- Learn Basic Accounting in Less than 1 Hour!
- Accounting Basics
- What are Accounting Principles
- Accounting Cycle
- Accrual Accounting Basis
- Cash Basis Accounting
- Matching Principle of Accounting
- Conservatism Principle of Accounting
- Revenue Recognition Principle
- Prudence Concept in Accounting
- Cash Accounting
- What are Accounting Policies?
- Relevance in Accounting
- Accounting Estimates
- Mark to Market Accounting
- Prior Period Adjustments
- Cash Accounting vs Accrual Accounting
- Break Even Point In Accounting
- Operating Cycle
- Fiscal Year
- Fiscal Year vs Calendar Year | Top Differences | Examples |
- Financial Reporting
- Financial Statements
- Accrual vs Provision
- Accrual vs Deferral
- Temporal Method
- Interim Financial Statements
- Pro Forma Financial Statements
- Consolidated Financial Statement
- Audited Financial Statements
- Financial Statement Audit
- Internal Audit vs External Audit
- Interim Reporting
- Accounting Scandals
- Quality of Earnings
- Audit Risk
- Sunk Cost
- Leasehold vs Freehold
- IFRS vs US GAAP
- IFRS vs Indian GAAP
- Accounting for Fair Value Hedges
- Debit vs Credit in Accounting
- Single Entry System in Accounting
- Double Entry Accounting System
- Journal in Accounting
- Adjusting Entries in Journal
- General Journal
- Accounting Journal Entry
- Ledger in Accounting
- T Accounts
- Account Balance
- Journal vs Ledger
- General Journal vs General Ledger
- What is Trial Balance ? | Examples | Steps | Prepare | Errors
- Nominal Account
- Adjusted Trial Balance
- Reconciliation of Books | Types, Best Practices | Useful Tips
- Petty Cash | Meaning | Template | Accounting | Example
- Petty Cash Book
- Debit Note | Debit Notes Accounting & its Top Characteristics
- Credit Note
- Debit Note vs Credit Note | Top 7 Differences (Infographics)
- Drawing Account
- Balance Sheet
- Balance Sheet
- Balance Sheet Purpose
- Capital Expenditure Formula
- Statement of Financial Position
- Accounting Equation
- Assets vs Liabilities | Top 9 Differences (with Infographics)
- Equity vs Assets
- Trial Balance vs Balance Sheet | Top 10 Differences You Must Know!
- Balance Sheet vs Consolidated Balance Sheet
- Bank vs Company Balance Sheet
- Banks Balance Sheet
- Commitments and Contingencies
- Management Discussion & Analysis
- Revenue Reserve vs Capital Reserve | Top 7 Differences
- Revenue Reserve
- Capital Reserve
- Capital Receipts vs Revenue Receipts | Top 8 Differences
- Capital Lease vs Operating Lease | Top Differences You Must Know!
- Debt vs Equity Financing | Advantages | Disadvantages | Example
- Internal vs External Financing | Top 7 Differences (Infographics)
- Available for Sale for securities
- Held to Maturity to securities
- Non-Performing Assets (NPA)
- Cash and Cash Equivalents | Examples, List & Top Differences
- Cash Equivalents
- Restricted Cash
- 3 Types of Inventory | Raw Material | WIP | Finished Goods
- Ending Inventory Formula
- Average Inventory Formula
- Closing Stock
- Inventory vs Stock
- Current Assets
- FIFO vs LIFO
- First In First Out (FIFO)
- Last in First Out (LIFO)
- LIFO Reserve
- Non-Current Assets
- Accounts Receivables? | Definition, Accounting Examples
- Accounts Receivables Factoring
- Trade Receivables
- Net Realizable Value (NRV)
- Allowance for Doubtful Accounts
- Accrued Revenue
- Liquid Assets
- Quick Assets
- Marketable Securities on the Balance Sheet | Top Examples
- Trading Securities in Balance Sheet
- Prepaid Expenses
- Prepaid Insurance
- Tangible vs Intangible Assets
- Tangible vs Intangible
- Contingent Asset
- Tangible Assets
- Deferred Tax Assets
- Capital Expenditure (Capex)
- Capex vs Opex
- Salvage Value
- Residual Value
- Fixed Capital vs Working Capital | Top 8 Differences (Infographics)
- Impariment of Assets
- Negative Goodwill
- Goodwill Valuation
- Capitalized Interest
- Accounts Payable | Days Payable Outstanding | Formula |
