First Motor

Topics: Generally Accepted Accounting Principles, Goodwill, Depreciation Pages: 8 (2640 words) Published: November 11, 2011
To:First Motors Corporation
From:Nam Do
CC:Dr. Jeff Archambault
Re:The Accounting Policies and Procedures
The purpose of the audit memo is to clarify the accounting policies and procedures used by clients and the accounting policies and procedures that should be followed. The audit memorandum also provides a clear explanation of a difference between the risk premium in discounting the free cash flow from Plant 3 and the risk premium in discounting the cash flows for the Macinaw Division and which of the appropriate discount rate for computation of goodwill impairment. The case mentioned about impairments which will be written down after the assets are tested for impairments and how the impairment loss will be allocated among group of assets. The audit memo gives the answer about whether long-lived asset or goodwill write-downs due to impartment or write-ups if the fair value subsequently increases. Fact:

To take advantage of the alternative fuel source expertise, First Motors purchased Macinaw Motors Corporation which has significantly specialized in hydrogen-powered cars. Although First Motors and Macinaw merged together, they want to operate separately to utilize its own efficiency and engage in its own business activities. Macinaw Motors has three manufacturing plants which are still in operation. Each plant is located in different locations such as Plant 1 (California) specializing in the hydro-powered Mankato, Plant 2 (Indiana) focusing in the hydrogen-powered Sheboygan and Plant 3 (Georgia) working on the gasoline-powered Spokane. The long-lived assets in Plant 3 do not generate the net cash flow as expected since the plant was retooled that caused the argument whether or not to keep Plant 3 open. Management required an impairment test to determine if the long-lived assets impaired. * The estimated remaining life: 11 years

* Net cash flow for next 11 years: $62,504,377
* Selling estimates after 11 years: $30 million
* Total estimated undiscounted net cash flow over next 11 years: $717,548,147 Issues:
The audit team figured out that risk-free rate 3 percent does not incorporate an inflation factor because the cash flow estimates were not adjusted for inflation. As you know that the discount rate should incorporate a risk premium. There was an argument on a discount rate of 3 percent that management thought that it is appropriate and you thought that that rate is low. Based on the analysis in the auto industry and review of First Motors and Plant 3, a 6 percent risk premium with a 3 percent risk-rate is more reasonable. The valuation method for any possible goodwill impairment testing was discussed but they had not come up the decision of which valuation method should be used. When the impairment test to the long-lived assets should be performed to test the assets whether or not impaired and what valuation methods for the Plant 3 should be applied. After the impairment test has been done and management came up with the impairment loss, how the impairment loss is allocated to the land, buildings, robots and related equipment and other equipment There is a difference in using discount rate for determining the implied goodwill value and the goodwill impairment loss. To the long lived asset impairment, the risk free premium 6% in discounting the cash flow from Plant 3 is different from the risk free premium 5% in discounting the cash flow for the Macinaw Division. The different brings arguments around the selection of an appropriate risk-free rate and risk premium rate. What are the reasons for the difference in risk premium? In case of impairment loss, the long-lived asset or goodwill should be written down and whether or not be written up when its fair value increases. Reasoning:

8A.3.2 checkpoint stated that “a long-lived asset is considered impaired when its carrying amount is not recoverable and exceeds the asset's fair value. The carrying...
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