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An asset is impaired if its future cash flows (undiscounted) are less than its carrying value.
An analyst determined the following information concerning Franklin, Inc.’s stamping machine:
The stamping machine is expected to generate $1,500,000 per year for five more years and will then be sold for $1,000,000. The stamping machine is:
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The carrying value of the stamping machine is its cost less accumulated depreciation. Depreciation taken through 7 years was ($22,000,000 - $4,000,000) / 12 × 7 = $10,500,000, so carrying value is $22,000,000 - $10,500,000 = $11,500,000. Because the $11,500,000 carrying value is more than expected future cash flows of (5 × $1,500,000) + $1,000,000 = $8,500,000, the stamping machine is impaired.
Lakeside Co. recently determined that one of its processing machines has become obsolete three years early and, unexpectedly, has no salvage value. Which of the following statements is most consistent with this discovery?
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Historically, economic depreciation was understated. If an asset becomes obsolete and its useful life is less than expected, accounting methods for depreciation will understate the economic depreciation. In addition, if there is no salvage value when positive salvage value was expected, the understatement problem is compounded.
As part of a major restructuring of business units, General Security (an industrial conglomerate operating solely in the U.S. and subject to U.S. GAAP) recognizes significant impairment losses. The Investor Relations group is preparing an informational packet for shareholders, employees, and the media. Which of the following statements is least accurate?
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Impairments cannot be restored under U.S. GAAP. Both remaining statements are correct.
An impairment write-down is least likely to decrease a company's:
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An impairment write-down reduces equity and has no effect on debt. The debt-to- equity ratio would therefore increase.
Taking an impairment of long-lived assets will result in:
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In future years, less depreciation expense is recognized on the written-down asset resulting in higher net income and return on assets since ROA = NI/Total Assets. Deferred tax liabilities related to the asset decrease because the impairment cannot be deducted from taxable income until the asset is sold or disposed of. The debt/equity ratio increases because equity decreases while debt is unchanged.
Selected information from Ingot Company’s financial statements for the year ended December 31, 20X4, was as follows prior to the consideration of its impaired asset write-down (in $):
Cash
120,000
Short-term Debt
290,000
Accounts Receivable
200,000
Long-term Debt
740,000
Inventory
300,000
Common Stock
800,000
Property Plant & Eq. (net)
1,700,000
Retained Earnings
490,000
2,320,000
2,320,000
Ingot Company’s excavation machine is permanently impaired. Its purchase price was $1,600,000 and its accumulated depreciation was $800,000 through 20X4. The present value of its future cash flows is $500,000.
The write-down of the excavation machine will cause Ingot’s total debt ratio (total debt-to-total capital) to:
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The write-down of the excavation machine in the amount of ((($1,600,000 ? $800,000) ? $500,000) =) $300,000 decreases retained earnings from $490,000 to $190,000. The total debt to equity ratio increases from (($290,000 + $740,000) / ($290,000 + $740,000 + $800,000 + $490,000) =) 0.44 to (($290,000 + $740,000) / ($290,000 + $740,000 + $800,000 + $190,000) =) 0.51
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