Determing the Impairment Loss of the following :
Net Book value of facilities = $28.4
COmpany determines that they will only gerate $3 for the next 7 years
Cost of capital is 10%
Under GAAP, what is the fair value and impairment loss?
Thanks.
The fair value is the present value of that 7 year stream of 3 dollars per year discounted at 10%, i.e the value in use.
Impairment loss is the difference between that and the net book value if its higher (which in this case it is).
At least that’s how I’d do it under IFRS…
First, you must test the un discounted cash flows against the carrying book value. 3x7=21
Since the undiscounted cash flows < carrying book value, the asset is considered to be impaired.
Then you can either use the fair value of the asset OR if the fair value is not available, the present value of cash flows is used. In this case, all we have to work with is the present value (good estimator of fair value) which is:
N=7, I=10, PMT=3, CPT PV=14.60
The amount of the loss will be the difference between the carrying book value and the present value of the assets cash flows.
28.4-14.60= 13.80 loss recognized
GAAP makes this distinguishing factor of undiscounted cash flows vs. discounted cash flows for the initial test so that firms don’t try bending the discount factor to recognize a loss when it is convenient.