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B
anning Technology
Background
Banning Technology manufactures integrated circuit boards used in cell phones and computers. To take advantage of low labor costs and less restrictive environmental regulations, Banning Technology (“Banning” or “the
C
ompany”) built a plant in a little know country just east of Italy. The plant was financed with non-recourse debt. It cost millions to build and management planned to operate it profitably for many years. Unfortunately, there has recently been a regime change in the country and new taxes and regulations have severely reduced the profitability of the plant. In fact, annual cash flows from the plant have declined by
40%
and this trend is expected to continue. Management is evaluating the following possible options for proceeding into
2022
and beyond:
- Continue operating the plant through the end of its useful life.
- Repurpose the plant to be a distribution center and operate through the end of its useful life.
- Operate the plant for two years and then turn it over to the lender which will mean a foreclosure on January 1,
2024
.
The following table presents management’s estimate of future cash flows from each of the alternatives. Management has also estimated how likely they are to follow alternative
A
or B.
Estimated Future Cash Inflows – Undiscounted
(in $ millions)
Option
Probability of Occurring
2022
2023
2024
2025
2026
Total
30%
$1.00
$0.80
$0.70
$0.60
$0.50
$3.60
$0.90
$3.60
C30%
$1.10
$1.00$2.80
[1]
$4.90
[1] Includes the plant’s FMV of $2.8 million treated as forgiveness of debt associated with the foreclosure up to FMV of the asset.
(This table is available on Canvas)
As of December 31, 2021, the plant’s estimated fair value is $2.8 million, net book value is $4.2 million, and an estimated remaining useful life is five years. In addition, the net carrying value of the nonrecourse debt is $3.1 million and there is $200,000 in a bank account directly attributable to the plant.
Management has determined that an annual discount rate of 5 percent is appropriate for investments of this nature.
Required
Your firm, Barrett & Blackstone LLP, has been engaged to audit the financial statements for the year ended December 31, 2021. You believe there may be an impairment issue under ASC 360-10 and have discussed this with the audit engagement partner, Franklin Perlman.
You have been asked to prepare a memo to Franklin Perlman, CPA, an audit partner at your firm, with a copy to the Banning Audit File. You are documenting the results of analyzing impairment of the carrying value of the assets. The memo will provide documentation for the files.
At a minimum your memo should describe:
- What assets and liabilities should be included in the “asset group” as defined for purposes of performing the recoverability test?
- How do the multiple operating scenarios impact the recoverability test?
- What impact should the potential foreclosure and extinguishment of debt have on the undiscounted cash flows used to perform the recoverability test?
- Describe the impairment test and whether or not recognition of impairment is required? If so, how much is the impairment write-down? Which asset will be adjusted?
