Impaired Assets

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Blog Author :

WallStreetMojo Team

Edited by :

Ashish Kumar Srivastav

Reviewed by :

Dheeraj Vaidya, CFA, FRM

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Impaired Assets Meaning

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 company's income statement.

Impaired Assets

Impairment of Assets is usually found in Balance Sheet items like goodwill, long-term assets, inventory, and accounts receivables. Such assets result from changes in demand for the product, any physical damage or outdated designs, or any legal problem. They are unexpected changes which results in a loss for the business.

Table of contents
  1. Impaired assets are assets on the company's balance sheet if their carrying value exceeds their market value (the amount that can be recovered), and a loss is shown on the income statement. 
  2. Goodwill, long-term assets, inventories, and accounts receivable are examples of things on the balance sheet that frequently have asset impairment.
  3. Investors and analysts can evaluate the management of the company and their decision-making using impaired assets and impairment. 
  4. The managers who must write down assets because of impairment may be unable to make wise investment decisions.

Impaired Assets Explained

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 concerning impairment except for the goodwill and other certain intangible assets in the case in which the 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 financial assets. These disclosures can act as 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 research before making any decision concerning the company.

Accounting Journal Entry

Let us see the accounting journal entry for impaired financial assets.

Journal entry for recording the impairment is the debit to the loss account or the expense account with the corresponding credit to an underlying asset or credit impaired assets.

Impairment Loss Account Debit

    To Undelying Asset Account.

Impaired assets accounting should be done only if it is anticipated that the future cash flows in the company are unrecoverable. When the impaired assets' carrying value is adjusted, the loss is to be recognized on the company's income statement.

Example

Company A ltd purchased company B ltd and paid $ 19 million as the purchase price for buying company B ltd. 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 company's working and due to the competitor's entrance in the same line of business with the cheaper substitute. As a result, the fair market value of company B ltd fell to the level of $ 12 million from the $ 15 million when the acquisition was made. Analyze the impact of the impairment.

Solution

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 '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 fell to the level of $ 12 million from the $ 15 million.

As per the Generally Accepted Accounting Principles, companies are required to test the goodwill and other certain intangible assets every year for the impairments. So, after a year, Company A ltd. will compare the fair value of its subsidiary company B ltd., With the carrying amount present on its balance sheet and goodwill. In case the fair value of B ltd. is less than its carrying value of the A ltd, then it is liable for the impairment.

In the present case, after a year of the company's fair market value, 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. This is how impaired assets accounting is done.

Advantages

  • Impaired assets and asset impairment analysis give the ways to the investors and analysts to assess the management of the company and their decision-making. The managers who have to write down the assets due to impairment might not have good investment decision power.
  • Many business failures occurred after a fall in the impaired value. These disclosures can act as early warning signals for the creditors and investors of the company for their investment analysis.

Disadvantages

  • There is no detailed guidance on the treatment of impaired assets. However, the accounting method used is debit impairment loss and credit impaired assets.
  • Generally, it becomes difficult to know the measurement value, which should be used for ascertaining the impairment amount in the asset impairment analysis.

Frequently Asked Questions (FAQs)

How can you tell if a property is damaged?

When an asset's book value, or net carrying value, exceeds the estimated future cash flows, the asset is deemed impaired in the US. It happens when a company invests money in an asset but later realizes a net loss due to unforeseen events.

What does the accounting term impaired mean?

Impairment is the accounting term for a long-term decline in a corporate asset's value. It could be an intangible asset or a fixed asset. The overall profit, cash flow, or other benefits that the asset can produce are periodically compared to its existing book value when an asset is tested for impairment.

How do you record asset impairment?

An asset's book value less its market value is known as an impairment loss. You must note the difference and enter the new amount in your records. The asset's increased value should be noted in your upcoming financial accounts. Additionally, you might need to provide a new sum for the asset's depreciation.