Accounting Question: Grana Enterprise Inc. (GEI) is a manufacturing company

Accounting Question: Grana Enterprise Inc. (GEI) is a manufacturing company

Subject: Business / Accounting
Question
Grana Enterprise Inc.
Grana Enterprise Inc. (GEI) is a manufacturing company with operations in Italy and
Serbia.
GEI in Italy:
In addition to other assets, GEI owns and operates a commercial building in Italy that is
carried at its cost less any accumulated depreciation and any accumulated impairment
losses. The building represents a cash-generating unit (CGU) for which the following
information is available as of December 31, 2010:
Building
Carrying amount
Value in use
Fair market value less costs to sell
Fair market value
Undiscounted future cash flows 12/31/10 in
thousands
$1,100
900
800
850
1,150 GEI in Serbia:
In Serbia, in 2008, GEI acquired a smaller competing company and goodwill was
allocated to the CGU shown below. Activities in Serbia represent the lowest level at
which internal management monitors goodwill. At the end of 2008 and 2009, the value in
use of the CGU including goodwill exceeded its carrying amount. Therefore the activities
of GEI in Serbia and the goodwill allocated to those activities were regarded as not
impaired.
However, at the end of 2010, the newly elected government passed legislation
significantly restricting exports of GEI’s main product.
The information below relates to the CGU (which includes goodwill) of GEI’s operations
in Serbia before the impairment analysis is performed. For this case, assume the basis of
segmentation for CGUs and reporting units (RU) is the same under IFRSs and U.S.
GAAP.
GEI’s Serbian CGU carrying value
Cash
Property, plant, and equipment (PP&E)
Land
Goodwill
Total assets
Liabilities
Carrying value 12/31/10
in thousands
$50
1,100
150
300
$1,600
(200)
$1,400
Copyright 2009 Deloitte Development LLC
All Rights Reserved. Case 10-2: GE Impairment Loss Page 2 As a result of the change in legislation, GEI’s production will be significantly affected for
the foreseeable future. In addition, external industry reports estimate no growth rate for
the foreseeable future. The significant export restriction and the resulting production
decrease are impairment indicators that require GEI to estimate the recoverable amount
of its operations at the end of 2010.
GEI’s management prepared the cash flow analysis shown below:
Discounted cash flows in thousands:
2011
$5,649
6%
3,389
2,260 2012
$6,045
7%
3,627
2,418 2013
$6,528
8%
3,917
2,611 2014
$7,181
10%
4,309
2,872 2015
$8,043
12%
4,826
3,217 847 906 979 1,077 1,206 1,413 1,512 1,632 1,795 2,011 Depreciation and amortization
Earnings before interest
and taxes (EBIT)
Available tax-loss carryforwards
Net taxable earnings 564 604 652 718 804 849
0
849 908
0
908 980
0
980 1,077
0
1,077 1,207
0
1,207 Income taxes
Net operating profit after-tax 296
553 317
591 342
638 377
700 422
785 564
(848)
0
$269
235 604
(903)
0
$292
222 652
(980)
0
$310
205 718
(1,077)
0
$341
195 804
(1,201)
0
$388
193 Total revenue
Growth
Cost of goods sold
Gross profit
Selling, general, and administrative
(SG&A)
Earnings before interest, taxes,
depreciation & amortization (EBITDA) Add back depreciation and amortization
Subtract capital expenditures
Subtract new net working cap.
Free cash flow
Present value of free cash flows at 15%
Total present value as of 12/31/10 $1,050 Assume the $1.05 million above is the appropriate fair value under U.S. GAAP and the
recoverable amount under IFRS. Further assume management estimates no costs to sell
would be incurred.
The five-year business forecast prepared by management reflects an increase in the
amount of capital expenditures in order to modify GEI’s main product, which, when
modified, will not be subject to legislation restrictions. The additional capital expenditure
estimates for these investments are $450,000 and $470,000, for 2011 and 2012,
Copyright 2009 Deloitte Development LLC
All Rights Reserved. Case 10-2: GE Impairment Loss Page 3 respectively (included in the capital expenditures line in the calculation of present value
of discounted cash flows). The amounts of capital expenditures for 2013 and 2014 also
include $50,000 and $70,000, respectively for future financing outflows GEI may incur
when borrowing funds for capital expenditures.
The remaining useful life of GEI’s identifiable assets is eight years at the beginning of
2010. GEI uses straight-line depreciation and anticipates no residual value.
Management determined the discount rate used in the calculation of present value is a
pre-tax discount rate of 15 percent using the weighted average cost of capital (WACC) of
GEI.
Required: Question 1 — Given the facts provided for GEI in Italy, is the building impaired
under IFRSs as of December 31, 2010, and if so, what is the amount of the
impairment? Question 2 — Given the facts provided for GEI in Italy, is the building impaired
under U.S. GAAP as of December 31, 2010, and if so, what is the amount of the
impairment? Question 3 — Using the information given for GEI’s CGU in Serbia, including
the present value of discounted cash flow calculation, determine the following:
1. Is there an impairment loss on goodwill? If so, determine the amount of
the impairment loss under IFRS and U.S. GAAP as of December 31, 2010.
Assume that the fair value of PP&E is 1 million and the fair value of all
other identifiable assets and liabilities, excluding goodwill, equal their
carrying amounts when testing for impairment.
2. Assume that the value in use calculation is appropriate. Are management’s
assumptions in calculating the value in use appropriate?
3. Calculate the new carrying value of assets and CGU under IFRSs. As
noted above, assume that the fair value of PP&E is 1 million and the fair
value of all individual assets and liabilities, excluding goodwill, equal
their carrying amounts. Question 4 — Assume that during 2011, the effects of the export laws on GEI’s
production in Serbia are less dramatic than initially expected by management. As
a result, management estimates that the recoverable amount of its Serbian CGU at
the end of 2011 increased to $1,200. On the basis of this information and the
information from 1–3 above, calculate the reversal of loss, if any, under IFRSs
and the carrying value as of December 31, 2011. The remaining useful life of
PP&E is seven years at the beginning of 2011. Assume there have been no other
changes in the carrying value of other assets or liabilities during 2011. Copyright 2009 Deloitte Development LLC
All Rights Reserved.