An impaired asset is defined as an asset whose market value is lower than the value listed on a company’s balance sheet. When an asset is identified as impaired, it must be written down to its current market value on the company’s balance sheet. This process also involves recording a loss on the income statement.
Key Points to Remember
- Regular tests for impairment prevent overstatement on the balance sheet.
- Assets prone to impairment include accounts receivable, intangibles, and fixed assets.
- When an impaired asset’s value is written down, a corresponding loss is noted on the income statement.
- GAAP and IFRS have different standards for handling impairment.
How Impaired Assets Work
An asset becomes impaired if its future cash flows are less than its current carrying value. Impairment may result from legal changes, market price shifts due to consumer demand changes, or physical damage. Moreover, if an asset is likely to be sold before its originally estimated disposal date, it signals potential impairment.
Assets that are particularly susceptible to impairment include a company’s accounts receivable, goodwill, and fixed assets. Long-term assets are more at risk due to extended time spans over which they might lose value.
To avoid overstatement, companies should periodically test their assets for impairment. GAAP suggests that certain assets, like goodwill, should be annually tested for impairment. Additionally, events and economic conditions occurring between these annual tests should be considered to determine whether the market value of an asset has fallen below its carrying value.
When anticipated future cash flows are unrecoverable, an impairment loss should be recorded. As soon as an asset’s carrying value is written down, the loss must be recognized on the company’s income statement in the corresponding accounting period.
Accounting for Impaired Assets
Under GAAP guidelines, the impairment’s dollar value is the difference between the asset’s carrying value and its fair market value. In contrast, IFRS measures impairment loss as the difference between the carrying value and the recoverable value, which could be either its market value if sold today or its value from use. The value from use is computed based on the asset’s potential contribution to the company’s profits for the remainder of its useful life.
Journal Entry for Impairment:
- Debit: Loss or expense account
- Credit: The related asset account or a contra asset impairment account. In situations where a contra asset impairment account is used, the net of the related asset, accumulated depreciation, and the contra asset impairment account will reflect the new carrying value.
After recording the impairment, the asset’s carrying value is reduced. Even if the market value returns to its original level, GAAP demands the asset remain listed at its lower, adjusted value, following conservative accounting principles. In some specific cases, IFRS permits the reversal of impairment losses.
Standard GAAP practices recommend testing for impairment at the lowest identifiable level of independent cash flows—for instance, individual machines in a manufacturing plant. When separate cash flows cannot be identified at this level, testing may be conducted at the asset group or entity level, where impairment is prorated among the group’s assets based on their current carrying values.
IFRS prefers impairment testing at the individual asset level; however, when it’s not feasible, impairment is addressed at the cash-generating unit (CGU) level.
Asset Depreciation vs. Asset Impairment
Depreciation is the regular accounting for an asset’s wear and tear over time, subject to a predetermined schedule (straight line or accelerated methods). Impairment, conversely, is recorded in response to an unusual or sudden decline in an asset’s market value.
Once a capital asset is impaired, adjustments in depreciation rates are made for future accounting periods based on the new, lower carrying value. Retroactive depreciation changes are unnecessary.
Real-World Example of an Impaired Asset
In 2015, Microsoft acknowledged impairment losses following its 2013 purchase of Nokia. Microsoft had initially recognized $5.5 billion in goodwill and another $4.5 billion in other intangible assets from the Nokia acquisition. However, due to underperformance in the cellphone sector, Microsoft deemed the book value of goodwill overstated, recording an impairment loss of $7.6 billion, which included the entire $5.5 billion in goodwill.
Frequently Asked Questions
How Do You Calculate the Impairment of an Asset Under GAAP? To calculate asset impairment, subtract its fair market value from its carrying value (historical cost minus accumulated depreciation). Record an impairment loss for the difference.
Where Does Impairment Appear on Financial Statements? Impairment losses are shown as a negative on the income statement. If using a contra asset account, report it below the asset on the balance sheet.
When Should an Asset Be Impaired? An asset should be impaired if its fair market value falls below its carrying value due to factors like physical damage, a dip in consumer demand, or legislative changes.
Conclusion: Staying Accurate and Conservative
When an asset’s value is lesser than previously accounted for on a company’s balance sheet, it signals impairment. By using accurate accounting practices, companies adjust the asset value on their balance sheets, capturing the loss on their income statements. It’s important to note that depreciation differs from impairment, and adjust implied depreciation must be recalculated for the asset’s remaining useful life. While GAAP and IFRS provide differing standards, both frameworks aim to represent asset values accurately.
Related Terms: market value, balance sheet, income statement, capital asset, depreciation.
References
- FASB. “Goodwill Impairment Testing”.
- FASB. “Accounting Standards Updates No. 2014-02: Intangibles—Goodwill and Other (Topic 350)”, page 2.
- RSM. “US GAAP vs. IFRS: Impairment of long-lived assets”.
- PWC. “3.10 Impairment Loss Reversal.”
- Stout. “ASC 360 Impairment Testing: Long-Lived Assets Classified as Held and Used”.
- Computer World. “Microsoft writes off $7.6B, admit failure of Nokia acquisition”.
