FR – L2 – Q34 – Impairment of Assets

The following is relevant to three tangible non-current assets held by Chantelle (Ghana) Ltd.

Machine 1 was purchased on 1 January Year 1 for GH¢420,000. It had an estimated residual value of GH¢50,000 and a useful life of ten years and was being depreciated on a straight-line basis. On 1 January Year 6 Chantelle (Ghana) Ltd revalued this machine to GH¢275,000 and reassessed its total useful life as fifteen years. On 1 January Year 7 an impairment review showed machine 1’s recoverable amount to be GH¢100,000 and its remaining useful life to be five years.

Machine 2 was purchased on 1 January Year 1 for GH¢500,000. It had an estimated residual value of GH¢60,000 and a useful life of ten years and was being depreciated on a straight-line basis. On 1 January Year 7 this machine was classified as held for sale, at which time its fair value was estimated at GH¢200,000 and costs to sell at GH¢5,000. On 31 March Year 7 the machine was sold for GH¢210,000.

Machine 3 was purchased on 1 January Year 1 for GH¢600,000. In Year 1 depreciation of GH¢30,000 was charged. On 1 January Year 2 this machine was revalued to GH¢800,000 and its remaining useful life assessed as eight years. On 1 January Year 7 this machine was classified as held for sale, at which time, its fair value was estimated at GH¢550,000 and costs to sell at GH¢5,000. On 31 March Year 7 the machine was sold for GH¢550,000.

Tax is at the rate of 30%.

Required
For each machine show the effect of the above on profit or loss, other comprehensive income and revaluation reserve of Chantelle (Ghana) Ltd in Year 7. You should also show the brought forward balance on the revaluation reserve (at 1 January Year 7) in respect of machines 1 and 3.

Effect on Year 7 profit or loss

Machine 1 Machine 2 Machine 3
GH¢ GH¢ GH¢
Impairment loss (107,500) (41,000)
(W1) (W2)
Depreciation charge (20,000)
(100,000 ÷ 5)
Gain on disposal 15,000
(210,000 – 195,000 (W2))

Effect on Year 7 other comprehensive income

Machine 1 Machine 2 Machine 3
GH¢ GH¢ GH¢
Revaluation reserve (28,000)
Deferred tax 12,000

Revaluation reserve brought forward at 1 January Year 7

  • Machine 1:
    Cost (1 January Year 1): GH¢420,000
    Depreciation to 1 January Year 6: ((420,000 – 50,000) ÷ 10 × 5) = GH¢185,000
    Carrying amount at 1 January Year 6: 420,000 – 185,000 = GH¢235,000
    Revalued to: GH¢275,000
    Revaluation reserve: 275,000 – 235,000 = GH¢40,000
    Depreciation Year 6: (275,000 ÷ 10) = GH¢27,500
    Transfer to retained earnings: ((275,000 – 235,000) ÷ 10) = GH¢4,000
    Revaluation reserve at 1 January Year 7: 40,000 – 4,000 = GH¢36,000
  • Machine 3:
    Cost (1 January Year 1): GH¢600,000
    Depreciation Year 1: GH¢30,000
    Carrying amount at 1 January Year 2: 600,000 – 30,000 = GH¢570,000
    Revalued to: GH¢800,000
    Revaluation reserve: 800,000 – 570,000 = GH¢230,000
    Depreciation to 1 January Year 7: ((800,000 ÷ 8) × 5) = GH¢500,000
    Transfer to retained earnings: ((800,000 – 570,000) ÷ 8 × 5) = GH¢143,750
    Revaluation reserve at 1 January Year 7: 230,000 – 143,750 = GH¢86,250

Workings

(1) Machine 1
In the year to 31 December Year 7, the impairment loss is GH¢147,500. Of this, GH¢40,000 reverses the gain in the previous year. The revaluation reserve is reduced by GH¢28,000 and the deferred tax liability by GH¢12,000. The remaining impairment loss of GH¢107,500 is written off as a loss in Year 7.

(2) Machine 2

GH¢
1 January Year 1 Cost 500,000
Depreciation to 1 January Year 7 (((500,000 – 60,000) ÷ 10) × 6) (264,000)
Carrying amount on 1 January Year 7 236,000
Fair value minus cost to sell (200,000 – 5,000) (195,000)
Impairment loss 41,000

(3) Machine 3

GH¢
1 January Year 1 Cost 600,000
Depreciation to 1 January Year 2 (30,000)
Carrying amount on 1 January Year 2 570,000
Revalued to 800,000
Taken to revaluation reserve/deferred tax (70%/30%) 230,000
Carrying amount on 1 January Year 2 800,000
Depreciation to 1 January Year 7 ((800,000 ÷ 8) × 5) (500,000)
Carrying amount on 1 January Year 7 300,000
Fair value on classification as held for sale 550,000
Value at lower of carrying amount and fair value less costs to sell: therefore 300,000