The management of Luis Inc., a small private company that uses the cost recovery impairment model, was discussing whether certain equipment should be written down as a charge to current operations because of obsolescence. The assets had a cost of $900,000, and depreciation of $400,000 had been taken to December 31, 2014. On December 31, 2014, management projected the undiscounted future net cash flows from this equipment to be $300,000, and its fair value to be $230,000. The company intends to use this equipment in the future.
Instructions
(a) Prepare the journal entry, if any, to record the impairment at December 31, 2014.
(b) Where should the gain or loss on the impairment, if any, be reported on the income statement?
(c) At December 31, 2015, the equipment’s fair value increased to $260,000. Prepare the journal entry, if any, to record this increase in fair value.
(d) Assume instead that as of December 31, 2014, the equipment was expected to have undiscounted future net cash flows of $510,000, and that its fair value was estimated to be $450,000. Prepare the journal entry to record the impairment at December 31, 2014, if any.
(e) Assume instead that as of December 31, 2014, the equipment was expected to have undiscounted future net cash flows of $45,000 per year for each of the next 10 years, and that there is no active market for the equipment. Luis Inc. uses a 10% discount rate in its cash flow estimates. Prepare the journal entry to record impairment at December 31, 2014, if any.
(f) Discuss why impairment is tested using undiscounted future cash flows rather than present value of future cash flows.