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Global Perspectives about Accounting Education Volume 5, 2008, 17-25 FIRST MOTORS CORPORATION: A CLASSROOM CASE ON IMPAIRMENTS Tim Krumwiede College of Business Bryant University Smithfield, Rhode Tropical isle USA Emily Giannini Graduate Student, College or university of Organization Bryant University or college Smithfield, Rhode Island USA ABSTRACT The case requires a detailed analysis of impairments of both long-lived assets and goodwill to get First Motor Corporation, a fictitious automobile company. By simply integrating multiple issues into this case, students are presented with some of the complexities and interrelationships that are seen in practice.
To properly prepare methods to this case, pupils must successfully read, interpret, and apply both accounting standards and concept statements.
The use of view in deciding on a discount rate for present value calculations is an important element of this case. In fact , an income management concern and ensuing conflict among First Power generators Management plus the company’s auditor revolves around the discount rate choice. In addition , the suggested questions provided with the case require that students address pieces of the conceptual framework inside the context of the impairment criteria.
This case works extremely well in uppr division economical reporting classes at possibly the undergrad or graduate level. Keywords: Impairment, goodwill, long-lived assets, discount level BACKGROUND capital t is currently 2013 and you are a member of the involvement team designated to examine First Power generators Corporation to get the year stopping 12/31/2012. Initially Motors Firm is a car manufacturing organization targeted on moving from the production of gasoline-based cars for the production of cars I 17 18 Krumwiede and Giannini depending on alternative fuel sources.
It had been one of the first car companies to successfully create hybrid-based automobiles in the United States. First Motors has successfully taken care of car sales and stored valuable staff while creating modern, effective cars. By simply 2008, 1st Motors was manufacturing two vehicles, both of which are nonetheless being made today. One model is actually a hybrid-powered car that can be customized in style and features for almost any purchaser around the world. This model, known as the Passaic, is produce in Detroit, The state of michigan, close to the company’s corporate hq.
First Motor also companies a gasoline-powered model, the Mendoza, in its plant in Lorain, Ohio. In 08, to take advantage of the alternative energy source expertise, First Engines purchased a large competitor, Macinaw Motors Company, which had made significant progress with hydrogen-powered cars. As the usa is going toward option energy sources, hydrogen is significantly being used as being a fuel source to replace fuel. To achieve these kinds of progress, many processes may be used to make hydrogen. According to the National Hydrogen Relationship (2006), hydrogen can be produced from water, biomass, coal, and natural gas.
Much of the hydrogen developed today comes from steam reforming natural gas. On the other hand, an electrolyzer can be used to individual water into its components, fresh air and hydrogen. The hydrogen can then be cooled down to form the liquid hydrogen which may be stored at hydrogen gas stations. Macinaw Motors got experimented with many hydrogen technologies but ultimately settled on the usage of liquid hydrogen in an interior combustion engine as the most powerful way to make substantial improvement with hydrogen as an alternative gas.
Due to Macinaw Motors’ useful research and development plan, operating efficiencies, and extraordinary reputation, area of the purchase price was allocated to goodwill. The amount recorded as goodwill was $1. 3 billion, or the big difference between the $5 billion cost (fair value) of Macinaw Motors all together and the $3. 7 billion dollars fair worth of it is identifiable net assets. When ever First Motor purchased Macinaw Motors, the combined company retained the name 1st Motors Company.
Although Initially Motors and Macinaw Motors merged, the former First Motor is operated while the Initially Motors Split and the ex – Macinaw Power generators is operated since the Macinaw Motors Section. Each division acts as a component of the venture that gets revenues and incurs bills from participating in its own organization activity. Additionally , each split is reviewed by the enterprise’s chief functioning decision machine to assess it is performance and each division possesses its own discrete group of financial information. At the time of the purchase, Macinaw Motors acquired three manufacturers, all of which continue to be operating today.
