Example of Impairment - In 20X1, new legislation has outlawed tobacco, alcohol,

Question

Example of Impairment - In 20X1, new legislation has outlawed tobacco, alcohol, nudity, and bad words during the Mardi Gras celebration in New Orleans. The owner of the French Quarter Inn suspects that once this legislation takes effect, the number of visitors to his hotel will decrease dramatically. Therefore, he reviews his property for impairment. Original cost $1,000,000 S/L over 25 years 10 years $35,000 (over remaining life)' Depreciation method: Remaining life: Estimated annual cash inflows: Relevant rate: Required: Sreet )-? 1. Determine whether the hotel is impaired (recoverability test) 00, ddg 2. Determine the amount of impairment (fair value test) and record the loss. 233 33 oor oo ew 0 tr n 3. Determine the new book value for the hotel after the journal entry above. BU 4. Determine depreciation for 20X2. Assume S/L and no residual value.

Explanation / Answer

1)

Depreciation per year as per straight line method = 1000000/25 = 40000

Property used = 25 - 10 = 15 years

Current Book Value = Original cost - Total depreciation charged = 1000000 - (40000*15) = 1000000 - 600000 = 400000

Estimated annual cashflow for 10 years = 35000

Relevant rate = 4%

Recoverable amount = 35000*Present value annuity factor(4%,10)

= 35000*8.1108 = 283878

Recoverable amount is less than current book value. So, hotel is impaired.

2)

Amount of impairment = Current Book value - Recoverable amount

= 400000 - 283878 = 116122

Journal Entry:

Impairment Loss Dr 116122

Property (Asset) Cr 116122

3)

New Book Value = 400000 - 116122 = 283878 i.e. Recoverable amount

4)

Depreciation for 2012 = New Book Value/Remaining life = 283878/10 = 28387.80

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