ABC Manufacturing Corp. is a private company that operates three manufacturing facilities. Each manufacturing facility produces one of the three product lines ABC sells. ABC purchased the facilities using nonrecourse debt. (Nonrecourse debt is a loan that is secured by a pledge of collateral, in this case the facility, but for which the borrower is not personally liable. If the borrower defaults, the lender can seize the collateral, but the lender’s recovery is limited to the collateral.) Each facility is independent of the others and operates as an autonomous part of the overall company.
Because of increased competition one product line has suffered a significant decline in sales. The manufacturing facility producing this product line has seen its operating performance decline significantly, which has directly contributed to a decline in its overall fair value. In the current year (2017), the affected manufacturing facility’s annual operating cash flows have declined by 30 percent to $15 million, and its annual operating cash flows are expected to continue to decline in the near term. Because of this decline in the facility’s fair value and operating performance, ABC’s management is evaluating the following possible options for proceeding into 2018 and beyond:
Option A – continue operating the facility in the same manner
Option B – continue operating the facility but shift production to other two product lines
Option C – For 2018, operate facility in the same manner. On December 31, 2018, turn the facility back to the lender (foreclosure) unless it is sold prior to end of year. (ABC does not expect to be able to sell the facility because of its location)
Estimated Future Cash Flows – Undiscounted
Option Probability 2018 2019 2020 2021 2022 Total
A 20% $15M $12M $10M $7M $5M $49M
B 30% $7M $8M $10M $15M $20M $60M
C 50% $15M $0 $0 $0 $0 $15M
These events indicate that the carrying amount of the asset group may not be recoverable and, therefore, ABC will test the asset group for recoverability and potential impairment in accordance with ASC 360-10 as of the end of the current fiscal year, December 31, 2017.
As of December 31, 2017, the facility’s estimated fair value is $45 million, net book value is $53 million, and estimated remaining useful life is five years. In addition, the net carrying value of the nonrecourse debt is $48 million, there is $2 million of networking capital (carried at fair value) directly attributable to the facility, and ABC has determined that an annual discount rate of 7 percent is appropriate.
Required:
1. How should ABC’s management perform the recoverability test for the facility as of December 31, 2017? In your answer, you should address the following questions (provide authoritative support where appropriate):
• What assets and liabilities should be included in the “asset group” as defined by ASC 360-10 for purposes of performing the recoverability test?
• How should the multiple options under evaluation impact the recoverability test?
• What impact should the potential foreclosure and extinguishment of debt have on the cash flows used to perform the recoverability test?
2. What impairment loss, if any, should be recorded as of December 31, 2017?