- Current Liabilities | List of Current Liabilities on Balance Sheet
- Accrued Liabilities
- Accrued Interest
- Notes Payable
- Accounts Payable vs Notes Payable
- Revolving Credit Facilities
- Bonds Payable Accounting
- Bad Debt Reserve Allowance
- Deferred Expenses
- Deferred Tax Liabilities
- Unearned Revenue (Sales)
- Deferred Revenue (Income)
- Current Portion of Long-Term Debt (CPLTD) | Balance Sheet
- Long-Term Debt in Balance Sheet
- Financial Liabilities | Definition, Types, Ratios, Examples
- Long-Term Liabilities
- Accounts Receivable vs Accounts Payable
- Minority Interest
- Accounting for Convertibles
- Accounting for Derivatives
- Financial Lease vs Operating Lease
- Off balance Sheet Financing
- Finance vs Lease
- Bond vs Loan
- Triple Net Lease
- Debtor vs Creditor
- Shareholders Equity
- Shareholders Equity Statement
- Negative Shareholders Equity
- Par Value of Stock
- Share Capital
- Outstanding Shares (Definition, Formula) | Stocks Outstanding
- Additional Paid-in Capital on Balance Sheet
- Retained Earnings (Formula, Examples) | How to Calculate?
- Retained Earnings Formula
- Statement of Retained Earnings
- Appropriated Retained Earnings
- Unappropriated Retained Earnings
- How to Calculate Net Worth of a Company | Formula | Top Examples
- Owners Equity
- Preferred Shares
- Non-Cumulative Preference Shares
- Participating Preferred Stock
- Weighted average Shares average outstanding
- Share Buyback
- Accelerated Share Repurchase
- Restricted Stocks Units (RSUs)
- Contingent Shares
- Stock Splits Share
- Treasury Stock Shares
- Dilutive Securities
- Anti Dilutive Securities
- Stock Dividend
- Cash Dividend
- Final Dividend
- Preferred Dividends
- Homemade Dividends
- Ex dividend date
- Date of Record of dividends
- Qualified vs Ordinary Dividend
- Wealth vs Profit Maximization
- Cost of preferred Stock
- Common Stock vs Preferred Stock | Top 8 Differences You Must Know
- Stocks Vs Shares
- Stock Options Vs RSU
- Shareholder Equity vs Net Worth | Top 5 Differences You Must Know!
- Stock vs Option
- Stock vs Mutual Funds
- Income Statement
- Income Statement | Top Examples | Template | Format | Analysis
- Variable Costing Income Statement
- Pro Forma Income Statement
- Purpose of Income Statement
- Cost of Goods Sold
- COGS Formula
- Average Total Cost Formula
- Gross Profit
- Direct Costs
- Indirect Costs
- Prime Cost
- Duty vs Tariff
- Net Income Formula
- EBITDA Formula
- Operating Expense (OPEX)
- Interest Expense
- LTM EBITDA
- Non Recurring Items
- EBIT vs EBITDA | Top Differences | Examples | Calculation
- Depreciation – Formula | Types | Most Comprehensive Guide
- Depreciation Tax Shield
- Accelerated Depreciation
- EBITDA vs Operating Income
- Straight Line Depreciation Method
- Sum of Year Digits Method of Depreciation
- Declining Balance Method of Depreciation
- Land Depreciation
- Double Declining Balance Method
- Amortization of Intangible Assets
- Depreciation vs Amortization
- Unrealized Gains (Losses)
- Non Cash Expense
- Accrued Income
- Share based compensation
- Restructuring Cost
- Extraordinary Items
- Interest Income
- Double Taxation
- Net Loss
- Pro-Forma Earnings
- Margin vs Profit
- Net Operating Loss (NOL)
- Tax Shield
- Sundry Expenses
- Trade Discount
- Percentage of Completion Method
- Interest vs Dividend | Top 9 Differences (with Infographics)
- EBITDA vs Net Income
- EBIT vs Net Income
- EBIT vs Operating Income
- Operating Income vs Net Income
- Cost vs Expense
- Expense vs Expenditure
- Accounting Profit vs Economic Profit
- Income Tax vs Payroll Tax
- Tax credits vs Tax deductions
- Tax Evasion vs Tax Avoidance
- Regressive Tax
- Gross Income vs Net Income
- Profit vs Revenue
- Revenue vs Earnings
- Revenue vs Net Income
- Revenue vs Income
- Profit vs Income
- Revenue vs Sales
- Revenue vs Turnover
- Capitalization vs Expensing
- Income Statement vs Balance Sheet | Top 5 Differences You Must Know!
