What is an Impaired Asset? Explained

What is an Impaired Asset? Asset impairment is often confused with asset depreciation, which is a predictable and expected occurrence as an asset ages or incurs wear and tears over the course of normal use. In contrast, asset impairment reflects a more dramatic drop in asset value due to extenuating circumstances, such as changes in regulations, market conditions, environmental conditions, or technology advancements—any change that renders the asset obsolete, less valuable, or too damaged to use as intended.

Impaired Asset

What is an Impaired Asset?

An impaired asset is one that has a book value less than its market value. In this situation, the book value should be reduced to the market value, which creates a loss in the amount of the difference.  Fixed assets and goodwill are the assets most commonly experiencing impairment write-downs. Impairment testing is to be conducted at regular intervals, so a business could experience a series of impairment charges against a single asset.

When an asset is being depreciated on an accelerated basis, it is less likely that the asset will be judged to be impaired. The reason is that the ongoing depreciation charges reduce its net book value so quickly that a decline in its market value will rarely drop below its remaining book value.

Impaired Asset Example

There are quite a number of the occurrence of impairment in assets across companies and industries. The most common one was when Microsoft had impaired assets and losses on goodwill in 2015. According to a report, impairment losses on assets and goodwill that Microsoft experienced were linked to 2013, when it acquired Nokia.

Although this acquisition increased the goodwill of Microsoft at first, Microsofts inability to maximize the potential of the business led to impairment which was also reported in its financial statement.

Journal Entry

Below is an impairment journal entry when the loss is $50,000.

AccountDebitCredit
Impairment Loss$ 50,000.00
Accumulated Impairment Loss$ 50,000.00
Total$ 50,000.00$ 50,000.00
DrImpairment lossx
CrAssetx
Journal Entry for Impaired Asset

Why Should Impaired Assets be Reported?

The asset impairment practice ensures that assets are reported on the balance sheet at their fair market value. The practice better reflects the financial picture of a company’s assets for users of the financial statements.

Asset impairment can also smoothen the loss of sales when the asset is disposed of. If an asset is continually depreciated at an underestimated amount, the asset will be reported at a book value that is higher than its market value, and this gap expands over time.

When the asset is sold at the market value after several years, the company will realize a large loss. Instead, if the company records impairments periodically, the book value of the asset will better align with the market value, and the large loss will instead be recognized over several impairment losses.

Causes of Impairment

There are many causes of impairment of assets. These causes can be internal or external. Companies must always identify them and evaluate whether they have resulted in the impairment of their assets.

External factors

External factors can impact an asset’s value and result in impairment. External factors may include economic, social, technological, political, legal, or environmental issues. Furthermore, if an asset’s fair value reduces in the market, it may also cause impairment to it. Similarly, changes in the market can also impact the company adversely, causing impairment to its assets.

Internal factors

Internal factors are straightforward to identify. Things that cause impairment internally include physical damage to the asset, causing a reduction in its value. Obsolescence of assets also results in impairment losses.

Furthermore, if the company alters the way it uses an asset, it may impact its value in use and its recoverable value. Lastly, if a company finds evidence that one of its assets performs worse than anticipated or expected, it may be an indicator of impairment.

Scope of Asset Impairment

IAS 36 – Impairment of Assets has a wide scope and applies to all assets that companies use. However, it does not include assets that have specific standards that take care of impairment. Therefore, impairment of assets does not apply to the following areas of a company:

  • Assets arising from employee benefits.
  • Construction contracts.
  • Deferred tax assets.
  • Financial assets or instruments.
  • Investment property is measured at fair value.
  • Assets are classified as held for sale.

All these assets have a specific standard that addresses how companies should deal with impairment for them. Therefore, the standard does not apply to these assets. Other than these, the impairment of assets applies to all other assets within a company.

How Impaired Assets Work

Impairment can occur as a result of overpaying for an asset or group of assets, such as when the value of assets acquired through a merger or acquisition has been overstated by the seller. Impairment also occurs when a collection of accounts receivable becomes unlikely.

Key Takeaways

  • Assets should be regularly evaluated for impairment to prevent overvaluation on the balance sheet.
  • Assets most likely to become impaired include accounts receivable and long-term assets.
  • A loss due to an asset impairment is recorded on both the balance sheet and the income statement.
  • Asset impairment occurs when the net carrying amount, or book value, cannot be recovered by the owner.
  • Asset impairment can occur from a one-time incident or a succession of events.

Asset Depreciation vs. Asset Impairment

A capital asset is depreciated on a regular basis in order to account for typical wear and tear on the item over time. The amount of depreciation taken each accounting period is based on a predetermined schedule using either a straight line or one of the multiple accelerated depreciation methods. Depreciation differs from an impairment, which is recorded as the result of a one-time or unusual drop in the market value of an asset.

When a capital asset is impaired, the periodic amount of depreciation is adjusted moving forward. Retroactive changes are not required for adjusting the previous depreciation already taken. However, depreciation charges are recalculated for the remainder of the asset’s useful life based on the impaired asset’s new carrying value as of the date of the impairment.

Assets Carrying Cost

The difference between the carrying value of an asset and the recoverable value sums up to give the impairment value. Usually, an impairment occurs when the present or market value of an asset is less than the book value of the asset, hence, to realize the value of the impairment, both values are calculated and deducted.

In a case where an impairment is written off, the carrying cost of the asset must also be aligned to this occurrence. According to GAAP, an impaired asset must be put on record if the market (present) value goes back to the normal level, this must be recorded in dollar equivalence.

Impairment Loss Reversals

At each balance sheet date, you should assess whether any impairment loss recognized in prior accounting periods no longer exists or has decreased. In either case, you should then estimate the recoverable amount of that asset.

If the estimated recoverable cost is more than the carrying cost of the asset, then the impairment loss recognized earlier must be reversed to the extent that the estimated recoverable cost exceeds the carrying cost of the asset.

After the reversal, the carrying amount of an asset should not exceed the lower of:

  • Estimated recoverable cost
  • Carrying cost that would have been determined (net of amortization or depreciation) had no impairment loss been recognized for the asset in prior accounting periods

The recoverable amount is the higher the net selling price or the value in use.

The impairment loss to be reversed is calculated as follows:

  • The recoverable amount is more than the historical net book value:
    • Impairment Loss Reversal = Historical Net Book Value – Net Book Value
  • The recoverable amount is less than the historical net book value:
    • Impairment loss Reversal = Recoverable Amount – Net Book Value

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