Asset Impairment

Definition

Asset impairment refers to the reduction in the carrying value of an asset when its fair market value falls below its book value. This occurs when an asset's expected future cash flows are lower than the asset's current carrying amount on the balance sheet, indicating that the asset has lost some of its economic value.

5 Must Know Facts For Your Next Test

1. Asset impairment is an accounting concept that applies to long-lived assets, such as property, plant, and equipment, as well as intangible assets like goodwill.
2. The impairment test is triggered when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
3. To test for impairment, the entity compares the asset's carrying value to its recoverable amount, which is the higher of the asset's fair value less costs to sell and its value in use.
4. If the recoverable amount is less than the carrying value, the asset is considered impaired, and the entity must recognize an impairment loss on the income statement.
5. The impairment loss reduces the asset's carrying value on the balance sheet and is a non-cash expense that affects the entity's net income.

Review Questions

• Explain how asset impairment relates to the allocation of capitalized costs through depreciation methods.
  • Asset impairment is closely tied to the depreciation of capitalized costs. When an asset's fair market value falls below its carrying value on the balance sheet, it indicates that the asset has lost some of its economic value and the remaining useful life and residual value estimates used in the depreciation calculation may no longer be accurate. This can result in the need to recognize an impairment loss, which effectively reduces the asset's carrying value and alters the future depreciation expense recognized on the income statement.
• Describe the process of testing for asset impairment and the factors that can trigger an impairment review.
  • The asset impairment test is triggered when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. This can include factors such as a significant decline in the asset's market value, changes in the asset's use or physical condition, changes in the business climate, or a history of operating or cash flow losses associated with the asset. To test for impairment, the entity compares the asset's carrying value to its recoverable amount, which is the higher of the asset's fair value less costs to sell and its value in use (the present value of the asset's expected future cash flows). If the recoverable amount is less than the carrying value, the asset is considered impaired, and the entity must recognize an impairment loss.
• Analyze the impact of recognizing an asset impairment loss on the financial statements and the implications for the allocation of capitalized costs through depreciation methods.
  • When an asset impairment loss is recognized, it has several implications for the financial statements and the allocation of capitalized costs through depreciation methods. The impairment loss is recorded as a non-cash expense on the income statement, reducing the entity's net income for the period. The asset's carrying value on the balance sheet is also reduced to its recoverable amount, which may necessitate a change in the asset's remaining useful life and residual value estimates used in the depreciation calculation. This, in turn, can alter the future depreciation expense recognized on the income statement, as the remaining capitalized costs are allocated over a revised useful life. The recognition of an impairment loss can also signal a need to reevaluate the appropriateness of the depreciation methods being used to allocate the asset's capitalized costs.

Related terms

Carrying Value: The amount at which an asset is reported on the balance sheet, which is its historical cost less any accumulated depreciation or amortization.

Fair Market Value: The price that an asset would sell for on the open market between a willing buyer and a willing seller, neither being under any compulsion to buy or sell.

Recoverable Amount: The higher of an asset's fair value less costs to sell and its value in use, which is the present value of the asset's expected future cash flows.