Impairment is an accounting term associated with a company’s intangible assets whose carrying amount exceeds its recoverable amount. The carrying amount of an asset is derived after deducting the fair value or the current value of an asset with the accumulated depreciation. The recoverable amount is the amount at which an asset is sold.
For Instance, if the cost of a building is $4 million, the carrying amount is $3.6 million, and the recoverable amount is $2.5 million, the company will have to record an impairment loss of $1.9 million.
The impairment of assets includes:
- Lands and buildings
- Machinery
- Goodwill
- Property
- Investments and other Intangible assets
- Capital
Indications of Impairment
Certain external and internal factors might lead to the impairment of assets or decline of assets.
Market value and trends are external indicators as market conditions vary daily and could affect the asset’s overall value.
Technological and law intervention
The negative decline in technology or change in specific laws could also affect the life of an asset.
High-interest rates
The increasing interest rates on land and property could decrease the value of assets.
Physical damage
Poor maintenance or working conditions could also decrease the asset’s overall value.
Worse economic conditions
This could be among the external factors that could impact the company’s overall growth by reducing the value and cost of assets.
Idle asset
An idle asset could not be used for a long time and would require high maintenance costs if it is sold.
How Impairment is Calculated
Impairment may impact a company’s financial statements, such as income statements and balance sheets. If there is any impaired loss of assets, the sheets are adjusted accordingly after calculating the loss.
The impairment loss is measured by subtracting the fair value from the accumulated depreciation, i.e., the carrying amount from the selling cost. For example, if the actual amount of a building is $50,000 and it carries the amount after subtracting accumulated depreciation is $30,000. Its selling cost is $10,000; then there is a loss of $20,000.
How to Record Impairment on Financial Statements
An impairment loss is recorded as an expense in the Income Statement, and the overall profits are decreased for the period. The accounts that need adjustment are goodwill, account receivables, and long-term assets. The balance sheet could hurt a company’s overall financial records while the cash flows remain the same after all the amounts have been adjusted as per GAAP (Generally Accepted Accounting Principles).
Impairment of Capital
Impairment is not limited to assets only, as the company’s capital can indicate impairment, too. It occurs when the par value of the company’s capital stock exceeds the total capital of the company. However, unlike assets, the company’s overall capital could be increased, and the impairment could be reversed.
Impairment of Goodwill
The company’s goodwill identifies the significance of assets and liabilities. A company with solid charity is more stable. Impairment of friendship in a company arises due to the incapability of such assets to generate cash flows.
Reversal of Impairment Loss
Sometimes, the asset’s value may include favorable changes due to changes in market conditions or overall improvement in the asset’s performance other than the company’s goodwill. The previously recognized loss may be reversed.
When an impairment loss is recognized as reversed, or it does not exist, then the value of an asset or its useful life may be adjusted and reviewed through the residual or amortization method
.Impairments play a vital role in the growth and wellness of the company as they are recorded in a company’s financial statements. An excellent financial statement of a company represents fewer losses and stable assets. Assessing or reviewing impairment loss could be lengthy and complicated since it requires planning at the initial stage, such as forecasting, etc.
The Executive staff and Finance Team are the key roles for assessing impairment loss and should possess the right skills with access to the proper knowledge.
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