- Statement of Comprehensive Income | Items | Colgate Example
- Variance Analysis
- Other Comprehensive Income
- Partial Income Statement
- Income Summary Account
- FOB Destination
- Explicit Cost
- Implicit Cost
- Direct cost vs Indirect Cost
- Fixed cost vs Variable cost
- Price vs Cost
- Hard Cost vs Soft Cost
- Period Cost vs Product Cost
- Overhead Costs
- Nopat vs Net Income
- Marginal Costing vs Absorption Costing
- Marginal Cost Formula
- Margin vs Markup
- Markup Formula
- Contribution Margin vs Gross Margin
- Cash Flow Statement
- Statement of Cash Flow
- Cash flow from Operations | Formula, Calculations & Examples
- Operating Cash Flow Formula
- Cash Flow from Investing Activities (Formula & Top Examples)
- Cash Flow From Financing Activities | Formula & Calculations
- Cash Flow Analysis
- Pro Forma Cash Flow Statement
- Fund Flow Statement
- FFO (Funds from Operations)
- Direct vs Indirect Cash Flow Methods
- Cash flow vs Net Income | Key Differences & Top Examples
- Cash Flow vs Fund Flow | Top 8 Differences (with Infographics)
- Accounting Careers
- Accounting Interview Questions
- Financial Accounting Careers
- Top Accounting Firms
- Big Four Accounting Firms
- Forensic Accounting
- Cost Accounting
- Financial Accounting
- Accounting vs Engineering
- Finance vs Accounting
- Bookkeeping vs Accounting
- Accounting vs Auditing
- Accountant vs Actuary
- Bookkeepers vs Accountants
- Accounting vs Financial Management
- Cost Accounting vs Financial Accounting
- Cost Accounting vs Management Accounting
- Financial Accounting vs Management Accounting
- Public vs Private Accounting
- Accounting vs CPA
- Controller vs Comptroller
- Personal Banker Job Description
- Accounting Firms in Australia
- Accounting Firms in Canada
- Top Accounting Firms in US
- Accounting Firms in Singapore
- Accounting Books
Impairments is an accounting principle used to permanently reduce the value of a company’s asset. The assets of a company are tested for impairment annually and if impaired, an impairment loss is recognized in the income statement and the balance sheet is adjusted accordingly. Cash flow statement is not affected by the impairment as there is no cash transaction taking place at the time of the impairment.
As we note from the snapshot above, Tata Steel with its most expensive acquisition of Corus Group Plc has taken approximately $3 billion of impairment charges until now. Impairment charges have negative impact on the financial statements as well as ratios.
In this article, we look at Impairments in detail –
- How are Tangible Assets Reported – US GAAP and IFRS
- Impairments of Assets under U.S. GAAP
- Impairments of Assets under IFRS
- How are Intangible Assets Reported – US GAAP and IFRS
- Impairments of Intangible Assets under U.S. GAAP and IFRS
- Example of Asset Impairment under IFRS
- Reversal of Impairment Loss
- Example of Asset Impairment under U.S. GAAP
- List of Companies with High Asset Impairment Charges
- Impact of Impairment on Financial Statements
- Impact of Impairment of Tangible Assets on Financial Statements
- Impact of Impairment of Intangible Assets on Financial Statements
- Impact of Impairment on Ratios
IMPAIRMENTS OF ASSETS UNDER U.S. GAAP
Mainly, Fixed Assets are tested for Impairment. There are two types of Fixed Assets – Tangible and Intangible. Before understanding how a specific asset is impaired, we need to understand how it is reported on the Balance Sheet.
