What Is an Impaired Asset?
An impaired asset is an asset that has a market value less than the value listed on the company's balance sheet. When an asset is deemed to be impaired, it will need to be written down on the company's balance sheet to its current market value.
Key Takeaways
- Assets should be tested for impairment on a regular basis to prevent overstatement on the balance sheet.
- Assets that are most likely to become impaired include accounts receivable, as well as long-term assets such as intangibles and fixed assets.
- When an impaired asset's value is written down on the balance sheet, there is also a loss recorded on the income statement.
- GAAP and IFRS have differing standards for impairment.
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How Impaired Assets Work
An asset is impaired if its projected future cash flows are less than its current carrying value. An asset may become impaired as a result of materially adverse changes in legal factors that have changed the asset’s value, significant changes in the asset’s market price due to a change in consumer demand, or damage to its physical condition. Another indicator of potential impairment occurs when an asset is more likely than not to be disposed prior to its original estimated disposal date. Asset accounts that are likely to become impaired are the company's accounts receivable, goodwill, and fixed assets.
Long-term assets, such as intangibles and fixed assets, are particularly at risk of impairment because the carrying value has a longer span of time to become impaired.
Assets are tested for impairment on a periodic basis to ensure the company's total asset value is not overstated on the balance sheet. According to generally accepted accounting principles (GAAP), certain assets, such as goodwill, should be tested on an annual basis. GAAP also recommends that companies take into consideration events and economic circ*mstances that occur between annual impairment tests in order to determine if it is "more likely than not" that the market value of an asset has dropped below its carrying value.
An impairment loss should only be recorded if the anticipated future cash flows are unrecoverable. When an impaired asset’s carrying value is written down to market value, the loss is recognized on the company’s income statement in the same accounting period.
Accounting for Impaired Assets
Under GAAP rules, the total dollar value of an impairment is the difference between the asset’s carrying value and its fair market value. Under International Financial Reporting Standards (IFRS), the total dollar value of an impairment is the difference between the asset's carrying value and the recoverable value of the item. The recoverable value can be either its fair market value if you were to sell it today or its value in use. The value in use is determined based on the potential value the asset can bring in for the remainder of its useful life.
The journal entry to record an impairment is a debit to a loss, or expense, account and a credit to the related asset. A contra asset impairment account, which holds a balance opposite to the associated asset account, may be used for the credit in order to maintain the historical cost of the asset on a separate line item. In this situation, the net of the asset, its accumulated depreciation, and the contra asset impairment account reflect the new carrying value.
Upon recording the impairment, the asset has a reduced carrying value. In future periods, the asset will be reported at its lower carrying value. Even if the impaired asset’s market value returns to the original level, GAAP states the impaired asset must remain recorded at the lower adjusted dollar amount. This is in compliance with conservative accounting principles. Any increase in value is recognized upon the sale of the asset. Under IFRS, impairment losses can be reversed in specific instances.
Standard GAAP practice is to test fixed assets for impairment at the lowest level where there are identifiable cash flows separate from other groups of assets and liabilities. For example, an auto manufacturer should test for impairment for each of the machines in a manufacturing plant rather than for the high-level manufacturing plant itself. However, if there are no separately identifiable cash flows at this low level, it's allowable to test for impairment at the asset group or entity level. If an asset group experiences impairment, the adjustment is allocated among all assets within the group. This proration is based on the current carrying value of the assets.
IFRS prefers fixed asset impairment at the individual asset level. If that is not possible then it can be impaired at the cash generating unit (CGU) level. The CGU level is the smallest identifiable level at which there are identifiable cash flows largely independent of cash flows from other assets or groups of assets.
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 straight line or one of multiple accelerated depreciation methods. Depreciation differs from 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.
Real-World Example of an Impaired Asset
In 2015, Microsoft recognized impairment losses on goodwill and other intangible assets related to its 2013 purchase of Nokia. Initially, Microsoft recognized goodwill related to the acquisition of Nokia in the amount of $5.5 billion, plus another $4.5 billion in other intangible assets.
The book value of goodwill from the Nokia purchase, and therefore assets as a whole, reported on Microsoft's balance sheet were deemed to be overstated when compared to the true market value. Because Microsoft had not been able to capitalize on the potential benefits in the cellphone business, the company recognized an impairment loss in the amount of $7.6 billion, including the entirety of the $5.5 billion in goodwill.
How Do You Calculate the Impairment of an Asset Under GAAP?
To calculate the impairment of an asset, take the carrying value of the asset (its historical cost minus accumulated depreciation) and subtract its fair market value. If its fair market value is less than the carrying value, you will need to record an impairment loss for the difference.
Where Does Impairment Show Up on My Company's Financial Statements?
An impairment loss shows up as a negative value on the income statement. If you keep a contra asset account for the value of the impairment to preserve the historical cost of the asset, it would be reported directly below the asset on your balance sheet. A contra asset account has a natural balance that is opposite that of a standard asset account, a credit.
When Should an Asset Be Impaired?
An asset should be impaired when its fair market value is less than its carrying value (historical cost minus accumulated depreciation). This may occur due to physical damage to the asset, a change in consumer demand, or legal changes surrounding the asset.
The Bottom Line
When a company has an asset that is now worth less than the value given for it on the company's balance sheet, that asset is impaired. Using an inflationary accounting method, the company will write down the asset's value on the company's balance sheet. The loss in value is also recorded on its income statement. GAAP and IFRS have differing standards for impairment. Depreciation is not the same thing as impairment, and when an asset is impaired, depreciation on that asset also needs to be adjusted.
