OCW041: Impairment of Assets

Impairment Recognition

An impairment loss is recognized and accrued through a journal entry to record and reevaluate the asset’s value.

Learning Objectives

Explain how to assess an asset for impairment

Key Takeaways

Key Points

  • Business assets should be tested for impairment when a situation occurs that causes the asset to lose value. Certain intangible assets, such as goodwill, are tested for impairment on an annual basis.
  • Impairment losses can occur for a variety of reasons: physical damage to the asset, a permanent reduction in market value, legal issues against the asset, and early asset disposal.
  • An impairment loss is recognized through a journal entry that debits Loss on Impairment, debits the asset’s Accumulated Depreciation and credits the Asset to reflect its new lower value.

Key Terms

  • accrue: To increase, to augment; to come to by way of increase; to arise or spring as a growth or result; to be added as increase, profit, or damage, especially as the produce of money lent.
  • depreciation: The measurement of the decline in value of assets. Not to be confused with impairment, which is the measurement of the unplanned, extraordinary decline in value of assets.

Impairment Recognition

Business assets should be tested for impairment when a situation occurs that causes the asset to lose value. An impairment loss is recognized and accrued to record the asset’s revaluation. Once an asset has been revalued, fluctuations in market value are calculated periodically. Certain intangible assets, such as goodwill, are tested for impairment on an annual basis. Impairment losses can occur for a variety of reasons:

  • when an asset is badly damaged (negative change in physical condition)
  • the asset’s market price has been significantly reduced
  • legal issues have had a negative impact on the asset
  • the asset is set for disposal before the end of its useful life A loss on impairment is recognized as a debit to Loss on Impairment (the difference between the new fair market value and current book value of the asset) and a credit to the asset. The loss will reduce income in the income statement and reduce total assets on the balance sheet.

A loss on impairment is recognized as a debit to Loss on Impairment (the difference between the new fair market value and current book value of the asset) and a credit to the asset.The loss will reduce income in the income statement and reduce total assets on the balance sheet.

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The impairment of an asset reduces its value on the balance sheet.: The cost of an impaired building beyond repair is disclosed as a loss on the income statement.

For an example, take a retail store that is recorded on the owner’s balance sheet as a non-current asset worth USD 20,000 (book value or carrying value is USD 20,000). Based on the asset’s book value, assume the store has a historical cost of USD 25,000 and accumulated depreciation of USD 5,000. A hurricane sweeps through the town and damages the store’s building. After assessing the amount of the damage, the owner calculates that the building’s market value has fallen to USD 12,000.

The Loss on Impairment is calculated to be USD 8,000 (20,000 book value – 12,000 market value)

The journal entry to recognize the Loss on Impairment:

  • Debit Loss on Impairment for USD 8,000
  • Debit Store Building-Accumulated Depreciation for USD 5,000
  • Credit Store Building for USD 13,000

The Loss on Impairment for USD 8,000 is recognized on the income statement as a reduction to the period’s income and the asset Store Building is recognized at its reduced value of USD 12,000 on the balance sheet (25,000 historical cost – 8,000 impairment loss – 5,000 accumulated depreciation). After the impairment, depreciation expense is calculated using the asset’s new value.

Impairment Measurement

Business assets that have suffered a loss in value are given two tests to measure and recognize the amount of the loss.

Learning Objectives

Summarize the steps a company takes to measure an assets impairment

Key Takeaways

Key Points

  • Two tests are performed to determine the amount of an impairment loss: recoverability and measurement.
  • The recoverability test evaluates if an asset ‘s undiscounted future cash flows are less than the asset’s book value. When cash flows are less, the loss is measured.
  • The measurement test uses the difference between the asset’s market value and book value to calculate the amount of the impairment loss.

Key Terms

  • recoverability: The property of being able to recover.
  • cash flows: cash received or paid by a company for its business activities.
  • intangible asset: Any valuable property of a business that does not appear on the balance sheet, including intellectual property, customer lists, and goodwill.

Business assets that have suffered a loss in value are subject to impairment testing to measure and recognize the amount of the loss.

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Physical damage to an asset can result in an impairment loss.: The impairment of a building is measured by determining the amount of value the asset has lost.