Each herb is used to create one car model. Flower 1 is situated in Irvine, A bunch of states, where the hydrogen-powered Mankato is produced. Herb 2 is located in Mishawaka, Indianapolis, where the hydrogen-powered Sheboygan is usually produced. Grow 3 is located in Braselton, Georgia, where the gasoline-powered Spokane can be produced. When Macinaw Motors was bought in 08, executives to start with Motors believed that buyers were continue to purchasing gasoline-powered vehicles since their cost was still lower than that of in the same way equipped hybrid-based or hydrogen-based vehicles.
Supervision of First Motors programs to convert Plant a few to manufacture a hydrogen-based vehicle at a later date. However , for the next several years, Initially Motors wants to capitalize on the market for gasolinepowered vehicles and Plant several will continue to be found in the production of gasoline-powered automobiles. In late 2008, management started out retooling Plant 3 of the Macinaw Split to create a new, efficient, and highly desired gasoline-powered type of the Spokane. To retool Plant a few, the First Motors Corporation: A Class room Case in Impairments 19 ivision received substantial products costs like the costs of body assemblage jigs, welded equipment, conveyors, robots, and a new program. Management made a decision to retool the plant and continue with a new version Spokane beneath the assumption that there was gonna be a significant increase in essential oil supply by expected essential oil reserves in the Arctic Nationwide Wildlife Haven of Alaska (ANWR). It had been believed the particular oil supplies would help keep the price of gasoline down which usually, in turn, could continue to promote demand for gasoline-powered cars. The retooling process was finished during 2009.
THE CASE In 2012, First Motors management was surprised to master that olive oil reserve estimations were inaccurate for the ANWR. Following debate more than this debatable drilling location, legislation was finally passed in 2010 that included authorization for ANWR oil drilling. Some individuals of Ak and other declares were angered by the fresh law and protested an approval of oil drilling. However, in 2012, going proceeded in a single small select and official area. Benefits of the primary drilling revealed that the expected oil supplies in that area were not nearly as huge as projected.
Due to the ANWR finding and turmoil in the centre East, there were a surge in fuel prices during 2012 as well as the sales of the Spokane version did not fulfill expectations. Closure of Plant 3 was considered, however , for four reasons, management decided to keep Plant three or more open. Initially, management presumed the spike in gas prices has not been permanent which other oil reserves will help to modest future essential oil prices. Second, significant costs had been made around the plant, and it would not require large amounts of additional capital in the near future.
Third, consumers had been still getting gasoline-powered automobiles because of the ongoing price differential box between these kinds of vehicles and vehicles applying alternative energy sources. Finally, as a result of union legal agreements, any manufacturing plant workers let go would be paid out wages by Macinaw Department at seventy five percent of straight-time shell out. Thus, administration determined it turned out not the proper time to convert Plant several to a hydrogen-based plant. Disability Despite these kinds of reasons to keep Plant 3 open, the long-lived resources will not make the net money flows formerly anticipated when the plant was retooled.
In fact , as the result of very profound discounting of the Spokane’s full price in the past year, it is possible which the final quantities for 2012 may possibly show bad operating cash flows relevant to Plant three or more. Accordingly, administration determined that an impairment test must be performed for the rose 3 long-lived assets. To determine if the possessions are reduced, management examines the future undiscounted cash runs of Herb 3 towards the book benefit of the plant’s long-lived possessions. As of 12/31/2012, the net publication value of Plant 3’s property, flower, and machines are $1. 4 billion, before any write-down from disability is registered.
Additional relevant information can be as follows: ¢ ¢ ¢ ¢ The estimated staying life of the assembly line machines are 11 years. Yearly anticipated net funds flows for every of the up coming 11 years is $62, 504, 377. It is assumed which the land, structures, and equipment for Plant 3 fetch the amount of $30 , 000, 000 at the end of the 11-year period. The total believed undiscounted net cash moves related to Flower 3 above the next 11 years happen to be $717, 548, 147 (($62, 504, 377 x 11) + $30, 000, 000). 20 Krumwiede and Giannini The assembly-line and related equipment are the primary possessions of Grow 3.
