On January 1, 2008, the Dolan Company purchased a new office building in Las Vegas, for $6,100,000, which it holds for rentals and capital appreciation. Dolan estimated the building would have a useful life of 25 years and a residual value of $1,100,000. Dolan uses straight-line depreciation for financial reporting and double-declining balance for tax purposes. There are no other permanent or temporary differences between taxable income and book income.
During 2014 and continuing into 2015, the building remains only partially occupied. Rental revenue in 2014 totaled $500,000. Dolan had plans to hold the building for 10 years and then sell it. Dolan estimates that the occupancy level will remain below its original estimates but will increase slightly (2% per year) from 2016–2025. Maintenance and other expenses are expected to remain steady at 80% of estimated rents.
At December 31, 2015, the fair value of the building based on an independent appraisal is $4,300,000. Estimated costs to sell the building are $200,000. The sum of the estimated net cash flows from the building is $4,598,000. The present value of the net cash flows at 8% is $4,258,000.
Any impairment charge that Dolan records in 2015 is not tax deductible and would only reverse when the asset is sold. If Dolan does not recognize an impairment loss on the building, book income before depreciation and taxes is $8,200,000. The enacted tax rate is 30%.
Before attempting this problem, review the discussion in Chapter 10 regarding the differences between IFRS and U.S. GAAP requirements for testing for and recognizing impairment losses on noncurrent, tangible assets.
1. Determine the book and tax bases of the building on December 31, 2015.
2. Determine the amount by which the deferred tax liability increased in 2015.
3. Determine the impairment loss (if any) Dolan would recognize under U.S. GAAP and prepare the resulting 2015 tax expense journal entry, assuming Dolan expects to have sufficient future income to fully utilize any deferred tax assets.
4. Determine the impairment loss (if any) Dolan would recognize under IFRS and prepare the resulting 2015 tax expense journal entry, assuming Dolan expects to have sufficient future income to fully utilize any deferred tax assets.