Granite, Inc. owns a machine with a carrying value of $3.0 million, a salvage value of $2 million, and a present value of future cash flows of $1.7 million. The asset is permanently impaired. Granite should: A) immediately write down the machine to its salvage value. B) immediately write down the machine to its present value of future cash flows. C) write down the machine to its present value of future cash flows as soon as it is depreciated down to salvage value.
Correct answer is B: Under IFRS, when an asset is permanently impaired, it must be written down to its recoverable amount (greater of value in use or fair value less selling costs) in the period in which the impairment is recognized.
Why is not A? Recoverable amount is greater of value in use or fair value less selling cost therefore I think it should be written down to its salvage value, which is the value of the asset if sold for scrap, isn’t it?
Think the value in use is the PV of cash flows. Also, I believe salvage value is a management estimate so wouldn’t reflect fair value (recall management can change salvage values to smooth earnings). As we’re not given fair value or selling costs, but are given value in use, the answer should be B.
Yeah, this question has more to do with the OP’s understanding of what salvage value is.
In the accounting world, salvage value is something like this (to give some real life context). I buy a laptop today for $1000 and plan to amortize it over 3 years 30% annually on a SL basis with 10% SALVAGE VALUE (estimation that at the end of useful life, I could sell it for $100). Obviously, when it comes to testing for impairment, this should have no bearing on what I write down the asset to.
Now, is the question said Net Realizable Value on disposal or something along those lines, then we can have a debate on what to do under US GAAP vs IFRS.