How are Tangible Assets Reported – US GAAP and IFRS
Different standards used by different countries all around the world have different methods of reporting.
U.S. GAAP uses cost model to report its tangible assets. Under cost model, Tangible Assets, mainly PP&E (Property, Plant & Equipment), other than Land is reported at amortized cost i.e. Historical cost minus accumulated depreciation, amortization, depletion and impairment losses. Here, Historical cost refers to the purchase price plus any cost necessary to get the asset ready for use. Over a period of time, the value of the asset reduces as we charge depreciation as expense every year in the income statement which then reduces the value of the asset in the balance sheet.
Under IFRS, most assets are reported at depreciated cost (the cost model). IFRS provides an alternative, the Revaluation Model, in which an asset can be reported at its Fair Value, till the time an active market is there for that asset. An active market is necessary because the asset’s fair value can be reliably estimated only if it is actively traded. The use of the revaluation model is not very frequent at the IFRS reporting firms.
WallStreetMojo Free Accounting Course
You will Learn Basics of Accounting in Just 1 Hour, Guaranteed!
* Please provide your correct email id. Login details for this Free course will be emailed to you
Impairments of Assets under U.S. GAAP
Under U.S. GAAP, the test for impairment of Fixed Assets is done only when events and circumstances indicate that the recovery of the carrying value might not be possible through future use. Determining impairment and calculating the loss potentially involves two steps. In the first step, the asset is tested for impairment by applying Recoverability Test. If the asset is impaired, the second step involves measuring the loss.
Recoverability Test: In this test, if the carrying value i.e. the original cost less accumulated depreciation is greater than the asset’s future cash flow stream (without discounting), then the asset is considered as impaired. As the recoverability test is based on estimates of future discounted cash flow, tests for impairment involve considerable management discretion.
Loss measurement: If impaired, the useful value of the asset is written down to its fair value on the balance sheet. Moreover, a loss is recognized in the income statement. This loss is taken to be equal to the excess of carrying value over the fair value of the asset.
Impairments of Fixed Assets under IFRS
Under IFRS, the firm needs to assess annually whether events or circumstances indicate an impairment of an asset’s value has occurred. For example, there may have been a considerable decline in the value of the asset or a major change in the asset’s physical condition. If so, the asset’s value must be tested for impairment.
When the carrying value of an asset exceeds the recoverable amount, the asset can be impaired. The recoverable amount is equal to its fair value minus any selling costs or its Value In Use, whichever is greater. The process of computation of value in use involves the following two steps:
- Estimation of the future cash flows that would be generated by the asset.
- Calculation of the present value of the future cash flows by applying an appropriate discount rate.
Reasonable assumptions must be taken in order to project the future cash flows. The items that should be avoided while projecting the future cash flows include exaggerated revenue growth rates, significant anticipated cost reductions and unreasonable useful lives for plant assets. Avoiding these items will result in more meaningful results. Similarly, any extraordinary growth of the recent times should be assumed to last only for the very near-term future and should not be projected to continue in the long-term.
If impaired, the asset’s value must be written down on the balance sheet to the recoverable amount. An impairment loss equal to the excess of carrying value over the recoverable amount is recognized in the income statement.
It is only under IFRS that the company is allowed to reverse its losses of the value of the impaired asset recovers in the future. However, the loss reversal is limited to the original impairment loss. Hence, the carrying value of the asset after reversal cannot exceed the carrying value before the impairment loss was recognized.
Note: Under U.S. GAAP, loss recoveries are not permitted unlike under IFRS where the company can recover its losses but cannot exceed the original carrying value as stated above.
