Asset impairment refers to a significant decrease in the value of a company’s assets, specifically its long-term assets such as property, plant, and equipment, intangible assets, or investments. This decrease in value is typically caused by various internal or external factors that affect the asset’s ability to generate future economic benefits at the originally anticipated levels.
When an asset is impaired, its carrying amount on the company’s balance sheet exceeds its recoverable amount. The recoverable amount is the higher of an asset’s fair value less costs to sell or its value in use. Fair value less costs to sell represents the amount that could be obtained from selling the asset in an arm’s length transaction, after deducting the selling expenses. Value in use, on the other hand, refers to the present value of expected future cash flows the asset can generate.
The assessment of asset impairment is a critical process for companies as it directly impacts the financial statements and key performance indicators. Generally, companies are required to perform impairment tests whenever there is an indication that an asset may be impaired. Indicators of impairment include significant adverse changes in market conditions, legal factors, technological advancements, or the asset’s physical condition.
To determine whether an impairment has occurred, companies follow a systematic approach. They estimate the asset’s recoverable amount and compare it to its carrying amount. If the carrying amount exceeds the recoverable amount, an impairment loss is recognized. The impairment loss is calculated as the difference between the carrying amount and the recoverable amount, and it is immediately recognized in the income statement.
The recognition of an impairment loss also triggers a reduction in the carrying amount of the asset to its recoverable amount. This adjustment serves to reflect the decreased value of the asset accurately. However, impairment losses for long-lived assets, such as property, plant, and equipment, can sometimes be reversed in subsequent periods if the impairment is deemed to be temporary and the recoverable amount of the asset increases.
It is important to note that impairment testing is not limited to individual assets but can also be applied to cash-generating units (CGUs). A CGU is the smallest identifiable group of assets that generates cash inflows independently. Assessing impairment at the CGU level allows companies to identify scenarios where the sum of the individual assets’ recoverable amounts may exceed the CGU’s higher value in use.
The financial reporting standards, such as the Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS), provide guidance on the recognition, measurement, and disclosure of asset impairments. Companies must comply with these regulations to ensure transparency and comparability in financial reporting.
In conclusion, asset impairment occurs when a company’s long-term assets experience a significant decline in value due to various internal and external factors. The assessment of impairment involves comparing the carrying amount of the asset with its recoverable amount. If the carrying amount exceeds the recoverable amount, an impairment loss is recognized, impacting the financial statements. By conducting impairment tests periodically and following the relevant financial reporting standards, companies can maintain the accuracy and reliability of their financial information.
