Home Computer, Inc. (also referred to as Home Computer) is a publicly traded company that focuses on the production and sale of computer hardware. It runs five manufacturing plants and 221 retail locations across 32 states. Home Computer comprises three divisions: (1) computer manufacturing, (2) printer manufacturing, and (3) retail store distribution.
On February 3, 2002, Home Computer approved the “Plan,” which was a restructuring plan introduced in January 2002. The Board of Directors held a special meeting to approve the Plan. Here are the specific details:
Operations for the Video Monitor
Home Computer manufactures computer component parts at its Seattle, Washington plant. However, the company will be discontinuing its video monitor operations in Seattle. They plan to establish a replacement facility in Sacramento, California. The rest of the component parts will still be manufactured in Seattle. The company will dispose of the equipment and “special interior building configuration assets” related to the video monitor operations as they won’t be needed anymore. It is estimated that it will take 10 months to bring the replacement facility online.
Management has identified video monitor operations as the lowest level where identifiable cash flows are independent of other assets and liabilities. This includes the equipment and “special interior building configuration assets.”
The company anticipates receiving $3.5 million in cash flows from the video monitor operations within a span of 10 months. These cash flows have been discounted using a rate that accounts for the associated risk, resulting in a present value of $3.2 million. This present value represents management’s assessment of the fair value of both the equipment and special interior building configuration assets.
The video monitor operations’ equipment and the “special interior building configuration assets” have a net book value of $8 million currently. Minimal proceeds from scrap sales are expected.
The net book value of the Seattle building is currently $15 million. After the 10-month phase-out period, the building could be sold for $26 million, which has a present value of $24 million.
Management has identified the “special interior building configuration assets” as the primary component asset that generates cash flow capacity for the video monitor operations.
Required:
• Home Computer needs guidance on how to classify the assets that will be scrapped in the video monitor operations on March 31, 2002, for impairment testing purposes.
Should Home Computer recognize an impairment charge for the video monitor assets? If an impairment charge is necessary, determine the amount.
Home Computer Inc.
Accounting Issue
Should Home Computer recognize an impairment charge for the video monitor assets?
Alternatives
Alternative 1 — Recognition of an impairment charge of $4.8 million [$8.0 – $3.2 = $4.8]. This charge reflects the disparity between the carrying amount ($8 million) and the fair value ($3.2 million) of the video monitor asset group.
Alternative 2 — The recognition of impairment charge should not be done as the combined undiscounted cash flows of the building and video monitor assets surpass the combined carrying amount of these assets.
Common Literature for Alternative 1 and 2 (see support for each alternative below)
Need to perform impairment check:
According to Paragraph 8 of Statement 144, it is necessary to assess the recoverability of a long-lived asset or asset group when there are indications that its carrying amount may not be recoverable. This paragraph provides various examples of such indications. In the case of both the video monitor and the printer manufacturing asset groups, conditions (b) and (f) mentioned in Paragraph 8 are met. Therefore, an impairment analysis needs to be conducted.
Conditions (b) and (f):
(b) Any considerable negative alteration in the extent or mode of utilization or physical state of a long-lived asset (asset group)
The current expectation is that an asset group, comprising a long-lived asset, will be sold or disposed of prior to its originally estimated useful life. [footnote excluded]
Asset grouping:
Under the impairment analysis prescribed by Statement 144, assets must be grouped according to the guidance in paragraph 10 of Statement 144:
Paragraph 14 states that when determining and evaluating an impairment loss, a long-lived asset or assets should be consolidated with other assets and liabilities at the lowest level where the identifiable cash flows are largely distinct from those of other assets and liabilities. However, any impairment loss that arises as a result of adhering to this guideline will only impact the carrying value of a long-lived asset or assets within the group.
In order to evaluate the possible recovery of a long-lived asset group, it is crucial to estimate the future cash flows. These estimations should consider the entity’s determination of the remaining useful life for the asset group.
Supporters of Alternative 1 argue that the video monitor operations’ equipment and “special interior building configuration assets” should undergo a two-step impairment test as outlined in Statement 144. This grouping represents the lowest level at which cash flows are mostly independent from other assets and liabilities, according to management. The projected cash flows of this asset group should cover the 10-month wind-down period, which aligns with the lifespan of the primary asset within the group. Therefore, it is necessary to compare the total carrying value of the asset group to its undiscounted cash flows it will generate. In this case, since the carrying value is $8 million and exceeds projected undiscounted cash flows of $3.5 million, an impairment loss is required. Consequently, there is an impairment loss equal to the difference between the carrying value of the assets ($8.0) and their estimated fair value ($3.2), resulting in $4.8 million.
It is evident that the Seattle building generates cash flows for the video monitor operations. However, it also accommodates various other operations. Consequently, the building serves as a central facility that benefits multiple asset groups and cannot be attributed to any particular set of assets and liabilities. Therefore, the Seattle facility should not be included in the asset group during the impairment test.
Literature in Support of Alternative 2
Proponents of Alternative 2 argue that comparing the cash flows generated by the video monitor operations to the carrying value of the equipment would be inappropriate. According to them, the cash flows result from the combined productivity of the video monitor assets and the building they are located in. Hence, these proponents believe that the combined cash flows of both the building and the video monitor assets should be compared to the combined carrying amount of these assets. They argue that this is the lowest level at which cash flows are mostly independent from other assets and liabilities.
Based on this approach, the combined cash flows of $3.5 million from future operations and $26 million from a potential sale of the building ($29.5 million in total) exceed the combined carrying amount of the building and equipment, which is $23 million ($8.0 + $15.0 = $23.0). Consequently, proponents contend that the carrying amount of the assets can be recovered, and there is no need for impairment loss.
Solution
Alternative 1 was found to be the suitable solution.