In measuring the impairment loss for Plant 3, managing considers several valuation options for this gear. It is established that most in the equipment has no alternative work with and that a sales worth is not readily available. Accordingly, following the guidance of Declaration of Financial Accounting Standards (SFAS) No . 157 (FASB, 2006), management determines that the good value in the Plant a few long-lived possessions is best measured by the present value of its future net cash runs. The company’s management measures the present value of future money flows using a riskfree low cost rate of three percent.
Since expected net cash goes are not altered for inflation, management does not incorporate a great inflation element into the price cut rate. Making use of the 3 percent rate, the modern day value of the net funds flows is usually $600 , 000, 000, resulting in an impairment decrease of $800 mil (book benefit of long-lived assets of $1. 5 billion less $600 mil fair value as based on discounted foreseeable future cash flows). Once the disability loss is determined, management is definitely not sure how to allocate this and makes a decision to wait for its auditors to assist in the portion.
The property, grow, and gear of Herb 3 could be divided into 4 primary groups: land, buildings, robots and related products, and all other equipment. In anticipation of the taxation, the following information is created regarding these Plant three or more assets: STAND 1 Herb 3: Property, Plant, and Equipment Property Buildings Software and Related Equipment Various other Equipment Total Net Book Value $500, 000 twenty, 000, 000 140, 1000, 000 you, 239, five-hundred, 000 $1, 400, 1000, 000 Fair Value $1, 000, 000* 20, 1000, 000* Unavailable Not Available $21, 000, 000 Without undue costs, the fair worth of the terrain and complexes are extracted from an outside appraisal. The 2012 Audit In early 2013, you decide to go with your taxation team towards the First Motors headquarters in Detroit, The state of michigan for the audit, intended for the year ending December 31, 2012. The team gets a quick head to of the manufacturing plant, and you find out about various modifications in our car sector, including the lack of oil reserves in the ANWR. You know that a great impairment damage was recorded for the Plant several assets, and then you’re impressed with management’s project in calculating, recording, and disclosing the loss.
However , you wonder if a great impairment damage should have been recorded to get the Mendoza, the different gasolinepowered car produced by Initial Motors. Thankfully, First Motor maintains income and revenue information on a plant simply by plant basis and you quickly learn that during 2012, sales from the Mendoza continued to be strong for its compact size and superb gas mileage. Following reviewing the documentation promoting the impairment charge, you note that foreseeable future cash runs are discounted at a risk-free rate of 3 percent and that this kind of rate will not incorporate an First Engines Corporation: A Classroom Circumstance on Impairments 1 inflation factor for the reason that cash flow estimates were not adjusted for inflation. You vaguely recall from a college class that a price cut rate should certainly incorporate a risk premium and although you are relatively recent to auditing, you know that a few percent is a rather low discount level. You strategy management wondering this low discount rate and so they become very defensive in explaining that 3 percent is the charge for all the Grow 3 possessions and that zero other level would be ideal. Upon inquiry about risk being regarded in such a charge, management stubbornly states the 3 percent rate is fine.
When requested justification, administration reasons that they can reached this kind of conclusion because a risk premium cannot be sufficiently measured. Additionally , they consider Statement of economic Accounting Principles No . several (FASB 2000), which suggests that in such a circumstance a risk-free rate can be utilized. In re-evaluating the net funds flows, along with discussions with management, you agree that the cash flows are in fact the only, most-likely sum in a range of feasible estimated quantities or the best estimate for the next 11 years (the anticipated life of the primary resources of Flower 3).
