Presented below is information related to equipment owned by Suarez Company at December 31, 2017. The company is a manufacturer of industrial machinery and has been in business for over 20 years. The equipment in question is a large metal press that was purchased in 2013 for $9,000,000. The equipment has a useful life of 10 years and a salvage value of $500,000. The company uses the straight-line method of depreciation and records depreciation expense at the end of each year.
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What is Impairment?
According to AccountingTools, impairment is the condition that exists when an asset’s carrying amount exceeds its recoverable amount. The carrying amount is the cost of the asset less accumulated depreciation, while the recoverable amount is the higher of the asset’s fair value less cost to sell or its value in use. Fair value is the amount that can be obtained from selling the asset in an orderly transaction, while value in use is the present value of the future cash flows expected from using the asset.
Impairment can occur due to various factors, such as physical damage, obsolescence, changes in market conditions, legal restrictions, or technological advances. When impairment occurs, the company must recognize an impairment loss in its income statement and reduce the carrying amount of the asset to its recoverable amount. This will also affect the future depreciation expense of the asset.
How to Test for Impairment?
According to AccountingCoach, there are two steps to test for impairment. The first step is to compare the carrying amount of the asset with its undiscounted future cash flows. If the carrying amount is higher than the undiscounted future cash flows, then the asset is impaired and the second step is required. The second step is to compare the carrying amount of the asset with its fair value. The difference between the carrying amount and the fair value is the impairment loss.
How to Apply Impairment to Suarez Company’s Equipment?
Based on the information provided, we can calculate the carrying amount and the undiscounted future cash flows of Suarez Company’s equipment as follows:
- Carrying amount = Cost – Accumulated depreciation
- Carrying amount = $9,000,000 – $1,000,000
- Carrying amount = $8,000,000
- Undiscounted future cash flows = Expected future net cash flows
- Undiscounted future cash flows = $7,000,000
Since the carrying amount ($8,000,000) is higher than the undiscounted future cash flows ($7,000,000), we need to perform the second step of impairment testing. The fair value of the equipment is given as $4,800,000. Therefore, we can calculate the impairment loss as follows:
- Impairment loss = Carrying amount – Fair value
- Impairment loss = $8,000,000 – $4,800,000
- Impairment loss = $3,200,000
The journal entry to record the impairment loss at December 31, 2017 is:
| Account | Debit | Credit |
| Loss on impairment | $3,200,000 | |
| Accumulated depreciation – Equipment | $3,200,000 |
This entry will reduce the carrying amount of the equipment to its fair value ($4,800,000) and recognize an expense in the income statement. The new depreciation expense for 2018 will be calculated as follows:
- Depreciation expense = (Carrying amount – Salvage value) / Remaining useful life
- Depreciation expense = ($4,800,000 – $500,000) / 4
- Depreciation expense = $1,075,000
The journal entry to record depreciation expense for 2018 is:
| Account | Debit | Credit |
| Depreciation expense – Equipment | $1,075,000 | |
| Accumulated depreciation – Equipment | $1,075,000 |
How to Account for Changes in Fair Value?
According to IFRS Standards, if an impaired asset’s fair value increases in a subsequent period due to a change in economic conditions or expectations, then the impairment loss can be reversed up to the original carrying amount before impairment. However, according to US GAAP, once an impairment loss is recognized for a long-lived asset held and used by a company (such as Suarez Company’s equipment), it cannot be reversed even if the fair value increases in a subsequent period.
Therefore, if we assume that Suarez Company follows IFRS Standards and that the fair value of its equipment at December 31, 2018 is $5,100,000 (an increase of $300,000 from the previous year), then we can reverse the impairment loss as follows:
- Reversal of impairment loss = Fair value – Carrying amount
- Reversal of impairment loss = $5,100,000 – $4,800,000
- Reversal of impairment loss = $300,000
The journal entry to record the reversal of impairment loss at December 31, 2018 is:
| Account | Debit | Credit |
| Accumulated depreciation – Equipment | $300,000 | |
| Gain on reversal of impairment | $300,000 |
This entry will increase the carrying amount of the equipment to its fair value ($5,100,000) and recognize an income in the income statement. The new depreciation expense for 2019 will be calculated as follows:
- Depreciation expense = (Carrying amount – Salvage value) / Remaining useful life
- Depreciation expense = ($5,100,000 – $500,000) / 3
- Depreciation expense = $1,533,333
The journal entry to record depreciation expense for 2019 is:
| Account | Debit | Credit |
| Depreciation expense – Equipment | $1,533,333 | |
| Accumulated depreciation – Equipment | $1,533,333 |
Conclusion
In this article, we have discussed how to account for impairment of equipment using the case study of Suarez Company. We have explained what impairment is, how to test for impairment, how to record impairment loss and depreciation expense, and how to account for changes in fair value. We have also shown the differences between IFRS Standards and US GAAP in terms of reversing impairment loss. We hope this article has helped you understand the concept and application of impairment accounting.
