Four years ago Alpha Products, Inc. acquired a computer-controlled milling machine to use in its medical device manufacturing operations at a cost of $5,000,000. The firm expected the machine to have an eight-year useful life and zero salvage value. The company has been using straight-line depreciation for the asset. Due to the rapid rate of technological change in the industry, at the end of Year 5, Alpha estimates that the machine is capable of generating (undiscounted) future cash flows of $1,500,000. Based on the quoted market prices of similar assets, Alpha estimates the machine to have a fair value of $1,200,000. Required:

Question

What is the book value of the machine at the end of Year 5? Should Alpha recognize an impairment of this asset?  Why or why not?  If yes, what is the amount of the impairment loss that should be recognized? 
At the end of Year 5, at what amount should the machine appear in Alpha's balance sheet? 
What would your answer to requirement (b.) have been if Alpha's estimate of the machine's (undiscounted) future cash flows was $2,000,000? 

What will be an ideal response?

Answer 1

a.  Book value = $5,000,000 ? [($5,000,000 ÷ 8) × 5] = $5,000,000 ? $3,125,000 = $1,875,000 
b.  Yes, the asset is impaired because the book value of $1,875,000 is greater than the undiscounted future cash flows of $1,500,000. The impairment loss to be reported on the income statement = book value ? fair value of the asset = $1,875,000 ? $1,200,000 = $675,000 
c.  The balance sheet amount at the end of year 5 is $1,200,000, the asset's fair market value. Alpha would depreciate this amount over the asset's remaining useful life.
d.  Had Alpha's estimate of the undiscounted future cash flows been $2,000,000 (instead of $1,500,000), the asset would not be deemed impaired because the book value would then be less than the cash flow estimate.