To measure the amount of the loss involves two steps:

  • Perform a recoverability test is to determine if an impairment loss has occurred by evaluating whether the future value of the asset’s undiscounted cash flows is less than the book value of the asset. If the cash flows are less than book value, the loss is measured.
  • Measure the impairment loss by calculating the difference between the book value and the market value of the asset.

The use of undiscounted cash flows in determining impairment loss assumes that the cash flows are certain and risk-free, and the timing of the cash flows is ignored. For example, assume a new USD 20,000 sewing machine, with a useful of life of 3 years, is damaged and has a new book value of USD 10,000.

The expected undiscounted cash flows generated by the machine after the damage are:

  • USD 2,000 in Year1
  • USD 2,000 in Year2
  • USD 2,000 in Year3

Since the asset’s future undiscounted cash flows are USD 6,000, less than the USD 10,000 book value, an impairment loss has occurred. Use the market value of the sewing machine, USD 20,000, and deduct the USD 10,000 book value to arrive at an impairment loss of USD 10,000.

Certain assets with indefinite lives require an annual test for impairment. Trademarks and Goodwill are examples of intangible assets that are tested for impairment on an annual basis.

Loss Restoration

Fixed asset values can be revised to reflect an increase or decrease in value; upward revisions can recover earlier impairment losses.

Learning Objectives

Explain when it would be applicable to revalue an impaired asset

Key Takeaways

Key Points

  • A revaluation that increases or decreases an asset ‘s value can be accounted for with a journal entry that will debit or credit the asset account.
  • An increase in the asset’s value should not be reported on the income statement; instead an equity account is credited and called a “Revaluation Surplus”.
  • The revaluation surplus account accounts for increases in asset value and it also offsets any downward revisions, such as an impairment loss, in asset value.
  • When the credit balance in the revaluation surplus account zeros out, an impairment loss is reported on the income statement.
  • Under US GAAP, once an asset is impaired, its value cannot be increased regardless of its fair market value. Once the value of an asset is decreased, it stays at that value unless its market value declines again.

Key Terms

  • Comprehensive Income: The change in a company’s owner’s equity [net assets] due to transactions and other events and circumstances from non-owner sources. Comprehensive income is the sum of net income and other items that must bypass the income statement because they have not been realized
  • International Financial Reporting Standards: International Financial Reporting Standards (IFRS) are designed as a common global language for business affairs so that company accounts are understandable and comparable across international boundaries

Asset Revaluation and Impairment Loss

Under US GAAP, once an asset is impaired its value cannot be increased regardless of what its fair market value is; once the value of an asset is decreased, it stays at that value unless its market value declines again. US GAAP does require that a business impair its assets if its fair market value decreases.

Under International Financial Reporting Standards, once a fixed asset has been revalued its book value can be adjusted periodically to market value using the cost model or the revaluation model. The cost model records an asset at its historical cost. If an asset becomes impaired and an impairment loss results, the asset can fall under the revaluation model that allows periodic adjustments to the asset’s book value. Future upward revisions to the value of the asset can recover losses from prior years under the revaluation model.

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An upward revision to an asset’s value can recover prior impairment losses: Only assets accounted for under the revaluation model can have their book value adjusted to market value.

Revaluation Surplus

A revaluation that increases or decreases an asset’s value can be accounted for with a journal entry. The asset account is debited (increased) for the increase in value or credited (decreased) for a decrease in value. An increase in the asset’s value should not be reported on the income statement; instead an equity account is credited called “Revaluation Surplus. ” Revaluation surplus is reported in the other comprehensive income sub-section of the owner’s equity section in the balance sheet. The revaluation surplus account accounts for increases in asset value, and it also offsets any downward revisions, such as an impairment loss, in asset value. When the credit balance in the revaluation surplus account zeros out, an impairment loss is reported on the income statement.

Revaluation and Depreciation

After an asset have been revalued, the asset’s depreciation expense must change to reflect the new value. The asset’s new book value can be divided by its remaining useful life to adjust the amount of depreciation expense reported on the income statement after the revaluation.


Source: Accounting