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solution

Perfect Industry Company Limited (PI) is an experienced original equipment manufacturer (OEM) in cameras. However, it focuses on film camera production while its production of compact digital cameras (CDCs) accounts for only 10% of its production. PI realises that the market for traditional film cameras is declining in terms of demand and profit margin because customers are shifting to digital cameras. In view of the market sentiment, PI is considering the following three options:

Option 1: Upgrading as an OEM manufacturer for consumer CDCs

Following this option, Perfect Industry would need to invest at least $40 million to replace its existing production facilities to meet customer requirements. Perfect Industry would remain principally an OEM manufacturer for consumer CDCs of major brands.

Option 2: Becoming an original brand manufacturer (OBM) for budget CDCs for the PRC using the “Perfection” brand

Following this option, Perfect Industry could retain its manufacturing facilities with minimum modification at a cost of approximately $10 million. However, substantial expenditure would be needed to develop the company’s brand name “Perfection” in the PRC market over the next few years. In the long run, Perfect Industry may need to outsource its manufacturing activities and form joint ventures with PRC manufacturers. Following this option, the company would need to reposition itself as a market-oriented organisation rather than a manufacturing organisation.

Option 3: Shifting to an OEM for non-CDC products

Following this option, the company would avoid direct competition with larger CDC manufacturers and would shift to exploring something different, such as PC cameras or toy cameras. Although the sales volume would decrease, the profit margin would remain relatively high since currently not many competitors are operating in this segment. No material investment or modification in the company’s existing production facilities and no marketing expenses would be needed. However, more talented product development staff would be required and the employment of a significant number of production workers would be terminated.

Required:

Discuss the key financial reporting issues in relation to the three options regarding the impairment of production facilities.

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