Impaired Asset: Meaning, Causes, How To Test, and How To Record

In 2006, Tata Steel Ltd, which ranks as one of India’s largest steel companies and in the world, made its biggest acquisition, purchasing Anglo-Dutch steelmaker Corus Group Plc. Corus was established in 1999 and was the second-largest steel company in Europe before its acquisition. Similarly, it can help stakeholders determine if a company might face any failures or damages and be an indicator of its efficiency and effectiveness. Impairment losses can also help stakeholders determine if a company’s policies or decisions may have failed. Any allowance for loan impairments should be fully documented with the appropriate analysis, and updated consistently from period to period. A loan is considered to be impaired when it is probable that not all of the related principal and interest payments will be collected.

• When an asset is impaired, the company must record a charge for the impairment expense during the accounting period.
• For impairment of an individual asset or portfolio of assets, the discount rate is the rate the entity would pay in a current market transaction to borrow money to buy that specific asset or portfolio.
• If the required test of impairment indicates that a loss must be recorded on its plant and equipment, its book value must be reduced and the resulting loss reported on its income statement.
• Other than these, the impairment of assets applies to all other assets within a company.
• Things that cause impairment internally include physical damage to the asset, causing a reduction in its value.

My Accounting Course  is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers. A decrease in the value of a long term asset to an amount that is less than the amount shown under the cost principle. The impairment cost is calculated using either the Incurred Loss Model or the Expected Loss Model. The Financial Accounting Standards Board (FASB) has rules in place for private and public companies, including those surrounding goodwill. For instance, Accounting Standards Codification (ASC) Topic 350 and Topic 805 allow companies to exercise discretion when allocating goodwill and determining its value.

Prior to the adoption of the new FASB accounting rules, companies were allowed to amortize the goodwill from any acquisitions they made every quarter. Natalya Yashina is a CPA, DASM with over 12 years of experience in accounting including public accounting, financial reporting, and accounting policies. Some industry experts also believed the Indian steel company was quite optimistic and aggressive in the whole process. The entire story of the bidding and the synergy benefit was not well taken by the markets, and the share price of the company fell by 11% on the day of the announcement of the deal and by more than 20% in a month.

An impaired asset is one that has a market value less than what is listed on the company’s balance sheet. There are various factors that can affect an asset’s value so periodically checking its value is prudent business management. The book value of goodwill from the Nokia purchase, and therefore assets as a whole, reported on Microsoft’s balance sheet were deemed to be overstated when compared to the true market value.

Causes of Impairment

Things could get ugly if increased impairment charges reduce equity to levels that trigger technical loan defaults. Most lenders require debtor companies to promise to maintain certain operating ratios. It is also possible for the allocation process to be manipulated to avoid flunking the impairment test. As management teams attempt to avoid these charge-offs, more accounting shenanigans will undoubtedly result. The company has high (greater than 70%) leverage ratios and negative operating cash flows.3. The company’s stock price has declined significantly in the past decade.

The recoverable value can be either its fair market value if you were to sell it today or its value in use. The value in use is determined based on the potential value the asset can bring in for the remainder of its useful life. Long-term assets, such as intangibles and fixed assets, are particularly at risk of impairment because the carrying value has a longer span of time to become impaired.

For example, a construction company may face extensive damage to its outdoor machinery and equipment due to a natural disaster. This will appear on its books as a sudden and large decline in the fair value of these assets to below their carrying value. The offset to the impairment allowance should be the bad debt expense account.

Amortizing an intangible asset over its useful life decreases the amount of expense booked related to that asset in any single year. Impairment losses are not usually recognized for low-cost assets, since it is not worth payroll accounting basics the time of the accounting department to conduct impairment analyses for these items. Thus, impairment losses are usually confined to high-cost assets, and the amount of these losses can be correspondingly large.

Amendments under consideration by the IASB

Under the U.S. generally accepted accounting principles, or GAAP, assets that are considered “impaired” must be recognized as a loss on an income statement. Under GAAP, an impaired asset must be recorded as a loss on the income statement. It is important to compare the value of the asset to the fair market value to help determine the loss.

What is the impairment of assets?

The amount of depreciation taken in each accounting period is based on a predetermined schedule using either a straight line method or one of a number of accelerated depreciation methods. When testing an asset for impairment, the total profit, cash flow, or other benefits that can be generated by the asset is periodically compared with its current book value. If the book value of the asset exceeds the future cash flow or other benefits of the asset, the difference between the two is written off, and the value of the asset declines on the company’s balance sheet. An impairment loss is a recognized reduction in the carrying amount of an asset that is triggered by a decline in its fair value. When the fair value of an asset declines below its carrying amount, the difference is written off. Carrying amount is the acquisition cost of an asset, less any subsequent depreciation and impairment charges.

The Profit and loss account

Current accounting standards require public companies to perform annual tests on goodwill impairment, and goodwill is no longer amortized. A meat packing plant in recent years invested large amounts in its plant and equipment. Since then, the company experienced a dramatic decline in the demand for its products and in the value of its plant and equipment.

An impairment loss should only be recorded if the anticipated future cash flows are unrecoverable. When an impaired asset’s carrying value is written down to market value, the loss is recognized on the company’s income statement in the same accounting period. An asset is impaired if its projected future cash flows are less than its current carrying value.

Even when impairment results in a small tax benefit for the company, the realization of impairment is bad for the company as a whole. Impairment occurs when a business asset suffers a depreciation in fair market value in excess of the book value of the asset on the company’s financial statements. Certain assets, such as intangible goodwill, must be tested for impairment on an annual basis in order to ensure that the value of assets is not inflated on the balance sheet.

Depreciation differs from impairment, which is recorded as the result of a one-time or unusual drop in the market value of an asset. A fair market calculation is key; asset impairment cannot be recognized without a good approximation of fair market value. Fair market value is the price the asset would fetch if it was sold on the market. This is sometimes described as the future cash flow the asset would expect to generate in continued business operations.

When Should an Asset Be Impaired?

If the required test of impairment indicates that a loss must be recorded on its plant and equipment, its book value must be reduced and the resulting loss reported on its income statement. To calculate the impairment of an asset, take the carrying value of the asset (its historical cost minus accumulated depreciation) and subtract its fair market value. If its fair market value is less than the carrying value, you will need to record an impairment loss for the difference.