Impaired Asset

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Last Updated:November 21, 2023

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What is an Impaired Asset?

An impaired asset is one with a fair value that is lower than the value indicated on the financial statements. When an asset is impaired, it must be written down to its current valuation on the company's balance sheet.

When an asset is impaired, the income statement records a write-down on the balance sheet and an economic loss. On impaired assets, IFRS and GAAP have differing standards.

If the asset's estimated future cash flows are less than its current carrying value, it is considered impaired.

Materially unfavorable legal conditions that have impacted the asset's worth, significant improvements in the asset's market price owing to a change in customer demand, or deterioration of its physical state can all cause an asset to become impaired.

When an asset seems more likely than not to be disposed of before its initial predicted disposal date, receipts, goodwill, and fixed assets are all asset accounts prone to becoming impaired.

Periodically, assets are assessed for impairment to guarantee that the company's overall asset value is not exaggerated on the balance sheet. In addition, certain investments, such as goodwill, must be tested yearly according to generally accepted accounting standards (GAAP).

To evaluate if the fair value of an asset has decreased below its revalued amount "more likely than not," GAAP suggests that corporations analyze events and economic situations that occur during annual impairment tests.

An impairment loss should be reported only if the expected future cash flows are unrecoverable. When the carrying value of an impaired asset is written down to market value, the loss is reported in the same balance sheet on the company's balance sheet.

If an asset's market value is less than its fair value, it is damaged and must be lowered to its fair market value, with the write-down amount recorded as a loss. For example, this happens when an asset is depreciated or amortized at a rate that is too low or when the asset's market value drops.

Key Takeaways

To avoid overestimation on the balance sheet, assets should be assessed for impairment regularly.
Trade receivables and long-term assets like soft skills and fixed assets are the most prone to become impaired.
When the value of an impaired asset is written down on the balance sheet, a loss is also recognized on the income statement.

Accounting for Impaired Assets

The difference between the asset's carrying cost and the item's decreased market value is the entire financial amount of impairment. A deduction to a loss, or cost, account and a credit to the underlying asset are used to record an impairment.

A counter intangible amortization account with a balance opposite the corresponding asset account might be utilized for the credit to keep the asset's historical cost on a distinct line item.

The additional carrying cost is reflected in the net of the asset, its cumulative depreciation, and the counter asset impairment account in this case.

The asset's carrying cost is lowered when the impairment is recorded. As a result, the asset will be reported at its lower carrying cost in future quarters.

Even if the market value of the impaired asset recovers to its previous level, GAAP requires that the impaired asset be recorded at the lower adjusted dollar amount.

This is following cautious accounting practices that are cautious. First, any gain in value is recorded when the item is sold.

According to GAAP, fixed assets are tested for impairment at the lowest level where there are identifiable cash flows. For example, rather than testing the high-level production facility itself, an automaker should evaluate each piece of equipment in a manufacturing plant for impairment.

If no traceable cash flows exist at this low level, it is permissible to test for impairment at the asset group or include tangible assets. If an asset group suffers from an impairment, the loss is spread across all assets in the group. This proration is based on the assets' current holding value.

Calculate an accurate and reliable fair value for the asset before making an impairment judgment. Then, on the company's balance sheet, compare that worth to the amount specified as a fair or book value.

If these figures are the same, the asset's previous value is preserved, and no balance sheet adjustments are necessary.

However, when goodwill should be recognized on the balance sheet, accounting becomes a little more difficult. Intangible assets, such as your company's brand name or reputation, or assets not individually traceable in M&A, are examples of goodwill.

Take, for example, the $105 million purchase of Lollipop Inc. by Big Candy Co. The company's physical assets, which include a production factory, delivery vans, and other equipment, were appraised at $80 million at the time of purchase.

Brand associations and recipes worth $10 million are among its intangible assets. On Big Candy Co.'s balance sheet, the gap between the value of Lollipop's assets and the amount paid, $15 million, will be recorded as goodwill.

Lollipop's brand awareness, distribution network, and strong social media following were deemed valuable by the corporation.

The corporation discovers the value of the recipes and trademarks obtained in purchasing Lollipop Inc.

It is less than projected after three years of falling sales. Therefore, a $5 million impairment cost is recorded.Depreciation and amortization have lowered the price of long-term investments by another $5 million. As a result, the subsidiary's net book value is $85 million.

Due to uneven marketing and a lack of inventive new items, Lollipop has also lost numerous big distributors. As a result, the corporation incurs a $10 million goodwill impairment charge.

