An asset is written down due to impairment. In subsequent accounting periods, the effects on the firm’s financial statements will include: a. Lower pretax cash flow b. Higher profitability. c. Higher depreciation expense. d. Higher shareholders’ equity. Which choice and why?
Higher profitability because depreciation expense should be lower in subsequent periods.
Higher Profits = Higher Equity as RE goes up…
I’m with B as well.
The initial impairment would lower equity, so the higher level of earnings in subsequent periods wil go towards just getting the equity level back to where it was before the impairment.
“The initial impairment would lower equity, so the higher level of earnings in subsequent periods wil go towards just getting the equity level back to where it was before the impairment.” But Equity would still be higher than the initial period. Same as profits. In fact, you could apply this same logic to profits (getting back to normal level), couldnt you? Where is the distinction…
It lowers the upper equitamorization of the minority interest.
This question was meant for the L1 forum, but here is what i wrote there: ok, here is what Stalla says: Shareholders’ equity will be reduced by the difference between the amount by which the asset’s book value is reduced on the balance sheet and the related change in the net deferred tax asset/liability. Whatever that means, I rest my case!
For what it is worth, when I used Stalla on level 1, I noticed that their Practice exam answers often had mistakes (all kinds, such as the answer it says letter wise didnt match up with what the description was, multiple correct answers, missing words in the questions such as NOT, etc). So just make sure to read them carefully…
Yeah… Write down an asset… That’s bad, you now own less stuff. Since the asset side has gotten hit, something on the other side also gets hit. Since your debts haven’t changed, it comes out of shareholder equity. Bummer. The good news (relatively speaking) is that you can claim the writedown as a depreciation expense. Exactly how much you take per period depends on the depreciation method you use, but you’ll get to do it in at least one future period. So, I’d say C. It’s possible that ROA and ROE could go up, if the impairment doesn’t affect operating profits, but I don’t see profits going up for any reason. Gross profit margins aren’t changing for any reason. Operating profit margins will go down due to the increased depreciation expense if they take it above the line, and net profit margins go down if they take it below the line.
When you have the impairment, you take the hit to the Income Statement right away…and since you dont have any book value left to depreciate the profits would be higher in future periods vs the initial period (all else equal). If profits are higher then equity is higher…So both are possible. But profits and Equity would be higher as vs the initial period. bchadwick - I dont understand why you say you get to claim the writedown as depreciation over the future periods…you have to recognize it in the period it is impaired. As soon as the assets is deemed impaired you take the hit…can you explain why you think you get to spread that out to the future?
I was thinking of an immediate hit to the balance sheet and the depreciation cost hitting the next income statement (which describes the current accounting period). I don’t remember enough FSA to remember if you’d be able to draw it out over more than one future period. I simply thought “the next income statement is going to reflect this cost, and it’s going to have more depreciation expense” As for an asset being impaired and written down, I did not think that it would have to be written down 100%. If it were completely impaired, you’d need to buy a new asset and that would need to be depreciated, so I don’t think profits would necessarily go up. I must admit, FSA is not my strong suit; I simply thought I understood the question and had something to offer.
SO, what’s the correct letter?
It is B. But we are trying to figure it what is wrong with D. Stalla says D not correct because: Shareholders’ equity will be reduced by the difference between the amount by which the asset’s book value is reduced on the balance sheet and the related change in the net deferred tax asset/liability.
In the period of the impairment the Equity would come down by the different in the impairment amount(which is taken to the P&L in the same period) and the deferred tax asset you woud have (you get a benefit of lower taxes later because you will recognize the impairment when the asset is sold for tax purposes…so assuming that is later one you now have a DTA) from the same transaction. This would happen in current period so I dont see why Equity will not track with profits in future periods. Again, I would check with Stalla (email them) because when I used the practice exams on L1 I would have about 5-10 questions per 120 set that were bogus (I emailed the on these to confirm).
I see Kevin’s point, this may just be a bad questions.
You are taking a hit to equity today. In subsequent periods, your equity is going to be lower than it would have been had you not taken the writedown. Sure, equity is going to go up each year with the profits (which are now higher), but it is still lower than it would have been without the impairment. The question is asking you to compare the scenario with no writedown and the scenario with a writedown, NOT period 0 and all subsequent periods in the writedown scenario. Period 0 and subsequent periods are meant to be compared writedown vs. no writedown.
"You are taking a hit to equity today. In subsequent periods, your equity is going to be lower than it would have been had you not taken the writedown. Sure, equity is going to go up each year with the profits (which are now higher), but it is still lower than it would have been without the impairment. " Wouldnt this depend on the level of impairment and how much Book Value the Asset had left to depreciate? I see your point, but it wont always be true in that comparison. I was comparing Write-Down today vs later period after Write-down.
kevinf12 Wrote: ------------------------------------------------------- > "You are taking a hit to equity today. In > subsequent periods, your equity is going to be > lower than it would have been had you not taken > the writedown. Sure, equity is going to go up each > year with the profits (which are now higher), but > it is still lower than it would have been without > the impairment. " > > Wouldnt this depend on the level of impairment and > how much Book Value the Asset had left to > depreciate? I see your point, but it wont always > be true in that comparison. I was comparing > Write-Down today vs later period after Write-down. I think you are making this a lot more complicated than it needs to be. It’s a pretty straight forward LI question, and I think you are just overthinking it. The asset has some book value, otherwise it wouldn’t need to be impaired. The level of the book value of the asset is irrelevant. If you impair the asset, equity is now lower than if you didn’t impair the asset. Next period, equity will again be lower than if you had never impaired the asset because it started from a lower base. Equity will go up in both cases, but it’s lower if the asset was previously impaired. Profits will be higher though, because you have lower depreciation expense.
"The asset has some book value, otherwise it wouldn’t need to be impaired. The level of the book value of the asset is irrelevant. If you impair the asset, equity is now lower than if you didn’t impair the asset. " If the asset had one year left of depreciation then the impairment would be equal to the depreciation and Equity would not be LOWER. Imagine an asset of 1 year life left…you impair it or depreciate it, same difference to equity as both go to PL. That was my point…it wont always be lower (this was separate from the question and I was replying specifically to the comment it would be LOWER - agree as to the question if you are comparing that period). Just pointing out that there is a scenario in which it will be the same impact to equity whether you impair it or not.