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Impairment Essay

1727 words - 7 pages

Dear Mr. Gabriel,

In response to your inquiry regarding potential adjustments to the carrying value of your corporation’s tangible assets for possible impairments in value and also for possible impairment of value of the Goodwill booked on the corporation’s Balance Sheet, I have researched and concluded the following information and proper disclosures for XYZ Corporation.

Tangible Assets
Let’s begin with the tangible assets of the corporation. Over the useful life of the asset, it is necessary to periodically test for impairment. Impairment exists when the carrying value of a long-lived asset exceeds the fair value of the asset and is not recoverable. Various events and changes in ...view middle of the document...

It is necessary to recognize and disclose an impairment loss to give a correct value to the assets on the Balance Sheet. If the value is understated or overstated, it could be misleading to investors, Board Members, and the general public. To give an illustration of what is explained above, I have given examples of impairments.

NO IMPAIRMENT
A piping company had an inventory of pipe with a book value of $450,000, which the fair value of the market had decreased. The expected future net cash flows and eventual disposal from the inventory is $480,000. Since the expected future net cash flows and disposal exceeds the book value (carrying value), there is no impairment of the pipe and a loss is not recognized for the company.

IMPAIRMENT
The same piping company the following year had an inventory book value of $800,000. The company performed another test for impairment due to another decrease in fair value of the market. The expected future net cash flows were $620,000 from the inventory. Therefore, the recoverability test indicates that the company needs to recognize impairment since the expected future net cash flows is less than the book value. The fair value of the inventory of pipe was valued at $700,000, which means the company should recognize an impairment loss of $100,000. The loss is calculated by subtracting the fair value from the book or carrying value (800,000-700,000). To record the loss, the entry needs to be as follows:

Loss on Impairment $100,000
Inventory $100,000

Since there was a $100,000 impairment loss, it needs to be included on the Income Statement of the company. It should be included in the continuing operations sections under “Other expense and losses.”

Goodwill Impairment
To address the goodwill of the corporation, first, goodwill is the excess value of cost of the purchase over the fair value of the identifiable net assets purchased. For example, if company Z bought a company R for $100,000, in which company R’s net assets were valued at $90,000. The goodwill that should be recorded on company Z’s Balance Sheet is $10,000. Goodwill should be tested annually for impairment.

As with tangibles, goodwill must be tested periodically for impairment and is similar in nature to that of tangible assets. It is a two-step process when applying the impairment rule to goodwill. First, you must compare the fair value of the reporting unit to the carrying value, which includes goodwill. If the fair value is greater than the carrying value, goodwill is not impaired. If the fair value is the less the carrying value, the company must recognize an impairment and perform the second step. The company should determine the value of the fair value of the goodwill and compare it to the carrying amount.

Lets take for example Company Z from above. The company determined $10,000 of goodwill from the purchase of Company R. When purchased, the fair value of the assets was $90,000 and was purchased by...

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