Yet , you believe risk is not factored into these kinds of cash flow quotes. You recommend adding a risk high grade to the price cut rate, to add fully raise the risk inherent inside the cash goes. After consultation with the firm’s valuation authorities, you happen to be told a risk high quality is appropriate. As well, based on their experience inside the auto industry and overview of First Motors and Herb 3, the valuation professionals suggest that an appropriate risk high grade is six percent. Off their advice, you conclude that 9 percent (3 percent risk-free charge + 6 percent risk premium) is known as a much more reasonable rate to include in discounting the amount flows.
You are very happy with your results and wish to make an excellent impression on your audit supervisor, Mr. Trouble. Although you needed briefly reviewed with him the degree of the impairment loss plus the discount charge used, this individual left the calculations and details up to you. When you way him, yet , he looks extremely irritated and clarifies that First Motors hardly ever even complied with the annual test intended for goodwill disability, as specific in SFAS No . a hunread forty two (FASB 2001). You claim that the goodwill impairment evaluation may be pointless because a great impairment damage for the plant assets had been recorded by management.
Mister. Bother mixtures his brain at you, grumbles, and informs you in a very stern manner that impairment of long-lived resources and goodwill often go hand in hand. He explains that upon purchase of Macinaw Motor, $1. three or more billion was recorded as goodwill (the more than the purchase price in the fair benefit of the recognizable net possessions of Macinaw Motors). Mr. Bother talks about to you which the fair worth must be re-evaluated and in comparison to the book benefit. Furthermore, you heard a lot of members of management grumbling about dropping their bonus deals if “these auditors keep coming up with more impairment fees. You realize managing has significant bonuses linked with the 2012 target profits, and a large impairment reduction will cause them to lose the expected bonus deals. A quick review shows that the largest total disability losses that could be recorded before the target income will be skipped and the management bonuses lost is $1. 75 billion. Your calculations is based on two facts: (a) 2012 unaudited net income ahead of impairment fees is $2. 25 billion and (b) the administration bonus set up states that bonuses only will be paid if 2012 net income exceeds $. five billion.
You go home that evening and realize that you may not really understand what Mr. Take the time said to you about goodwill impairment. To begin with, you do not know if Mister. Bother was referring to the fair value and publication value with the entire organization or just the Macinaw Department. You print out the business training material on impairments and spend the rest of the night reading regarding SFAS No . 142. twenty-two Krumwiede and Giannini The next day, you go to a meeting with management and Mr. Bother. During the getting together with, you are first enthusiastic when you hear management indicate that they produced an error inside the recorded disability charge for long-lived possessions.
You think that management finally realizes the necessity for incorporating a risk aspect into the low cost rate. However , your jubilation is quickly deflated when ever management implies that the disability testing pertaining to long-lived possessions should have been done at a different level. In particular, administration states that impairment assessment of long-lived assets must have been to get the company overall (Plant you, Plant two, and Herb 3 from the Macinaw Division, plus the two plants from the First Engines Division) and that the result is a impairment fee should not have been recorded.
Management claims this kind of result would hold since the decline inside the value of the Plant several long-lived resources could be counter by the embrace the value of the longlived possessions at the different plants. It is further described that the individual who made the error is no longer with the organization. Mr. Take the time explains to management the fact that issue will probably be examined more closely. Ahead of any further description can be presented, members of management are called away another meeting.
As you leave the meeting you recognize that you do not know whether managing is correct about combining long-lived assets for all plants of First Motors to perform the impairment test out. Furthermore, you wonder if impairment testing is performed for the two plant possessions and goodwill, if it could be a combined test out, and if it needs to be done in a specific order. After looking at your paperwork and the organization records, you also begin to wonder if a mistake was performed in the original calculation with the impairment damage related to long-lived assets.
Particularly, for reasons of the present value measurements, you be aware that the terrain and structures are presumed to be sold at the end of 11 years. However , you recall via discussions with management that manufacturing plants bring many years and are retooled over and over. Accordingly, that seem suitable to presume the sale of the land and buildings following 11 years. After all, in line with the accounting documents, the complexes have a remaining beneficial life of 25 years plus the land has an unlimited valuable life. 2 or 3 days earlier, the valuation method for any conceivable goodwill impairment testing was discussed.
