GADGET WORLD, Inc. is an electronics retailer. In addition to operating its Gadget World product stores, for the last 5 years the company has run a service division—called “Nerd Patrol”—t

GADGET WORLD, Inc. is an electronics retailer. In addition to operating its Gadget World product stores, for the last 5 years the company has run a service division—called “Nerd Patrol”—that offered installation and repair service to its customers. The service business has not been as successful as management had hoped and the decision was made and announced on October 31, 2016 to get out of the service business. At this date, the applicable tax rate is 30%.

Case 2: Disposal Date After Year-End

In this case, the disposal occurs after year end so at the end of 2016, the Services division is classified as “held for sale.” Since the sale has not yet occurred, we can’t recognize a gain or loss on the actual sale. But we must evaluate whether we expect a loss when the sale is completed, and, if so, record an IMPAIRMENT LOSS to reduce the carrying value of the assets.

The following worksheet shows GADGET WORLD’s operating results. Note that the 2016 operating results for the Services Division have changed since they include results for the full year—through Dec. 31, 2016. The results for 2015 are unchanged.

2016 2015
Company Divisions Company Divisions
Total Services Products Total Services Products
Sales $235,000 $75,000 $160,000 $230,000 $80,000 $150,000
Cost of Goods Sold $75,000 $25,000 $50,000 $110,000 $25,000 $85,000
   Gross Profit $160,000 $50,000 $110,000 $120,000 $55,000 $65,000
Less: Operating Expenses $10,000 $5,000 $5,000 $10,000 $5,000 $5,000
     Operating Income(loss) $150,000 *$45,000 $105,000 $110,000 $50,000 $60,000
Impairment Loss
     Income before taxes
Income tax expense/(benefit)
     Net Income(loss)
* 2016 Services Div. operating income includes activity thru 12/31.

The assets of the Services Division still have a carrying value of $2,000,000. But, the company now estimates that the fair value of the Services Division (expected selling price) to be $2,100,000, and $150,000 of costs are expected to complete the sale. Therefore, the expected proceeds of the sale are $1,950,000.

Required (continued on the next page):

1. What is the gain or loss expected on this disposal? Complete the “Impairment Loss” and “Income before taxes” rows of the worksheet above.

2. If a journal entry is required to record an impairment loss, what would it look like?

3. What is the tax effect of the operating results and the planned disposal? Complete the “Income tax expense/(benefit)” and “Net income(loss)” rows of the worksheet above.

4. Prepare an Income Statement (assume 100,000 shares outstanding in both years):

2016 2015
Sales
Cost of Goods Sold
Gross Profit
less: Operating Expenses
Income Before Taxes and Disc. Oper.
Income Tax Expense/(Benefit)
Income from Continuing Operations
Discontinued Operations:
Income(loss) from operation
Impairment loss
Income tax expense (benefit)
Income(loss) from Disc. Oper.
Net Income
EPS from Continuing Operations
EPS from Discontinued Operations
Net Income per share

Expert Answer

 

1
Loss expected on disposal
(2100000-150000)-2000000= -50000
2. Journal entry break-up in the event of sale
Debit Credit
Asset 100000
Gain on valuation of asset 100000
Cash 2100000
Asset 2100000
Exp.on sale 150000
Cash/A/cs payable 150000
Gain on valuatio 100000
Loss on disposal 50000
Exp.on sale 150000
Combining the above entries,
Cash 2100000
Asset 100000
Impairment loss 50000
Asset 2100000
Cash/A/c spayable 150000
3. Tax effect Company Divisions
Total Services Products
Sales 235000 75000 160000
Cost of Goods Sold 75000 25000 50000
   Gross Profit 160000 50000 110000
Less: Operating Expenses 10000 5000 5000
     Operating Income(loss) 150000 45000 105000
Impairment Loss -50000 -50000
     Income before taxes 100000 -5000 105000
Income tax expense/(benefit) 30000 -1500 31500
     Net Income(loss) 70000 -3500 73500
4. Income Statement (assume 100,000 shares outstanding in both years):
2016 2015
Sales 235000 230000
Less:Cost of Goods Sold 75000 110000
Gross Profit 160000 120000
less: Operating Expenses 10000 10000
Income Before Taxes and Disc. Oper. 150000 110000
Less: Income Tax Expense/(Benefit) 45000 33000
Income from Continuing Operations 105000 77000
Discontinued Operations:
Income(loss) from operation 45000
Impairment loss -50000
Income tax expense (benefit) -15000
Income(loss) from Disc. Oper. -35000
Net Income 70000 0
EPS from Continuing Operations=105000/100000 shares = 1.05 0.77
EPS from Discontinued Operations= -35000/100000 shares = -0.35 0
Net Income per share 0.7 0.77
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