Calculation of Impaired Asset

Accounting standards govern whether an asset should be impaired and how much it should be. Regarding impaired assets, IFRS and US GAAP have differing requirements.

1. IFRS Regulations

The International Financial Reporting Standards (IFRS) use a one-step technique to identify and report impaired assets. First, when the carrying value of an asset exceeds its recoverable value, an impairment loss occurs.

Depending on which is greater, the recoverable amount is either the market value minus the selling cost or the value in use (the present value of all future cash flows the asset is projected to generate).

Assume that an asset is predicted to provide $10,000 in cash income each year for the following three years at a discount rate of 2%, resulting in a current year value in use of $28,839. The recoverable value is $30,000 if the item can be sold for $30,000 without selling costs.

The asset will be written down by $8,000, and an equivalent amount of impairment loss will be recognized, with a carrying value of $38,000.

If an asset has been impaired, but the recoverable amount rises beyond the carrying value in a subsequent year, impairment recovery is allowed under IFRS.

Companies cannot grow their balance sheets by matching carrying amounts to higher market values since the recovery amount is restricted to the cumulative reported impairment losses.

2. GAAP Requirements

The US GAAP employs a two-step strategy. The first step is to perform a recoverability test to establish whether an asset should be impaired.

When an asset's book value exceeds the asset's predicted present cash flows, the asset's book value is regarded as non-recoverable, and an asset impairment should be reported.

After completing the first test, the second stage assesses the impairment loss. The difference between the asset book value and fair value is used to calculate the write-down amount (or the sum of discounted future cash flows if the fair value is unknown).

In the same case, the sum of undiscounted future cash flows is $30,000, which is less than the carrying value of $38,000.

As a result, the modifiability test has been passed, and the asset should now be considered impaired. According to the second stage, the impairment loss will be $8,000 ($38,000 – $30,000). The impairment loss will be $9,161 ($38,000 – $28,839).

When assessing asset impairment under GAAP, it's vital to remember that the first step uses undiscounted cash flows, while the second uses discounted cash flow methods.

Another distinction between GAAP and IFRS regulations is that GAAP does not provide impairment recovery.

How do companies figure out if an asset is Impaired?

Assets are deemed impaired in the United States when their book value, or net carrying value, exceeds projected future cash flows. This happens when a company invests in an asset, but circumstances change, and the investment becomes a net loss.

Several appropriate testing procedures can be used to detect assets that are degraded.

If the impairment is permanent, the corporation should calculate the impairment loss using an acceptable method and include it in the income statement.

The Internal Revenue Service (IRS), the Financial Accounting Standards Board (FASB), and the Governmental Accounting Standards Board (GASB) are all in charge of impairment recognition and measurement (GASB).

The typical criterion for impairment is a lack of recoverability of the net carrying amount, as defined by generally accepted accounting standards (GAAP).

When an asset is judged impaired, the owner is responsible for calculating a loss equal to the difference between the asset's net acquisition cost and its fair value. Most organizations depreciate long-term, physical assets.

FASB Statement No. 144: Accounting for the Impairment or Disposal of Long-Lived Assets addresses these impairments.

This declaration discusses how to apply goodwill assignment to long-term assets and a better approach for predicting cash flow (probability-weighted) and when assets should be kept for sale.

Regulatory changes, technological changes, major alterations in customer tastes or community attitude, a change in the asset's utilization rate, or other projections of long-term non-profitability can all cause tangible asset impairment. However, the impairment of intangible assets is less evident.

FASB 144 covers several forms of intangible assets, and FASB 147 adds more. However, the following criteria may not always apply to intangible assets. It is generally impracticable to assess the profitability of every asset in every accounting period.

Rather, companies should wait until an incident or contextual change indicates that a certain carrying amount may not be recovered.

Before use, assets must be appropriately appraised (fair value) in compliance with GAAP. In addition, the work should be performed on groups of similar assets, with the lowest level of identifiable cash flows regarded irrespective of other assets.

The carrying amount should be tested to see if it exceeds the purchase price cash flows associated with the asset's use and liquidation. Unless otherwise prohibited by the Internal Revenue Service or GAAP, the asset can be impaired and written down if this can be proven.

Impaired assets have a market value that is less than their book value. Impairment can happen to any asset, intangible or physical.

Entities must undertake impairment tests, except for property and other specific intangible assets, if there are signs of impairment. The impairment test needs to be performed periodically per the requirements of the Generally Accepted Accounting Principles.

Many businesses have failed because of the value of their damaged assets plummeting. These disclosures can serve as early warning signs for the firm's creditors and investors as they do their due diligence.