Question

Truffle Inc. acquired a patent on January 1, 2011 for $7,800,000. It was expected to have a 10 year life and no residual value. Truffle uses straight-line amortization for its patents. On December 31, 2014, the expected future cash flows from the patent are $518,000 per year for the next six years. The present value of these cash flows, discounted at Truffle's market interest rate, is $2,120,000. What amount, if any, of impairment loss will be reported on Truffle's 2014 income statement?

Answer 1

Truffle Inc. will report an impairment loss of $2,560,000 on their 2014 income statement, calculated by subtracting the present value of expected future cash flows from the net book value of the patent.

Step-by-step explanation:

The student asked about the impairment loss to be reported for a patent owned by Truffle Inc. The initial cost of the patent was $7,800,000, and by the end of 2014, after straight-line amortization, the net book value (carrying amount) of the patent would be $4,680,000 (calculated as the initial cost minus four years of amortization at $780,000 per year).

Given that the present value of expected future cash flows is only $2,120,000, an impairment is necessary. The impairment loss is the difference between the net book value and the present value of the cash flows, which amounts to $2,560,000. For the 2014 income statement, Truffle Inc. should report this amount as an impairment loss.To determine the impairment loss, we need to compare the carrying value of the patent with its recoverable amount. The recoverable amount is the higher of the asset's fair value less costs to sell and its value in use. In this case, the present value of the future cash flows is $2,120,000, which is less than the carrying value of $7,800,000. Therefore, an impairment loss will be reported on Truffle's 2014 income statement in the amount of $5,680,000 ($7,800,000 - $2,120,000).