Question

Four years ago Omega Technology, Inc., acquired a machine to use in its computer chip manufacturing operations at a cost of $35,000,000. The firm expected the machine to have a seven-year useful life and a zero salvage value. The company has been using straight-line depreciation for the asset. Due to the rapid rate of technological change in the industry, at the end of Year 4, Omega estimates that the machine is capable of generating (undiscounted) future cash flows of $11,000,000. Based on the quoted market prices of similar assets, Omega estimates the machine to have a fair value of $9,500,000.Required:1. What is the machine’s book value at the end of Year 4?2. Should Omega recognize an impairment of this asset? Why or why not? If so, what amount of the impairment loss should be recognized?3. At the end of Year 4, at what amount should the machine appear in Omega’s balance sheet?

Answer 1

Answer:

book value before impairment: 15,000,000

impairment: 4,000,000

net value of the machine in the balance sheet 11,000,000

Explanation:

Book value of computer chip:

35,000,000 / 7 = 5,000,000 depreciation expense per year

depreciation accumulated after 4 years:

5,000,000 x 4 = 20,000,000

book value at end of year 4:

35,000,000 - 20,000,000 = 15,000,000

When there is indication of impairment of an asset, the company should do a test for impairment. This will be evaluate based on the ability to generate cash inflows independent from other assets.

In this case this is a know figure, so we can use it to compare with the book value.

fair value (future value of the cash flow generate for the microchip)

11,000,000

Loss on impairment: 11,000,000 - 15,000,000 = 4,000,000

At the end of year 4 it will have a value of 11,000,000