 Hello and welcome to the session in which we would look at an impairment loss exercise that could appear on the CPA exam or in your intermediate accounting courses. I want to make sure you understand. So this is impairment loss for a physical asset because we have impairment loss for intangibles. We have impairment losses for goodwill. So we are dealing specifically with a piece of equipment. So let's go ahead and take a look to see how we would solve a problem like this. Presented below is information related to the equipment owned by Adam as of December 31st 2021. We have the cost of the equipment. We have accumulated depreciation to date. We have the expected future net cash flow. We have the fair value. We are told that Adam will be using this equipment in the future. In other words, this asset is used for operation because again there are slightly different roles whether the assets are used in operation or whether the assets is held for sale. And as of December 31st the equipment has a remaining useful life of four years. So we are going to prepare the impairment loss entry if any, the depreciation expense and determine what happens if the fair value of the asset increases the following period. So let's go ahead and start with the first question. Prepare the impairment loss journal entry if any or simply put compute the impairment loss and we're going to journalize it. Well, how do we know whether we have an impairment loss or net or not? Well, there are two step process, two testers, a test one and a test two. The first test is you will look at your book value and you compare your book value versus the expected future cash flow not discounted. So future cash flow I'm going to put here not discounted. So simply put the first test is do we have enough cash flow coming from this company un-discounted to cover at least the book value? Well, let's find out. Well, I don't see the book value here. Well, the book value is cost minus accumulated depreciation. So we are giving this information indirectly. Eight million is the book value. The expected future cash flow is only seven million. The future cash flow and notice here it doesn't say discounted. So the expected future cash flow is seven million. Well, guess what? This asset cannot recover its book value. What does that mean? It means yes, we have an impairment loss. Now most students they jump and they say, okay, that's easy. The impairment loss is a million. Absolutely not. The first test will tell you whether you have an impairment or not. Simply put, if the first test failed, so let's assume the future cash flow were 9.5 million, then the answer would be no, and you will stop. There is no impairment loss. There is an impairment loss, but it's not a million. Now you go to test two, T2. Again, in T2 you would compare the book value, notice the book value in both versus the fair value. And here's where they would trick you. Okay, let's see. The book value is eight. The fair value is given as 4.8. Now in test two, this is your impairment loss, which is if you take the difference would be 3.2 million. So how do they trick you? They trick you by giving you, rather than giving you the fair value, sometimes they give you the discounted cash flow. Well, the discounted cash flow could be considered the fair value if the fair value is not giving. And remember that the book value is used in test one, but first you compare your book value to the future value of undiscounted cash flow. Simply put, would this asset generate enough cash to recover its book value? If the answer is no, the asset is definitely impaired, but we have to look at how much it's impaired, then you compare the book value to the fair value. And it's 3.2. Let's go ahead and journalize the journal entry. You will debit loss on impairment, 3.2 million, credit accumulated depreciation, 3.2 million. Now bear in mind, loss on impairment is part of your operation operating expenses. So it goes on your income statement. Nothing is unusual about it. It's not special. Companies buy assets and those assets becomes impaired. Now if you don't know what impairment is, obviously go to far hat lectures because I explained impairment loss in a prior session, which what triggers an impairment loss, how to book the journal entry, so on and so forth. But this is an exercise. Now we impair the asset. The question is now prepare the journal entry to record depreciation expense for X2 or simply put, what's the depreciation expense going forward after X1 after we book the impairment? Now before we look at the depreciation expense entry, most likely you are an accounting student or a CPA candidate. And that's great. You are looking for some help. You arrive to the right place. Farhatlectures.com can assist you. I provide you with lectures, multiple choice, through false exercises that's going to help you do better in your classes on the CPA exam. This is a list, a partial list of my accounting courses. My CPA material is aligned with your becker, Roger, Wiley, Gleam. So it's very easy to go back and forth between my material and your CPA review course. I also give you access to previously released AI CPA questions. Please connect with me on LinkedIn if you haven't done so. Like this recording. If you're watching, it means it's helping you. Like it. Share it. Connect with me on Instagram, Facebook, Twitter, Reddit, and you can join my CPA exam support group on GroupMe. So how do we compute the depreciation expense going forward? Well, here's what's going to happen. We are going to determine the new book value of the asset. What does that mean? Simply put, we have a new asset and that asset has a book value. What is that book value? Well, it's a new book value. Well, let's think about it. The book value was 8 million prior, 8 million prior to the impairment. After the impairment, notice we reduced it by 3.2 million. What does that mean? It means now going forward, if we take 8 minus 3.2, our book value, our new book value is 4.8. Now, this asset will be used for the next four years. We are giving this in this information and this is important. It's used in operation. Therefore, if I divide 4.8 by the remaining life of the asset for years, I find out that my depreciation, my future depreciation expense is 1.2 million per year. Great. I will debit depreciation expense 1.2. Credit accumulated depreciation 1.2. And if nothing else changes going forward, simply put, if this asset is not impaired any further, this entry would repeat itself for the next four years and that's that. Basically, we kind of remove the asset from the books and in a sense that we fully depreciate the asset. Now, let's assume the fair value of the equipment increased by December 31st, X2 by the end of the year to 5.3 million. Notice it was 4.8. Well, something happened. The asset becomes more useful. Now it increased to 5.3. What do we have to do? Well, what do we have to do? And the answer is nada, nothing. Why? Be careful. This asset, as I remember what I told you, it's used in operation. So this asset is continued to be used in the business. It means it's used in operation. What does that mean? It means once you write it down, you cannot write it up. And this is, I'm talking here about US GAAP, United States Generally Accepted Accounting Principle. If you're using IFRS, you might have different rules. You can't write it up. Now, if this asset, so the answer is not applicable, we don't do anything. Now, if this asset was held for sale, simply put, sometimes we have an asset we're no longer using it. It's not useful for us. It's either old, we change our product, we change our business strategy, and we need to sell this asset. And those assets could be impaired as well. If this asset was held for sale, rather than used in operation, and we lost value on it, we had to book loss on impairment, then this asset recovered some of its value, then we can recover, we can book a recovery. Simply put, we can book again to recover the losses. But bear in mind, if that's the case, we can only write it up, up to the amount of losses. So let's assume the asset somehow became very popular and everybody wanted to buy it. Well, that's fine. Let's assume it jumped up to 10 million. Now, the fair value of it is 10 million. If it's held for sale, the only amount you can recover is 3.2. If it's really 10 million, go ahead sell it and book the gain. But don't book the gain before you sell it. But if it's held for sale, the rules are different. Impairment loss is an important topic because you have impairment losses for physical assets. What we did here, you have impairment losses for intangible asset. And the good news I'm going to tell you here, impairment losses for physical asset and intangibles are similar, which is good. You have impairment for goodwill, which is different, which is different. So be careful. Just because you are being asked for impairment, what type of asset am I dealing with? Is it a physical asset? Is it intangible? The good news, they're the same. Is it a good will? And be careful if it's a physical asset. Is this asset being held for used in operation? Or is it used? Is it held for sale? Be careful about this. At the end of this recording, I'm going to remind you again to go to farhatlectures.com now, work multiple choice through false exercises, practice, invest in yourself. If you're not a subscriber, subscribe. Don't shortchange yourself. Accounting is important. Good luck, study hard, and of course, stay safe.