Impairment testing

Definition

Impairment testing is the process of evaluating whether an asset's carrying amount exceeds its recoverable amount, leading to a potential write-down in financial statements. This assessment is crucial for ensuring that assets are not overstated and reflects a company's actual financial position. It connects to the broader concepts of fair value reporting, goodwill recognition, and the treatment of non-controlling interests by determining how these elements can be affected when assets lose value.

5 Must Know Facts For Your Next Test

1. Impairment testing must be performed at least annually for goodwill and whenever there are indications that an asset may be impaired.
2. The recoverable amount is determined as the higher of fair value less costs of disposal or value in use.
3. If an asset is found to be impaired, the carrying amount is reduced to its recoverable amount, resulting in an impairment loss.
4. Impairment losses must be recognized in profit or loss in the period they occur, impacting net income and equity.
5. Reversals of impairment losses are allowed under certain conditions, but only for assets other than goodwill.

Review Questions

• How does impairment testing impact the valuation of goodwill on a company's balance sheet?
  • Impairment testing directly affects goodwill valuation by ensuring that the recorded amount reflects the current fair value of the business it represents. If the testing reveals that the carrying amount of goodwill exceeds its recoverable amount, the company must recognize an impairment loss, which decreases both goodwill and total assets on the balance sheet. This process helps maintain transparency in financial reporting by preventing overstatement of intangible assets.
• What role does fair value play in impairment testing for assets, and how does it affect reported earnings?
  • Fair value plays a critical role in impairment testing as it is used to determine if an asset's carrying amount is recoverable. When conducting impairment tests, if the fair value less costs to sell is lower than the asset's carrying amount, it triggers a write-down. This adjustment can significantly affect reported earnings, as impairment losses reduce net income for that reporting period, highlighting potential issues with asset management or market conditions.
• Evaluate the implications of failing to perform adequate impairment testing on non-controlling interests within consolidated financial statements.
  • Neglecting to perform proper impairment testing on non-controlling interests can lead to significant misstatements in consolidated financial statements. It may result in overstating the value of these interests and misrepresenting the overall financial health of the parent company. This oversight can mislead investors about the actual performance and risk associated with subsidiaries where control is not fully held, potentially eroding trust and leading to regulatory scrutiny as stakeholders rely on accurate representations for decision-making.

Related terms

Fair Value: The estimated price at which an asset could be sold or a liability settled in an orderly transaction between market participants.

Goodwill: An intangible asset that arises when a buyer acquires an existing business and pays more than the fair value of its identifiable net assets.

Non-controlling Interest: An ownership stake in a subsidiary company that is not enough to give control over the subsidiary's operations and decisions.