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Impaired Asset

What is an 'Impaired Asset'

An impaired asset is a company's asset that has a market price less than the value listed on the company's balance sheet. Accounts that are likely to be written down are the company's goodwill, accounts receivable and long-term assets because the carrying value has a longer span of time for impairment. Upon adjusting an impaired asset’s carrying value, the loss is recognized on the company’s income statement.

Explaining 'Impaired Asset'

An impairment should only be recorded if the anticipated future cash flows are unrecoverable. The journal entry to record an impairment is a debit to a loss, or expense, account and a credit to the underlying asset. A contra asset impairment account may be used for the credit to maintain the original carrying cost of the asset on a separate line item. The net of the asset and contra asset reflect the new carrying cost. If an asset group experiences an impairment, the impairment adjustment is allocated among all assets within the group. This proration is based on the current carrying cost of the assets.

Asset’s Carrying Cost

The total dollar value of an impairment is the difference between the asset’s carrying cost and the market value of the item. Upon writing off the impairment, the asset has a reduced carrying cost because the adjustment recognized a loss and reduced the asset. In future periods, the asset must be reported at carrying cost. Even if the impaired asset’s market value returns to the original level, generally accepted accounting principles (GAAP) state the impaired asset must remain recorded at the adjusted dollar amount. Any increase in value is recognized upon the sale of the asset.

Tests for Impairments

An asset is impaired if projected cash flow losses are associated with the asset. In addition, an asset is impaired if there have been materially adverse changes in legal factors that have changed the asset’s value, significant changes in the asset’s market price or severe changes in the asset's manner of use due to its physical condition. Another indicator of an impaired asset is if the asset is more than 50% likely to be disposed of significantly before the original estimated disposal date.

Depreciation

A capital asset is depreciated based on the carrying cost of the asset. Therefore, if a capital asset is impaired, the periodic amount of depreciation is adjusted. Retroactive changes are not required for fixing the amount of depreciation to record. Only depreciation charges going forward are recalculated based on the impaired asset’s new carrying cost.

Impaired Asset Example

In 2015, Microsoft recognized impairment losses on goodwill and other assets related to its 2013 purchase of Nokia. Upon the acquisition, Microsoft recognized an increase in goodwill of $5.5 billion. However, because it had not been able to capitalize on the potential benefits in the cellphone business, Microsoft recognized the impairment loss as the book value assets and goodwill reported on its financial statements were overstated when compared to the true market value.


Further Reading


Discussion write-offs: Manipulation or impairment?
www.jstor.org [PDF]
… the results are equally consistent with the new management making strategic changes that impair goodwill … Do they believe that a decline in stock prices causes an impairment … increase in the book-to-market ratio reflects investors' expectation that the firm has impaired assets …

How did financial reporting contribute to the financial crisis?How did financial reporting contribute to the financial crisis?
www.tandfonline.com [PDF]
… the results are equally consistent with the new management making strategic changes that impair goodwill … Do they believe that a decline in stock prices causes an impairment … increase in the book-to-market ratio reflects investors' expectation that the firm has impaired assets …

The economic consequences of relaxing fair value accounting and impairment rules on banks during the financial crisis of 2008-2009The economic consequences of relaxing fair value accounting and impairment rules on banks during the financial crisis of 2008-2009
papers.ssrn.com [PDF]
… the results are equally consistent with the new management making strategic changes that impair goodwill … Do they believe that a decline in stock prices causes an impairment … increase in the book-to-market ratio reflects investors' expectation that the firm has impaired assets …

Fair value accounting and intangible assets: Goodwill impairment and managerial choiceFair value accounting and intangible assets: Goodwill impairment and managerial choice
www.ingentaconnect.com [PDF]
… the results are equally consistent with the new management making strategic changes that impair goodwill … Do they believe that a decline in stock prices causes an impairment … increase in the book-to-market ratio reflects investors' expectation that the firm has impaired assets …

Do differences in financial reporting attributes impair the predictive ability of financial ratios for bankruptcy?Do differences in financial reporting attributes impair the predictive ability of financial ratios for bankruptcy?
link.springer.com [PDF]
… the results are equally consistent with the new management making strategic changes that impair goodwill … Do they believe that a decline in stock prices causes an impairment … increase in the book-to-market ratio reflects investors' expectation that the firm has impaired assets …

Did fair-value accounting contribute to the financial crisis?Did fair-value accounting contribute to the financial crisis?
www.aeaweb.org [PDF]
… the results are equally consistent with the new management making strategic changes that impair goodwill … Do they believe that a decline in stock prices causes an impairment … increase in the book-to-market ratio reflects investors' expectation that the firm has impaired assets …

Optimal impairment rulesOptimal impairment rules
www.sciencedirect.com [PDF]
… the results are equally consistent with the new management making strategic changes that impair goodwill … Do they believe that a decline in stock prices causes an impairment … increase in the book-to-market ratio reflects investors' expectation that the firm has impaired assets …

Leading indicators of goodwill impairmentLeading indicators of goodwill impairment
journals.sagepub.com [PDF]
… the results are equally consistent with the new management making strategic changes that impair goodwill … Do they believe that a decline in stock prices causes an impairment … increase in the book-to-market ratio reflects investors' expectation that the firm has impaired assets …



Q&A About Impaired Asset


How do you calculate fair market value for a fixed asset?

The fair market value is determined by comparing similar items sold in recent transactions between unrelated parties at arm’s length prices.

What is impairment?

Impairment is the diminishing in quality, strength amount, or value of an asset.

What are accounts likely to be written down?

Accounts receivable and long-term assets because the carrying value has a longer span of time for impairment.

What is an impaired asset?

An impaired asset is a company's asset that has a market price less than the value listed on the company's balance sheet.

How do you determine if there has been a loss on an impaired asset?

You compare the carrying amount of the asset with its fair market value. If this comparison shows that there has been a loss on an impaired asset then it must be recorded in your financial statements.

How do you recognize an impairment loss?

The total dollar value of an impairment is the difference between the assets carrying cost and the market value of the item.

Does depreciation affect capital assets differently from non-capital assets ?

No depreciation affects both capital and non-capital assets similarly but only when they become impaired . Retroactive changes are not required for fixing depreciation charges going forward . Only depreciation charges going forward will be affected by impairments .

Can we depreciate fixed assets before they become impaired ?

Yes , we can depreciate fixed assets before they become impaired . However , once they become impaired , their remaining

Is it necessary to test all fixed assets for potential impairments annually?

No, only those items whose carrying amounts exceed their respective recoverable amounts need to be tested for potential impairments annually.

What happens to future periods if there was an impairment in previous period?

In future periods, it must be reported at carrying cost.

Can goodwill ever become impaired?

Yes it can but not until after five years from its acquisition date and only if one or more events occur that indicate there has been a decline in its estimated future cash flows resulting from any changes in circumstances since purchase including but not limited to significant adverse changes in legal factors or business climate affecting ability to operate profitably or competition within industry resulting from new products introductions technological developments etc., or any other reasons beyond control of management .

When does an impairment need to be recorded?

Upon adjusting an impaired assets carrying value, loss is recognized on company's income statement.

What are examples of assets that may experience impairment?

Fixed assets commonly known as PPE (Property, Plant & Equipment), refers to long-lived assets such as buildings, land, machinery and equipment; these assets are most likely to experience impairment which may be caused by several factors.

What does impairment cost?

An impairment cost must be included under expenses when the book value of an asset exceeds the recoverable amount.

If market price increases, what should happen with adjusted amount?

Generally accepted accounting principles (GAAP) state that it remains recorded at adjusted dollar amount. Any increase in value is recognized upon sale of asset.

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