Impaired Assets Definition
Impaired Assets are those assets on the company’s balance sheet whose carrying value of the assets on the books exceeds the market value (recoverable amount) and the loss is recognized on the income statement of the company. Impairment of Assets is usually found in Balance Sheet items like goodwill, long term assets, inventory and accounts receivables.
Example of Impaired Assets
Company A ltd purchased company B ltd and paid $ 19 million as the purchase price for buying company B ltd. At the time when the purchase was made, the book value of the assets of Company B was $ 15 million. Over the year after the acquisition, the sales of Company B ltd. fell by around 38 % because of some changes made by the management in the working of the company and due to the entrance of the competitor in the same line of business with the cheaper substitute. As a result, the fair market value of company B ltd falls to the level of $ 12 million from the $ 15 million when the acquisition was made. Analyze the impact of the impairment.
Company A ltd purchased company B ltd and paid $ 19 million as the purchase price for buying company B ltd. When the book value of the assets of Company B was $ 15 million The extra amount of $ 4 million ($19 – $15 million) paid by the Company A ltd above the book value of the assets of the Company B is to be recorded as the goodwill on the assets side of the Company A’s balance sheet. Over the year after the acquisition was made, the sales of Company B ltd. fell by around 38 %, and as a result, the fair market value of company B ltd falls to the level of $ 12 million from the $ 15 million.
As per the requirement of the Generally Accepted Accounting PrinciplesGenerally Accepted Accounting PrinciplesGenerally accepted accounting principles (GAAP) are the minimum standards and uniform guidelines for the accounting and reporting. These standards prohibit firms from engaging in unethical business activities and enable for a more accurate comparison of financial reports to investors., companies are required to test the goodwill and other certain intangible assetsIntangible AssetsIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can't touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. every year for the impairments. So, after a year, Company A ltd. will compare the fair value of its subsidiary companySubsidiary CompanyA subsidiary company is controlled by another company, better known as a parent or holding company. The control is exerted through ownership of more than 50% of the voting stock of the subsidiary. Subsidiaries are either set up or acquired by the controlling company. B ltd., with the carrying amount which is present on its balance sheet along with the goodwill. In case the fair value of B ltd. is less than its carrying valueCarrying ValueCarrying value is the book value of assets in a company's balance sheet, computed as the original cost less accumulated depreciation/impairments. It is calculated for intangible assets as the actual cost less amortization expense/impairments. of the A ltd, then it is liable for the impairment.
In the present case, after a year of the fair market value of the company, B ltd falls to the level of $ 12 million from the $ 15 million. Now, this fair market value of the B ltd along with the goodwill will be compared with the actual value recorded in the books of accounts, and with the differential amount, goodwill will be reduced.
Current Fair market value + Goodwill = $ 12 million + $ 4million = $16 million
This $ 16 million will be compared with the initial purchase price paid ($19 million), and the difference will be impairment of the goodwill.
Impairment =$19 million – $16 million =$3 million
This amount will be reduced from the Goodwill amount present in the books of accounts
=Goodwill initially recorded – $3 million = $ 4 million – $ 3 million = $ 1 million
Thus the goodwill, in this case, is the impaired assets, and on the balance sheet, the amount of new goodwill to be shown will be $ 1 million.
- Impaired assets and Impairment gives the ways to the investors and analysts to assess the management of the company and their decision making the record as the managers who have to write down the assets due to impairment might not be having the good investment decision power.
- Many business failures occurred after a fall in the impaired value. These disclosures can act as the early warning signals for the creditors and investors of the company for their investment analysisInvestment AnalysisInvestment analysis is the method adopted by analysts to evaluate the investment opportunities, profitability, and associated risks in their portfolios. In addition, it helps them to determine whether the investment is worth it or not..
- There is no detailed guidance on the treatment of impaired assets.
- Generally, it becomes difficult to know the measurement value, which should be used for ascertaining the impairment amount.
Important Points About Impaired Assets
- Impairment should be recorded only if it is anticipated that the future cash flowsCash FlowsCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. in the company are unrecoverable.
- Journal entry for recording the impairment is the debit to the loss account or to the expense account with the corresponding credit to an underlying assetAn Underlying AssetUnderlying assets are the actual financial assets on which the financial derivatives rely. Thus, any change in the value of a derivative reflects the price fluctuation of its underlying asset. Such assets comprise stocks, commodities, market indices, bonds, currencies and interest rates..
- When the carrying value of the impaired assets is adjusted, then the loss is to be recognized on the income statement of the company.
Impaired assets are those assets whose market value is below their book value. All assets, either intangible or tangible, are prone to impairment. It is required by the entities to conduct the impairment tests in case indications are there with respect to impairment with the exception of the goodwill and other certain intangible assets in case of which impairment test is to be done annually as per the requirement of the Generally Accepted Accounting Principles. Many business failures occurred after falling into the value of the impaired assets. These disclosures can act as the early warning signals for the creditors and investors of the company for their investment analysis. Thus the impaired assets also help the different stakeholders in different ways for their analysis before they make any decision with respect to the company.
This has been a guide to what is Impaired Assets and its definition. Here we discuss an example of Impaired Assets along with advantages and disadvantages. You can learn more about accounting from the following articles –