Also, have a look at US GAAP vs IFRS
How are Intangible Assets Reported – US GAAP and IFRS
Intangible Assets are of two types- Identifiable and Unidentifiable. Identifiable are the type of assets which have a finite life and therefore, these assets are amortized over a period of time and the expense is recorded in the income statement. Examples of Identifiable Assets include Trade Mark, Copy Write etc. Unidentifiable Assets have an indefinite life and cannot be amortized. These are tested for impairment just like Tangible Assets. An example includes Goodwill. Under U.S. GAAP, Goodwill can be tested once in a while. Under IFRS, Goodwill must be tested for impairment annually.
Reporting of Unidentifiable Intangible Assets is done similar to Tangible Assets under U.S. GAAP and IFRS both.
Impairments of Intangible Assets under U.S. GAAP and IFRS
Goodwill which is created in a purchase acquisition can be tested for impairment. Goodwill created internally should be expensed as incurred.
Impairment of Goodwill is similar to Tangible Assets under U.S. GAAP and IFRS both.
As we see from below, Toshiba Corp had to record $2.3 billion Goodwill impairment charge on the value of Westinghouse (Cranberry-based nuclear firm).
Asset Impairment Example under IFRS
On April 1, 2005 Belfor Inc. bought a building for around $2 million. The estimated life of the building at the time of purchase was 20 years, depreciation method used is straight line method. On March 31, 2009 the company came to know about a fly-over construction which would be adjacent to the building which would reduce the access to the building, decreasing its value. For 1 million, the company estimated to sell the building but would have to incur some costs of $50,000. Another option which the company considered was to use it which would help the company generate a present value of $1.2 million.
Now, if the carrying value exceeds the recoverable amount. We will impair the building by the difference between the carrying value and the recoverable amount.
Carrying amount– the building was originally bought at $2 million with its life estimated to be 20 years which is used for 5 years so far. This gives us an accumulated depreciation of $2/20*5= $0.5 million. To calculate the carrying amount of the building we need its formula which is carrying value = amount at which the asset was purchased minus accumulated depreciation. Therefore, $2 million minus $0.5 million = $1.5 million.
Now, Recoverable amount– the recoverable amount is the higher of fair value minus cost to sell or value in use as we discussed above. Therefore, in this case $1 million minus $0.05 million = $0.95 million. The value in use is equal to be the present value of the future cash flows, which, in the question, was given to be $1.2 million. As discussed above, the recoverable amount is higher of $0.95 million and $1.2 million.
The carrying amount is $1.5 million while the recoverable amount is $1.2 million. The company will have to book an impairment loss of $0.3 million.
Reversal of Impairment Loss
Reversal of impairment loss happens if the impaired asset regains or bounces back in its value, then, a gain of that specific amount will be recorded in the income statement which should not be more than the original impairment amount.
Let us extend the example of Belfor Inc. In the year 2010, a service road parallel to the highway was constructed by the government. This resulted in an improvement of the recoverable amount to $1.4 million. And the depreciation for the year 2010 was $0.12 million.
As the recoverable amount changed, the carrying amount as of March 31, 2010 will also change to $1.08 million ($1.2 million minus $0.12 million). The improvement in recoverable amount shows that the building will have to be appreciated by $0.32 million. $0.3 of this amount will be booked in the income statement as the original impairment loss was $0.3 million. The additional $0.02 million will be credited to revaluation reserve.
Fixed Asset Impairment Example under U.S. GAAP
Lakme Ltd. purchased a building on 1st April, 2008 worth $200,000. The building was recorded using the following journal entry: Building 200,000 Dr. ; cash 200,000 Cr. The building has a useful life of 20 years and the company uses straight-line method to depreciate it. Now, the yearly depreciation according to the method will be $10,000 and accumulated depreciation as of March31, 2010 will be $10,000*3 = $30,000. Carrying amount is $200,000 minus $30,000 = $170,000.
The building remains at historical cost (cost of acquiring the asset plus any extra cost to make it ready to use) and is depreciated annually with no adjustment in value. In case the asset got impaired, the impairment loss would have been reported in the income statement subsequently valuing the asset downwards.
List of Companies with High Asset Impairment Charges
|S. No||Name||Market Cap ($ million)||Asset Impairment Charge (Annual) – $ million|
|9||Merck & Co||171,565||3,948|
|12||Mitsubishi UFJ Financial||81,384||3,762|
Impact of Impairment on Financial Statements
Impact of Impairment of Fixed Assets on Financial Statements
Income Statement: If Impaired, an impairment loss is recognised in the income statement in the same section where we report other operating income and expenses. With this loss, the profitability for the year is affected negatively.
