Chapter 12, Problem 6P

1.

To determine

Prepare journal entries to record the impairment of intangible assets of Company W at December 31, 2016.

Explanation of Solution

Impairment: Impairment refers to the decrease in the value of long-lived assets due to obsolescence, damage. If the remaining book value of a plant asset could not be recovered from the future cash flows expected to be generated from the use of the asset, the value of the plant asset is said to be impaired. When the long-lived asset is impaired, then the future cash flows expected to be generated from the use of the asset is less than the current book value of the asset.

Prepare journal entries to record the impairment of intangible assets of Company W at December 31, 2016 as follows:

Loss on impairment of patent:

Date	Accounts Title and Explanation	Post Ref.	Debit ($)	Credit ($)
December 31, 2016	Loss on impairment-Patent (3)		18,000
	Patent			18,000
	(To record the impairment loss of patent)

Table (1)

• Loss on impairment-patent is an expense account and it decreases the equity value. Hence, debit the loss on impairment account with $18,000.
• Patent is an asset account and it is decreased. Therefore, credit the patent account with $18,000.

Working note (1):

Calculate the accumulated depreciation for 4 years.

$\begin{array}{c}\text{Accumulated depreciation = }\frac{\text{Cost of aquisation}}{\text{Useful life}}\times \text{Depreciation incurred}\\ \text{=}\frac{\$100,000}{10\text{ years}}\times 4\text{ years}\\ \text{=\$40,000}\end{array}$

Working note (2):

Calculate the book value of patent.

$\begin{array}{c}\text{Book value of patent = }\left(\begin{array}{l}\text{Cost of patent as on 2015}-\\ \text{Accumulated depreciation}\end{array}\right)\\ =\$100,000-\$40,000(1)\\ =\$60,000\end{array}$

Working note (3):

Calculate the impairment loss of patent.

$\begin{array}{c}\text{Impairment loss = Fair value}-\text{Book value}\\ \text{=\$42,000}-\$60,000(3)\\ =(\$18,000)\end{array}$

Loss on impairment of tradename:

In this case, trade name is not impaired, because the fair value of trade name is higher than the original cost. At the same time, GAAP does not allow revaluation of intangible assets as a result the carrying value of the trade name is not increased.

Loss on impairment of goodwill:

In this case, the fair value of subsidiary company ($400,000) is greater than its carrying value ($150,000). Hence, company W must perform two step quantitative impairment tests.

1. 1. If the fair value of subsidiary company ($400,000) is not greater than the book value ($750,000), then company W should perform second step of impairment test.
2. 2. When the implied fair value of the goodwill ($80,000) is less than the carrying value of goodwill ($150,000), it indicates that Company W has recognized impairment loss on goodwill.

Date	Accounts Title and Explanation	Post Ref.	Debit ($)	Credit ($)
December 31, 2016	Impairment loss on Goodwill (5)		70,000
	Goodwill			70,000
	(To record the impairment loss of goodwill)

Table (2)

• Impairment loss on goodwill is an expense account and it decreases the equity value. Hence, debit the loss on impairment account with $70,000.
• Goodwill is an asset account and it is decreased. Therefore, credit the goodwill account with $70,000.

Working note (4):

Calculate the implied fair value of goodwill.

$\begin{array}{c}\begin{array}{l}\text{Implied fair value }\\ \text{of goodwill }\end{array}\}\text{= }\left[\begin{array}{l}\text{Fair value of subsidiary company }-\\ \left(\begin{array}{l}\text{Fair value of subsidiary company}\times \text{Allocated}\\ \text{percentage of identifiable assets and liabilities }\end{array}\right)\end{array}\right]\\ =\$400,000-\left(\$400,000\times \frac{80}{100}\right)\\ =\$400,000-\$320,000\\ =\$80,000\end{array}$

Working note (5):

Calculate the impairment loss of goodwill.

$\begin{array}{c}\text{Impairment loss = }\left(\begin{array}{l}\text{Implied fair value of goodwill}-\\ \text{Carrying value of goodwill}\end{array}\right)\\ \text{=\$80,000}-\$150,000\\ =(\$70,000)\end{array}$

2.

To determine

Prepare journal entries to record the amortization expense of Company W for December 31, 2017.

Explanation of Solution

Prepare journal entries to record the amortization expense of Company W for December 31, 2017 as follows:

Amortization expense of patent:

Date	Account Title and Explanation	Debit ($)	Credit ($)
December 31, 2017	Amortization expense (6)	7,000
	Patent		7,000
	(To record the amortization expense incurred)

Table (3)

• Amortization expense is component of shareholders’ equity, and it decreases the value of shareholders equity. Hence, debit the amortization expense with $7,000.
• Patent is an asset account, and it decreases the value of asset. Hence, credit the patent account with $7,000.

Working note (6):

Calculate the amortization expense of patent.

$\begin{array}{c}\text{Amortization expnes = }\frac{\text{Fair value of patent}}{\text{Remaing useful life}}\\ =\frac{\$42,000}{\left(\text{10 years}-4\text{ years}\right)}\\ =\$7,000\end{array}$

Amortization expense of trade name:

Date	Account Title and Explanation	Debit ($)	Credit ($)
December 31, 2017	Amortization expense (7)	16,000
	Trade name		16,000
	(To record the amortization expense incurred)

Table (4)

• Amortization expense is component of shareholders’ equity, and it decreases the value of shareholders equity. Hence, debit the amortization expense with $16,000.
• Trade name is an asset account, and it decreases the value of asset. Hence, credit the trade name account with $16,000.

Working note (7):

Calculate the amortization expense of patent.

$\begin{array}{c}\text{Amortization expnes = }\frac{\text{Cost of trade name}}{\text{Useful life}}\\ =\frac{\$80,000}{5\text{ years}}\\ =\$16,000\end{array}$

Amortization expense of goodwill:

In this case, the goodwill is not amortized during 2017.