It was determined that no reasonable value was readily available for Initial Motors or perhaps its categories. Additionally , because the stock cost of Initially Motors was so unstable over the past 12 months, the market capitalization was not a fantastic indicator in the fair value of 1st Motors. You, Mr. Trouble, and managing came to an agreement that reduced future cash flows was the appropriate value technique to work with. However , the calculations provided by management included a riskfree discount level of 3 percent. You required the initiative to do your own calculations based on a great 8 percent discount charge, which includes a 5% risk high grade.
The 5 percent risk premium was suggested by the same valuation professionals from the company who advised a 6 percent risk premium for use in the Plant three or more long-lived asset impairment. Management calculations as well as your calculations happen to be summarized beneath in Dining tables 2 and 3. The information in the first portion of Stand 2 presents the total reasonable value of First Motors and its sections based on deals of 3 percent and almost eight percent, respectively. Presented in the second area of Table two is the predicted fair benefit of recognizable net assets based on discount rates of 3 percent and almost eight percent, respectively.
Finally, provided in Table 3 is actually a summary in the book worth of identifiable net property and the publication value of net possessions before recording any disability for long-lived assets (the difference signifies the book value of goodwill). First Motors Corporation: A Classroom Case upon Impairments DESK 2 Reasonable Value Information 3% Price cut Rate Total Fair Benefit: First Engines Division Macinaw Division Total (First Motors) Fair Worth of Identifiable Net Assets: First Motors Division Macinaw Division Total (First Motors) $2, 600, 000, 500 3, 200, 000, 000* $5, 800, 000, 1000 8% Discount Rate $2, 045, 1000, 000 2, 550, 1000, 000* $4, 595, 1000, 000 3 2, five-hundred, 000, 500 2, 800, 000, 1000 $5, three hundred, 000, 1000 $2, 010, 000, 500 2, 200, 000, 000 $4, 210, 000, 000 * Take note that the total fair worth for the Macinaw Section includes the combined net assets of Plants 1, 2, and 3. STAND 3 Book Value Initial Motors Department Macinaw Split Total (First Motors) Identifiable Net Resources $2, 500, 000, 500 3, 500, 000, 500 $5, 000, 000, 500 Goodwill $0 1, three hundred, 000, 500 $1, 300, 000, 000 Net Possessions $2, 500, 000, 000 4, three hundred, 000, 1000 $6, 300, 000, 500 QUESTIONS (Assume that at present enacted GAAP is still appropriate in the year 2012) Part one particular Please provide detailed details in responding to each of the pursuing questions.
Intended for questions 2a, 3a, 4a and a few, provide a citation to the ideal accounting standard that supports your debate. 1 . Diagram the company structure of First Motors Corporation. installment payments on your a. Beneath what instances is a company needed to perform impairment testing to get long-lived resources? b. Was impairment screening of long-lived assets required for First Motor? Why or why not? a few. a. For what level is disability testing completed for long-lived assets? n.
Are the business owners of Initial Motors correct in suggesting that the disability of longlived assets at Plant 3 is unnecessary because the fall in the value of the Plant 3 possessions can be counter by the embrace the fair value of long-lived resources at other plants? 5. a. At what level is disability testing done for goodwill? 24 b. 5. Krumwiede and Giannini For 1st Motors, for what level should this kind of testing be performed (i. elizabeth., should it be carried out for the organization as a whole or just for the Macinaw Division)? If disability testing of both goodwill and long-lived assets is necessary, in what purchase is it carried out?
Part two Please give detailed answers in answering each of the pursuing questions. Give citations for the standards for each of the pursuing: questions 6a, 7a, 8a, and 10a. Additionally , it is strongly recommended that you present citations to SFAC Second seed (FASB 1980) when responding to questions 10b, 11, and 12. 6. a. Make a schedule demonstrating the calculation of the long-lived asset impairment loss at both the several percent lower price rate as well as the 9 percent discount price. In the details provided in the case, it was believed that the terrain and buildings for Grow 3 were sold at the conclusion of 14 years.