Below is the income statement of Schlumberger Ltd. It reported a significant impairment charge of $3,172 million in its income statement resulting in a Net Loss of -$1,687 million
Balance Sheet: If impaired, the asset is written down to the amount equal to the impairment loss which is recognized in the income statement.
Cash Flow Statement: There is no impact on the Cash Flow Statement as no cash transaction took place.
Below is a snapshot of Schlumberger Ltd cash flow. We note that cash flow from operations is prepared using Indirect method, wherein you start with the Net Income and add back all the noncash items included in the Income Statement.
We note that Impairment charges have been added back in the cash flow from operations in Schlumberger Ltd
Impact of Impairment of Intangible Assets on Financial Statements
- Income Statement: Impairment loss is recognized in the income statement just like in the case of Tangible Asset. This, again, negatively affects the Net Income for the year in which the loss has been recognized.
- Balance Sheet: The asset is written down to the amount equal to the impairment loss we reported on the income statement when impaired.
- Cash Flow Statement: The impairment will not affect the Cash Flow as no cash transaction took place.
Impact of Impairment on Ratios
Profitability Ratios and Activity Ratios are majorly affected by the impairment losses reported on the Financial Statements of the company. For example, a lower Net Income means that the company would report a lower Net Profit Margin. A lower Net Profit Margin is not a good sign for any company. Similarly, a Higher Asset Turnover ratio is again a negative sign on the Asset side of the Balance Sheet would go down.
Shown below is the table of ratios showing effects of Impairment:
|Ratios||If the Asset is Impaired||If the Asset is not Impaired|
|Total Asset Turnover||High||Low|
|Fixed Asset Turnover||High||Low|
|Net Profit Margin||Low||High|
|Operating Profit Margin||Low||High|
|Return on Assets||Low||High|
|Operating Return on Assets||Low||High|
|Return on Total Capital||Low||High|
Also, have a look at Complete Guide to Ratio Analysis
Impairment is an accounting principle used to permanently reduce the Asset. Under IFRS, an asset is tested for impairment annually unlike under U.S. GAAP where there are two stages from which the company decides whether they have to impair the asset or not. Generally, Fixed Assets are tested for impairment. Fixed Assets include both Tangible and Intangible Assets. There are two types of Intangible Assets- Identifiable and Unidentifiable Intangible Asset. Identifiable Assets are amortized over the life of the asset and Unidentifiable Assets are tested for Impairment.
Under IFRS, Fixed Assets are reported at a depreciated cost (cost model). IFRS also provides Revaluation Method in which the asset is reported at Fair Value. If the carrying value is greater than the recoverable amount then the asset is said to be impaired and the impairment loss ( the difference between carrying value and recoverable amount) is recognized in the income statement.
Under U.S. GAAP, Fixed Assets are reported at depreciated cost (cost model). The asset is tested for impairment in two stages. First, there is a recoverability test which helps determine if the asset is impaired or not. Second, there is loss measurement i.e. if the asset is impaired then what amount of loss do we have to report on the income statement. An impairment loss can be recovered only under IFRS and not under U.S. GAAP.
Impairment losses negatively impact the Financial Statements of the company. In the income statement, it affects the profitability of the company and in the Balance Sheet, the assets get reduced. Impairment losses also negatively affect the Financial Ratios of the company. Mainly, Profitability and Activity Ratios are negatively affected. This can negatively impact the value of the company in the market and investor’s sentiments towards the company.
- Fixed Asset Turnover Ratio Formula – Examples
- How Net Losses Influence Taxable Income?
- Accounts Receivable vs Accounts Payable (Comparison Table)
- Fundamental Analysis Importance
- Revolving Credit Facilities Definition
- Marketable Securities Definition
- Financial Liabilities Ratios
- Calculate Cash and Cash Equivalents
- Accounts Receivables Days
- FIFO vs LIFO advantages
- Examples of Capital Lease vs Operating Lease