Impairment

What Is Impairment?

In accounting, impairment is a permanent reduction in the value of a company asset. It very well might be a fixed asset or a intangible asset.

While testing an asset for impairment, the total profit, cash flow, or other benefit that can be created by the asset is periodically compared with its current book value. On the off chance that the book value of the asset surpasses the future cash flow or other benefit of the asset, the difference between the two is written off, and the value of the asset declines on the company's balance sheet.

Grasping Impairment

Impairment is most usually used to portray an extraordinary reduction in the recoverable value of a fixed asset. The impairment might be brought about by a change in the company's legal or economic conditions or by a casualty loss from an unforeseeable disaster.

For instance, a construction company might face broad damage to its outside machinery and equipment due to a natural disaster. This will show up on its books as a sudden and large decline in the fair value of these assets to below their carrying value.

An asset's carrying value, otherwise called its book value, is the value of the asset net of accumulated depreciation that is recorded on a company's balance sheet.

Periodic Evaluation for Impairment

An accountant tests assets for potential impairment periodically. Assuming any impairment exists, the accountant writes off the difference between the fair value and the carrying value. Fair value is typically derived as the sum of an asset's undiscounted expected future cash flows and its expected salvage value, which is what the company hopes to receive from selling or discarding the asset toward the finish of its life.

Different accounts that might be impaired, and subsequently should be audited and written down, are the company's goodwill and its accounts receivable.

A company's capital can likewise become impaired. A impaired capital event happens when a company's total capital turns out to be not exactly the par value of the company's capital stock.

Dissimilar to impairment of an asset, impaired capital can naturally reverse when the company's total capital increments back over the par value of its capital stock.

Impairment versus Depreciation

Impairment is unexpected damage. Depreciation is expected wear and tear.

The value of fixed assets, for example, machinery and equipment devalues over the long run. The amount of depreciation taken in each accounting period depends on a foreordained schedule utilizing either a straight line method or one of a number of accelerated depreciation methods.

Depreciation schedules allow for a set distribution of the reduction of an asset's value over its lifetime.

Dissimilar to impairment, which accounts for an unusual and uncommon drop in the fair value of an asset, depreciation is utilized to account for regular wear and tear on fixed assets after some time.

GAAP Requirements for Impairment

Under generally accepted accounting principles (GAAP), assets are viewed as impaired when their fair value falls below their book value.

Any write-off due to an impairment loss can unfavorably affect a company's balance sheet and its subsequent financial ratios. It is, subsequently, important for a company to periodically test its assets for impairment.

Certain assets, like elusive goodwill, must be tried for impairment on an annual basis to guarantee that the value of assets isn't swelled on the balance sheet.

GAAP additionally suggests that companies think about events and economic conditions that happen between annual impairment tests to decide whether it is "in all likelihood" that the fair value of an asset has dropped below its carrying value.

Reasons for Impairment

Explicit situations in which an asset could become impaired and unrecoverable incorporate when a huge change happens to an asset's planned use, when there is a decline in consumer demand for the asset, damage to the asset, or adverse changes to legal factors that influence the asset.

Assuming these types of situations emerge mid-year, it's important to promptly test for impairment.

Standard GAAP practice is to test fixed assets for impairment at the lowest level where there are identifiable cash flows. For instance, a car manufacturer ought to test for impairment for every one of the machines in a manufacturing plant as opposed to for the significant level manufacturing plant itself. Assuming there are no identifiable cash flows at this low level, it's allowable to test for impairment at the asset group or entity level.

Illustration of Impairment

ABC Company, situated in Florida, purchased a building quite a long time back at a historical cost of $250,000. It has taken a total of $100,000 in depreciation on the building, and thusly has $100,000 in accumulated depreciation. The building's carrying value, or book value, is $150,000 on the company's balance sheet.

A category 5 hurricane damages the structure fundamentally. The company establishes that the situation meets all requirements for impairment testing.

Subsequent to evaluating the damages, ABC Company decides the building is currently just worth $100,000. The building is thusly impaired and the asset value must be written down to prevent overstatement on the balance sheet.

A debit entry is made to "Loss from Impairment," which will show up on the income statement as a reduction of net income, in the amount of $50,000 ($150,000 book value - $100,000 calculated fair value).

As part of a similar entry, a $50,000 credit is likewise made to the building's asset account, to reduce the asset's balance, or to one more balance sheet account called the "Arrangement for Impairment Losses."

Features

• An impairment loss records an expense in the current period that shows up on the income statement and at the same time reduces the value of the impaired asset on the balance sheet.
• In the event that impairment is confirmed because of testing, an impairment loss ought to be recorded.
• Assets ought to be tried for impairment routinely to prevent overstatement on the balance sheet.
• Impairment exists when an asset's fair value is not exactly its carrying value on the balance sheet.
• Impairment can happen as the consequence of an unusual or one-time event, for example, a change in legal or economic conditions, a change in consumer demand, or damage that influences an asset.

FAQ

How Is Impairment Accounted for?

An accountant will write off the difference between the fair value and the carrying value on the off chance that impairment is available, and the value of the asset diminishes on the company's balance sheet. Fair value is normally the sum of an asset's undiscounted expected future cash flows and its expected salvage value, which is what the company would hope to receive from selling or discarding the asset toward the finish of its helpful life.

What's the Difference Between Depreciation and Impairment?

Impairment includes an unexpected and uncommon drop in the fair value of an asset. Depreciation alludes to regular and expected wear and tear on assets over the long run. It is regularly accounted for utilizing a foreordained schedule and methodology. For example: - A work vehicle devalues in value from one year to another all through its helpful lifetime.- A farm hauler that gets squashed by a falling tree has encountered an impairment that must be recorded on the books thusly.

How Is Impairment Determined?

The generally accepted accounting principles (GAAP) characterize an asset as impaired when its fair value is lower than its book value. To check an asset for impairment, the total profit, cash flow, or other benefit expected to be created by the asset is compared with its current book value. Assuming it is resolved that the book value of the asset is greater than the future cash flow or benefit of the asset, an impairment is recorded.