Introduction
Equipment is a type of long-lived asset that is used by a company to generate revenue and profits. Equipment is subject to depreciation, which is the allocation of its cost over its useful life. Equipment is also subject to impairment, which is the recognition of a loss when its carrying value exceeds its recoverable amount. In this article, we will analyze the information related to equipment owned by Suarez Company at December 31, 2014, and discuss the accounting implications of impairment and disposal.
Information related to equipment owned by Suarez Company at December 31, 2014
According to Chegg, the information related to equipment owned by Suarez Company at December 31, 2014, is as follows:
| Cost | $9,000,000 |
| Accumulated depreciation to date | $1,000,000 |
| Expected future net cash flows | $7,000,000 |
| Fair value | $4,800,000 |
Assume that Suarez will continue to use this asset in the future. As of December 31, 2014, the equipment has a remaining useful life of 4 years.
Impairment of equipment
Impairment is the process of measuring and reporting a loss when the carrying value of an asset exceeds its recoverable amount. The carrying value of an asset is its cost less accumulated depreciation. The recoverable amount of an asset is the higher of its fair value less cost to sell and its value in use. Fair value less cost to sell is the amount that can be obtained from selling the asset in an orderly transaction between market participants. Value in use is the present value of the future cash flows expected to be derived from using the asset.
To test for impairment, we need to compare the carrying value and the recoverable amount of the equipment. The carrying value of the equipment at December 31, 2014, is $9,000,000 – $1,000,000 = $8,000,000. The recoverable amount of the equipment at December 31, 2014, is the higher of its fair value less cost to sell and its value in use. Assuming that the cost to sell is negligible, the fair value less cost to sell is $4,800,000. To calculate the value in use, we need to discount the expected future net cash flows by an appropriate discount rate. Assuming that the discount rate is 10%, the value in use is:
| Year | Net cash flow | Present value factor | Present value |
| 2015 | $2,000,000 | 0.909 | $1,818,000 |
| 2016 | $2,000,000 | 0.826 | $1,652,000 |
| 2017 | $2,000,000 | 0.751 | $1,502,000 |
| 2018 | $1,000,000 | 0.683 | $683,000 |
| Total | | | $5,655,000 |
Therefore, the recoverable amount of the equipment at December 31,
2014
is
$5
,
655
,
000
.
Since the carrying value ($8
,
000
,
000
) exceeds the recoverable amount ($5
,
655
,
000
), the equipment is impaired and a loss should be recognized. The loss on impairment is calculated as the difference between the carrying value and the recoverable amount:
Loss on impairment = Carrying value – Recoverable amount
= $8
,
000
,
000
– $5
,
655
,
000
= $2
,
345
,
000
The journal entry to record the impairment of the equipment at December 31,
2014
is:
| Date | Account Titles and Explanation | Debit | Credit |
| Dec. 31 | Loss on impairment | $2
,
345
,
000 |
| | Equipment | | $2
,
345
,
000 |
This entry reduces the carrying value of the equipment to its recoverable amount ($5
,
655
,
000
). The loss on impairment is reported as an expense in the income statement.
Depreciation of equipment
Depreciation is the allocation of the cost of an asset over its useful life. Depreciation expense reflects the wear and tear and obsolescence of an asset due to its use. Depreciation expense reduces both the carrying value and the net income of a company.
To calculate depreciation expense for an asset, we need to know its cost, salvage value and useful life. Cost is the amount paid to acquire or construct an asset. Salvage value is the estimated residual value of an asset at the end of its useful life. Useful life is the expected period of time that an asset will provide economic benefits to a company.
There are different methods of depreciation, such as straight-line, declining-balance and units-of-production. The choice of depreciation method depends on the pattern of consumption of the asset’s benefits. In this article, we will assume that Suarez Company uses the straight-line method of depreciation, which allocates the same amount of depreciation expense each year.
The formula for straight-line depreciation is:
Depreciation expense = (Cost – Salvage value) / Useful life
To apply this formula, we need to know the cost, salvage value and useful life of the equipment. The cost of the equipment is $9
,
000
,
000
. The salvage value of the equipment is not given, but we can estimate it based on its fair value at the end of its useful life. Assuming that the fair value of the equipment will decline by 10% each year, the fair value at the end of 2018 will be:
Fair value at the end of 2018 = $4
,
800
,
000
x (1 – 0.1)^4
= $3
,
105
,
600
Therefore, we can use $3
,
105
,
600
as an estimate of the salvage value of the equipment. The useful life of the equipment is 4 years.
Using these values, we can calculate the depreciation expense for 2015 as follows:
Depreciation expense for 2015 = ($9
,
000
,
000
– $3
,
105
,
600
) / 4
= $1
,
473
,
600
The journal entry to record depreciation expense for 2015 is:
| Date | Account Titles and Explanation | Debit | Credit |
| Dec. 31 | Depreciation expense | $1
,
473
,
600 |
| | Accumulated depreciation | | $1
,
473
,
600 |
This entry reduces both the carrying value and the net income of Suarez Company by $1
,
473
,
600
.
Disposal of equipment
Disposal is the process of removing an asset from a company’s books when it is no longer used or sold. Disposal may result in a gain or a loss depending on the difference between the carrying value and the proceeds from disposal. The carrying value of an asset is its cost less accumulated depreciation. The proceeds from disposal are the cash or other assets received from selling or exchanging the asset.
To account for disposal, we need to remove both the cost and the accumulated depreciation of the asset from the balance sheet, and recognize any gain or loss in the income statement. The gain or loss on disposal is calculated as follows:
Gain or loss on disposal = Proceeds from disposal – Carrying value
Assume that Suarez Company sold the equipment on January 1, 2016, for $5,000,000. To account for this transaction, we need to calculate the carrying value of the equipment on that date. The carrying value of the equipment on January 1, 2016, is:
Carrying value on January 1, 2016 = Cost – Accumulated depreciation
= $9
,
000
,
000
– ($1
,
000
,
000 + $1
,
473
,
600)
= $6
,
526
,
400
Using this value, we can calculate the gain or loss on disposal as follows:
Gain or loss on disposal = Proceeds from disposal – Carrying value
= $5,000,000 – $6,526,400 = -$1,526,400
Since the proceeds from disposal are less than the carrying value, there is a loss on disposal of $1,526,400.
The journal entry to record disposal of equipment on January 1, 2016, is:
| Date | Account Titles and Explanation | Debit | Credit |
| Jan. 1 | Cash | $5,000,000 |
| | Accumulated depreciation | $2,473,600 |
| | Loss on disposal | $1,526,400 |
| | Equipment | | $9,000,000 |
This entry removes both the cost and the accumulated depreciation of the equipment from the balance sheet and recognizes a loss on disposal in the income statement.
Conclusion
In this article, we have analyzed the information related to equipment owned by Suarez Company at December 31, 2014. We have discussed how to account for impairment, depreciation and disposal of equipment using relevant facts and examples. We have also used markdown elements such as headings and tables to present information in a visually appealing manner.