Make sure to consider and discuss in case the land and buildings’ “assumed sale following 11 years is appropriate or perhaps if the “assumed sale needs to be at the end of the buildings’ beneficial life. m. Do you think that management is proper in using the 3 percent rate, and/or the auditors correct in suggesting the 9 percent rate, or perhaps can either rate of interest be validated? Provide a thorough answer to this kind of question including a discussion of a risk high quality. Be sure to consider the type of cash flow information provided by management. 7. a. Once an impairment of long-lived assets is decided, how is a write-down allotted among multiple assets?
Make a schedule displaying this portion for Plant 3 (use the impairment loss determined based on the discount level you chose in question 6b). b. Refer to your answer for portion a. Following the allocation is done, will every longlived property (or advantage category) that First Power generators wrote down be explained at reasonable value? So why or really want to? c. How will the disability loss as well as the corresponding decrease of publication value towards the long-lived possessions affect upcoming depreciation expense to be noted, (potential) long term impairment fees and/or future gains or losses around the sale of the long-lived assets? 8.. Determine the intended goodwill benefit and the goodwill impairment reduction, if virtually any, using equally a three or more percent and an almost 8 percent low cost rate. Which in turn rate ought to be used and why? n. The value experts advised that the risk premium (6 percent) in discounting the free cash flows from Plant three or more, for reasons of the long-lived asset impairment, should surpass the risk high quality (5 percent) in discounting the cash moves for the Macinaw Split. Why is this difference in a risk superior justified? 9. a. Will certainly management still receive additional bonuses if the three or more percent lower price rate is employed in the measurements?
If the on the lookout for percent and 8 percent discount rates are used? b. What is earnings administration? c. Discuss the relationship among earnings managing and the range of discount price to be employed in discounting future cash goes for the long-lived property impairment of Plant several and the goodwill impairment of the Macinaw Section. First Motor Corporation: A Classroom Case on Impairments 10. twenty-five 11. 12. Once crafted down as a result of impairment, may long-lived property write-downs or goodwill write-downs be reclaimed if predictions change (i. e., the fair worth subsequently increases)?
Is there this kind of a thing like a write-up for either long-lived assets or goodwill? a. Regarding dependability of financial details, comment on the verifiability and representational faithfulness characteristics in the conceptual construction as they relate to accounting pertaining to impairments. Make sure to incorporate Initially Motors with your discussion. w. Discuss the trade-off between the relevance and reliability of reporting long-lived assets and goodwill by fair value. How does the principle of conservatism apply to this trade-off? Consider the situation of First Motors in your discussion.
Discover a real-world firm that has considered an impairment charge (either for goodwill or longlived assets) and discuss the way the relevant info was revealed in the notes to the financial statements and the affect the charge had on net income or net lack of the company. EDUCATING NOTES Teaching notes can be obtained from the manager. Send a request in the “For Contributors page with the journal website, http://gpae. bryant. edu. REFERRALS Financial Accounting Standards Board. 1980. Qualitative Characteristics of Accounting Data. Concepts Statement No .. (Norwalk, CT: FASB). _______, 2000, Using Cashflow Information and Present Benefit in Accounting Measurements, Ideas Statement No . 7. (Norwalk, CT: FASB). _______, 2001. Goodwill and Other Intangible Resources. Statement of Financial Accounting Specifications No . a hunread forty two. (Norwalk, CT: FASB). _______, 2006. Reasonable Value Measurements. Statement of Financial Accounting Specifications No . 157. (Norwalk, COMPUTERTOMOGRAFIE: FASB). The National Hydrogen Association. Frequently Asked Questions. Retrieved This summer 12, 2006, from http://www. hydrogenassociation. org/general/faqs. asp.