Professional judgmentframework
Property, Plant and Equipment: Impairment
Background
Toyda, Inc. (Toyda) is one of the worldâs leading carmanufacturers. They sell cars exclusively in the US. In recentyears, Toyda has begun producing electric cars, as well asspecialized equipment that is used to charge electric cars.Management of Toyda had been very optimistic about this recentventure. For internal purposes, Toyda projected a growth rate of40% for the electric car production and for the production of thespecialized equipment. Management believes that these estimateswere conservative. Currently, Toyda is the only carmaker in the USthat is producing electric cars.
In December 2012, a number of oil reserves were discovered inAlaska. These oil reserves are much more significant than anyreserves that currently exist. Consumers in the US are euphoricover these discoveries. Accordingly, many automobile manufacturingcompanies and industry and government analysts believe that thedemand for electric cars will decrease substantially.
While the CEO is exceedingly worried about this new turn ofevents, she is not really worried about the financial statementsfor the December 31, 2012 year-end. Because Toyda is still in theearly stages of producing and selling electric cars, most of thecompanyâs current net income is attributable to traditional cars.The current consensus analyst forecast for net income per share is$10.25, which equates to $30.0 million ofnet income. Although Toyda has not yet finalized theirfinancial statements for 2012, the draft income statement providedto the CEO on February 1, 2013, showed net income of $35million, an effective tax rate of 20% and total assets of $500.0million. Toyda is audited annually.
The CFO at Toyda has been consulting with external valuationspecialists since early December to determine if there is a need toimpair one or both production facilities. Toyda is notconsidering a potential sale or an alternative use of itsproduction facilities. The valuation specialists have extensiveexperience with the global automotive industry, including theelectronic car industry in Europe. The valuation specialists issuedtheir report on February 3, 2013. The report included an analysisof expected growth rates based on available market data, industrytrends, historical results and other pertinent data. The reportindicated that Toyda will be able to maintain their expected growthrates for two more years, until the newly discovered oil reservesare ready to begin production. Beginning in 2015, they would expectgrowth rates between 15% and 19% for the specialized equipmentfacility and the car production facility. They anticipate thatToyda will be able to dispose of the production facility forelectric cars in 20 years, with proceeds of $500,000. Likewise, theproduction facility for the specialized equipment could be disposedof in 10 years with proceeds of $10,000. The valuation specialistsalso believe that the highest and best use of the facility is itscurrent use and an expected present value technique (i.e., expectedcash flows) would be the most appropriate method to make a fairvalue determination. The CFO has been heavy involved in thepreparation and review of the valuation specialistsâ report and shebelieves it is a balanced and fair assessment.
The table below provides data on the two facilities.
Asset group: production facilities
Carrying value
December 31, 2012
Remaining
life in years
Actual data
Operating cash flows
Operating income
2010
2011
2012
2010
2011
2012
Electric cars
$25,000,000
20
$45,000
$77,000
$98,000
$32,000
$43,000
$57,000
Electric car chargers
$4,000,000
10
$5,000
$19,000
$25,000
($8,000)
($15,000)
($12,000)
The following table provides the annual yield on the risk-freerate expected over the next 20 years obtained from the U.S.Department of the Treasury. The CFO has engaged in discussions withinvestment bankers to determine what the appropriate risk premiumwould be for these facilities (analyzed and supported based onmarket data available for comparable companies). Based on thesediscussions, she believes that a risk premium of 8% to 12% shouldbe added to the risk-free rate to reflect a current discountrate.
Year
Yield*
1
0.12%
2
0.27%
3
0.40%
4
0.62%
5
0.89%
6
1.12%
7
1.41%
8
1.67%
9
1.81%
10
1.97%
11
2.05%
12
2.11%
13
2.25%
14
2.32%
15
2.45%
16
2.50%
17
2.59%
18
2.62%
19
2.65%
20
2.67%
*This represents the annual yield to maturity for each timeperiod. Thus, for example, an investment held for 10 years wouldyield a 1.97% return per year.
As the junior accountant, the CFO has asked you to provide heran analysis of the need for an impairment of the productionfacilities and the amount of impairment loss to be recorded, ifany.
Required
⺠Reference the professional judgmentframework handout and application template separately provided.
⺠For December 31, 2012, using your judgment,perform an analysis of the need for an impairment of the productionfacilities and the amount of impairment loss to be recorded, ifany. Using the professional judgment framework, complete theapplication template for all process steps and provide theappropriate information in the documentation column.
â In performing youranalysis, you should use an Excel spreadsheet to support anycalculations.
⺠Using the information you documentedregarding the overarching considerations and the specificconsiderations for each process step in the framework, prepare amemorandum that you will provide to the CFO (not to exceed threepages). Be sure to include specific references to the applicableguidance and quote the applicable guidance. Also attach your excelspread sheet with your calculations. Upon completing yourdocumentation, make certain that you are able to answer thefollowing considerations:
â Is the documentationsufficient to support your judgment?
â Can another professionalunderstand how you reached your conclusion (including whyreasonable outcomes and possible alternatives identified were notselected)?
