Question

Zeltec Inc. has 800 hectares of agricultural land as part of its property, plant, and equipment. The land had an original cost of $4.4 million, which is also its reported value as of June 30, 2021. Zeltec rented out this land under a five-year lease that expired on June 30, 2021, at an annual rent of $400 per hectare. The company follows the cost model for measuring the land.

Due to the current state of the agricultural sector, the board of directors is concerned about whether the value of the land has been impaired.
The new rental lease agreement requires rental payments of $350 per hectare for five years beginning July 1, 2021, with the first payment due on July 1, 20212020. There is no indication that rental values will increase in the foreseeable future. The land was formally appraised as of July 1, 2021, and that appraisal indicated a market value, if sold, of $4,800 per hectare, with estimated selling costs of $100,000.
Explain to the board of directors whether impairment has occurred and, if so, prepare the journal entry required to reflect the impairment in the accounts for the year to June 30, 2021. Assume the required rate of return is 7%. The company follows IFRS for reporting purposes.

Answer 1

To determine whether impairment has occurred on the land, we need to compare its carrying amount to its recoverable amount. The fair value less selling costs is calculated as the market value minus the estimated selling costs. The value in use is calculated based on the present value of expected future cash flows from renting out the land.

To determine whether impairment has occurred on the land, we need to compare its carrying amount (the original cost of $4.4 million) to its recoverable amount, which is the higher of its fair value less selling costs or its value in use. The fair value less selling costs is calculated as the market value of $4,800 per hectare minus the estimated selling costs of $100,000, which equals $4,700 per hectare. The value in use is calculated based on the present value of expected future cash flows from renting out the land at the new rental rate.

Using the required rate of return of 7% and the new rental payment of $350 per hectare, we can calculate the present value of the expected cash flows over the next five years:

1. Year 1: $350 per hectare
2. Year 2: $350 per hectare
3. Year 3: $350 per hectare
4. Year 4: $350 per hectare
5. Year 5: $350 per hectare

Using the formula for the present value of an annuity, we can find that the present value of the expected cash flows is $1,514 per hectare. Since the fair value less selling costs of $4,700 per hectare is higher than the value in use of $1,514 per hectare, there is no impairment.

The journal entry to reflect the impairment, if it had occurred, would be:

Debit: Loss on Impairment $0

• Credit: Accumulated Depreciation $0