235 604 (903) 0 $292 222 Add back depreciation and amortization Subtract capital expenditures Subtract new net working cap. Free cash flow Present value of free cash flows at 15% Total present value as of 12/31/10 652 718 804 (980) (1,077) (1,201) 0 0 0 $310 $341 $388 205 195 193 $1,050 Copyright 2009 Deloitte Development LLC All Rights Reserved. Case 10-2: Eagle Impairment Loss Page 3 Assume the $1.05 million above is the appropriate fair value under U.S. GAAP and the recoverable amount under IFRS. Further assume management estimates no costs to sell would be incurred. The five-year business forecast prepared by management reflects an increase in the amount of capital expenditures in order to modify Eagle's main product, which, when modified, will not be subject to legislation restrictions. The additional capital expenditure estimates for these investments are $450,000 and $470,000, for 2011 and 2012, respectively (included in the capital expenditures line in the calculation of present value of discounted cash flows). The amounts of capital expenditures for 2013 and 2014 also include $50,000 and $70,000, respectively for future financing outflows Eagle may incur when borrowing funds for capital expenditures. The remaining useful life of Eagle's identifiable assets is eight years at the beginning of 2010. Eagle uses straight-line depreciation and anticipates no residual value. Management determined the discount rate used in the calculation of present value is a pre-tax discount rate of 15 percent using the weighted average cost of capital (WACC) of Eagle. Required: Question 1 Given the facts provided for Eagle in Italy, is the building impaired under IFRSs as of December 31, 2010, and if so, what is the amount of the impairment? Question 2 Given the facts provided for Eagle in Italy, is the building impaired under U.S. GAAP as of December 31, 2010, and if so, what is the amount of the impairment? Question 3 Using the information given for Eagle's CGU in Serbia, including the present value of discounted cash flow calculation, determine the following: 1. Is there an impairment loss on goodwill? If so, determine the amount of the impairment loss under IFRS and U.S. GAAP as of December 31, 2010. Assume that the fair value of PP&E is 1 million and the fair value of all other identifiable assets and liabilities, excluding goodwill, equal their carrying amounts when testing for impairment. 2. Assume that the value in use calculation is appropriate. Are management's assumptions in calculating the value in use appropriate? 3. Calculate the new carrying value of assets and CGU under IFRSs. As noted above, assume that the fair value of PP&E is 1 million and the fair value of all individual assets and liabilities, excluding goodwill, equal their carrying amounts. Question 4 Assume that during 2011, the effects of the export laws on Eagle's production in Serbia are less dramatic than initially expected by management. As Copyright 2009 Deloitte Development LLC All Rights Reserved. Case 10-2: Eagle Impairment Loss Page 4 a result, management estimates that the recoverable amount of its Serbian CGU at the end of 2011 increased to $1,200. On the basis of this information and the information from 1-3 above, calculate the reversal of loss, if any, under IFRSs and the carrying value as of December 31, 2011. The remaining useful life of PP&E is seven years at the beginning of 2011. Assume there have been no other changes in the carrying value of other assets or liabilities during 2011. Copyright 2009 Deloitte Development LLC All Rights Reserved
