Question

The following information concerns Franklin Inc.'s stamping machine:

Acquired: January 1, 2010
Cost: $22 million
Depreciation: straight-line method
Estimated useful life: 12 years
Salvage value: $4 million
As of December 31, 2016, the stamping machine is expected to generate $1,500,000 per year for five more years and will then be sold for $1,000,000. The stamping machine is:
a) Impaired because expected salvage value has declined.
b) Not impaired because annual expected revenue exceeds annual depreciation.
c) Not impaired because it continues to produce revenue.
d) Impaired because its book value exceeds expected future cash flows.

Answer 1

After calculating the accumulated depreciation, Franklin Inc.'s stamping machine has a book value of $11.5 million as of December 31, 2016. Expected future cash flows total $8,500,000. Therefore, the machine is impaired because the book value exceeds the future cash flows.

Step-by-step explanation:

To determine if the stamping machine of Franklin Inc. is impaired, we must compare its book value as of December 31, 2016, against the expected future cash flows from its use and eventual sale. The straight-line method of depreciation will be used to calculate the annual depreciation expense and the book value. The annual depreciation is calculated based on the original cost minus the salvage value, over the useful life:

Annual Depreciation = (Cost - Salvage Value) / Useful Life = ($22 million - $4 million) / 12 years = $1.5 million per year.

By December 31, 2016, after seven years, the accumulated depreciation will be 7 years * $1.5 million per year = $10.5 million. Therefore, the book value at that time would be the original cost minus accumulated depreciation: $22 million - $10.5 million = $11.5 million.

The expected future cash flows from the machine over the remaining five years is $1,500,000 per year for five years, plus the expected salvage value at the end: ($1,500,000 * 5) + $1,000,000 = $8,500,000.

Since the expected future cash flows of $8,500,000 are less than the book value of $11.5 million, the asset is considered impaired as its book value exceeds the expected future cash flows.