Professional judgmentframework
Property, Plant and Equipment: Impairment
Background
Toyda, Inc. (Toyda) is one of the worldâs leading carmanufacturers. They sell cars exclusively in the US. In recentyears, Toyda has begun producing electric cars, as well asspecialized equipment that is used to charge electric cars.Management of Toyda had been very optimistic about this recentventure. For internal purposes, Toyda projected a growth rate of40% for the electric car production and for the production of thespecialized equipment. Management believes that these estimateswere conservative. Currently, Toyda is the only carmaker in the USthat is producing electric cars.
In December 2012, a number of oil reserves were discovered inAlaska. These oil reserves are much more significant than anyreserves that currently exist. Consumers in the US are euphoricover these discoveries. Accordingly, many automobile manufacturingcompanies and industry and government analysts believe that thedemand for electric cars will decrease substantially.
While the CEO is exceedingly worried about this new turn ofevents, she is not really worried about the financial statementsfor the December 31, 2012 year-end. Because Toyda is still in theearly stages of producing and selling electric cars, most of thecompanyâs current net income is attributable to traditional cars.The current consensus analyst forecast for net income per share is$10.25, which equates to $30.0 million ofnet income. Although Toyda has not yet finalized theirfinancial statements for 2012, the draft income statement providedto the CEO on February 1, 2013, showed net income of $35million, an effective tax rate of 20% and total assets of $500.0million. Toyda is audited annually.
The CFO at Toyda has been consulting with external valuationspecialists since early December to determine if there is a need toimpair one or both production facilities. Toyda is notconsidering a potential sale or an alternative use of itsproduction facilities. The valuation specialists have extensiveexperience with the global automotive industry, including theelectronic car industry in Europe. The valuation specialists issuedtheir report on February 3, 2013. The report included an analysisof expected growth rates based on available market data, industrytrends, historical results and other pertinent data. The reportindicated that Toyda will be able to maintain their expected growthrates for two more years, until the newly discovered oil reservesare ready to begin production. Beginning in 2015, they would expectgrowth rates between 15% and 19% for the specialized equipmentfacility and the car production facility. They anticipate thatToyda will be able to dispose of the production facility forelectric cars in 20 years, with proceeds of $500,000. Likewise, theproduction facility for the specialized equipment could be disposedof in 10 years with proceeds of $10,000. The valuation specialistsalso believe that the highest and best use of the facility is itscurrent use and an expected present value technique (i.e., expectedcash flows) would be the most appropriate method to make a fairvalue determination. The CFO has been heavy involved in thepreparation and review of the valuation specialistsâ report and shebelieves it is a balanced and fair assessment.
The table below provides data on the two facilities.
Asset group: production facilities | Carrying value December 31, 2012 | Remaining life in years | Actual data | |||||
Operating cash flows | Operating income | |||||||
2010 | 2011 | 2012 | 2010 | 2011 | 2012 | |||
Electric cars | $25,000,000 | 20 | $45,000 | $77,000 | $98,000 | $32,000 | $43,000 | $57,000 |
Electric car chargers | $4,000,000 | 10 | $5,000 | $19,000 | $25,000 | ($8,000) | ($15,000) | ($12,000) |
The following table provides the annual yield on the risk-freerate expected over the next 20 years obtained from the U.S.Department of the Treasury. The CFO has engaged in discussions withinvestment bankers to determine what the appropriate risk premiumwould be for these facilities (analyzed and supported based onmarket data available for comparable companies). Based on thesediscussions, she believes that a risk premium of 8% to 12% shouldbe added to the risk-free rate to reflect a current discountrate.
Year | Yield* |
1 | 0.12% |
2 | 0.27% |
3 | 0.40% |
4 | 0.62% |
5 | 0.89% |
6 | 1.12% |
7 | 1.41% |
8 | 1.67% |
9 | 1.81% |
10 | 1.97% |
11 | 2.05% |
12 | 2.11% |
13 | 2.25% |
14 | 2.32% |
15 | 2.45% |
16 | 2.50% |
17 | 2.59% |
18 | 2.62% |
19 | 2.65% |
20 | 2.67% |
*This represents the annual yield to maturity for each timeperiod. Thus, for example, an investment held for 10 years wouldyield a 1.97% return per year.
As the junior accountant, the CFO has asked you to provide heran analysis of the need for an impairment of the productionfacilities and the amount of impairment loss to be recorded, ifany.
Required
⺠Reference the professional judgmentframework handout and application template separately provided.
⺠For December 31, 2012, using your judgment,perform an analysis of the need for an impairment of the productionfacilities and the amount of impairment loss to be recorded, ifany. Using the professional judgment framework, complete theapplication template for all process steps and provide theappropriate information in the documentation column.
â In performing youranalysis, you should use an Excel spreadsheet to support anycalculations.
⺠Using the information you documentedregarding the overarching considerations and the specificconsiderations for each process step in the framework, prepare amemorandum that you will provide to the CFO (not to exceed threepages). Be sure to include specific references to the applicableguidance and quote the applicable guidance. Also attach your excelspread sheet with your calculations. Upon completing yourdocumentation, make certain that you are able to answer thefollowing considerations:
â Is the documentationsufficient to support your judgment?
â Can another professionalunderstand how you reached your conclusion (including whyreasonable outcomes and possible alternatives identified were notselected)?
