Chapter 12, Problem 1SSC

Surfing the Standards Case 1: Impairments of PPE under IFRS

A&N, Inc. is a manufacturer and retailer of specialized office equipment. It currently operates in two countries, both of which follow IFRS for their financial reporting. For the sake of simplicity, assume that both countries have the same currency, the dollar. During its annual impairment assessment of PPE, A&N determined that one of its factories presents with various impairment indicators. Facts related to this factory follow:

1. The estimated future life of the factory is 20 to 25 years, and it has a current carrying value of $1,200,000.

2. A&N has no sales agreement for the factory, nor does an active market exist. It did sell a similar factory several years ago in another country for $1,000,000. The costs to sell the factory were $67,000.

3. A&N has a similar factory in the other country in which it currently operates. Due to differences in the market for their products in the two countries, the cash flow streams will not be similar.

4. The table on the next page presents the projected cash inflows for the factory based on the most recent budgets approved by management.

5. Although management can demonstrate that its short-term projects tend to be reasonably accurate, there is some uncertainty as to the projected cash flows. Management assesses that there is a range on either side of the projected cash inflows: The cash inflows could be as much as 10% lower than projected or 5% greater than projected. While the most likely amount is included m the following schedule presented, the probabilities associated with each amount are unknown.

6. The table on the next page also presents the total projected cash outflows for overhead as well as specific projected outflows for maintenance of the factory. Generally, 25% of overhead is allocable to the use of the factory.

7. The increase in projected cash inflows in Year 4 is related to a planned overhaul of the factory. The estimated cash outflow for the overhaul is $50,000 (which is included in the table’s Other Projected Cash Outflows column). The anticipated increase in cash inflow is $10,000 a year.

8. The cash-flow amounts presented are net of the corporate tax rate of 20%.

9. A&N anticipates a steady long-term growth rate of 3%. Its historical growth rate has been 0.5%.

10. Management anticipates that it will ultimately sell the factory for $1,000,000 because that is the amount of the last factory sale and that disposal costs will be similar to those incurred for the last sale. Because this anticipated sale is far off in time, the confidence range on this transaction is 50% less and 25% greater than these estimates. Although management finds it 60% likely that it will obtain the sales price of $1,000,000 (and disposal costs of $67,000), the firm believes that the bottom of the range and the top of the range are each 20% likely.

11. All cash flows are presented in nominal terms as opposed to real terms.

12 A&N’s pre-tax weighted cost of capital is currently 8%. Management expects this amount to increase in Year 4 to 9% due to a change in the term structure of interest rates. These rates include an expectation for general inflation.

13. The operations in the particular country in which this factory is located are a bit riskier due to political unrest than in the other country in which A&N operates. Management believes that this increased risk would translate into a 1% increase in the appropriate discount rate for the factory itself.

Read IAS 36, Impairment of Assets, paragraphs 18 through 57 as well as paragraphs A1 through A21 in its Appendix A. Provide answers to the following questions based upon this reading.

1. Because the determination of the amount of the impairment loss involves the use of the fair value (net of disposal costs), does A&N have to use the $933,000 net selling price of its other factory to approximate the fair value less disposal costs even though this number may not be very solid?

2. What adjustments does management need to make to the projected cash inflows presented in the following table in order to reflect projected cash inflows that are consistent with the requirements in IAS 36 for determining value in use?

3. What adjustment does management need to make to the projected cash outflows presented in the following table in order to reflect projected cash outflows that are consistent with the requirement in IAS 36 for determining value m use?

4. How should A&N include the expectations about the anticipated sale of the factory in the computation of value in use?

5. What discount rate should A&N use to compute value in use?

Original Projections by Management
Year	Projected Cash Inflows	Total Projected Overhead	Other Projected Cash Outflows	Total Cash Outflows
1	$70,000	$8,000	$2,500	$10,500
2	$73,000	$8,040	$2,500	$10,540
3	$72,000	$8,080	$2,500	$10,580
4	$83,000	$8,121	$52,500	$60,621
5	$84,000	$8,161	$2,500	$10,661
6	$86,520	$8,202	$2,500	$10,702
7	$89,116	$8,243	$2,500	$10,743
8	$91,789	$8,284	$2,500	$10,784
9	$94,543	$8,326	$2,500	$10,826
10	$97,379	$8,367	$2,500	$10,867
11	$100,300	$8,409	$2,500	$10,909
12	$103,309	$8,451	$2,500	$10,951
13	$106,409	$8,493	$2,500	$10,993
14	$109,601	$8,536	$2,500	$11,036
15	$112,889	$8,579	$2,500	$11,079
16	$116,276	$8,621	$2,500	$11,121
17	$119,764	$8,665	$2,500	$11,165
18	$123,357	$8,708	$2,500	$11,208
19	$127,058	$8,751	$2,500	$11,251
20	$130,869	$8,795	$2,500	$11,295
21	$134,795	$8,839	$2,500	$11,339
22	$138,839	$8,883	$2,500	$11,383
23	$143,004	$8,928	$2,500	$11,428
24	$147,295	$8,972	$2,500	$11,472
25	$151,713	$9,017	$2,500	$11,517