Impairment

Definition

Impairment refers to the reduction in the value or usefulness of an asset, resulting in a decrease in its carrying amount on the balance sheet. This concept is particularly relevant in the context of accounting for tangible and intangible assets, as well as in addressing special issues related to long-term asset management.

5 Must Know Facts For Your Next Test

1. Impairment testing is required when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
2. Intangible assets with indefinite useful lives, such as goodwill, must be tested for impairment at least annually, regardless of whether there are any indicators of impairment.
3. The impairment loss is recognized in the income statement and reduces the carrying amount of the asset on the balance sheet.
4. Impairment losses on tangible assets, such as property, plant, and equipment, may be reversed in subsequent periods if the asset's value increases, but impairment losses on intangible assets, such as goodwill, cannot be reversed.
5. Impairment accounting is a critical aspect of asset management, as it ensures that the reported values of assets on the balance sheet accurately reflect their economic value and potential for future benefits.

Review Questions

• Explain how the concept of impairment is relevant in the context of accounting for tangible assets.
  • Impairment is an important consideration in the accounting for tangible assets, such as property, plant, and equipment. If events or changes in circumstances indicate that the carrying amount of a tangible asset may not be recoverable, the entity must perform an impairment test. This involves comparing the asset's carrying amount to its recoverable amount, which is the higher of the asset's fair value less costs to sell and its value in use. If the carrying amount exceeds the recoverable amount, an impairment loss is recognized, reducing the asset's carrying value on the balance sheet and recording the loss in the income statement. Impairment losses on tangible assets can be reversed in subsequent periods if the asset's value increases.
• Describe the role of impairment in the accounting for intangible assets, particularly those with indefinite useful lives.
  • Intangible assets, such as goodwill, that have indefinite useful lives must be tested for impairment at least annually, regardless of whether there are any indicators of impairment. The impairment test for these assets involves comparing the asset's carrying amount to its recoverable amount, which is the higher of the asset's fair value less costs to sell and its value in use. If the carrying amount exceeds the recoverable amount, an impairment loss is recognized, reducing the asset's carrying value on the balance sheet and recording the loss in the income statement. Unlike tangible assets, impairment losses on intangible assets with indefinite useful lives, such as goodwill, cannot be reversed in subsequent periods.
• Analyze the importance of impairment accounting in the context of long-term asset management and the accurate reporting of a company's financial position.
  • Impairment accounting is a critical aspect of long-term asset management, as it ensures that the reported values of assets on the balance sheet accurately reflect their economic value and potential for future benefits. By regularly testing for impairment and recognizing any necessary write-downs, companies can avoid overstating the value of their assets and provide a more accurate representation of their financial position. This is particularly important for long-lived assets, such as property, plant, and equipment, as well as intangible assets with indefinite useful lives, like goodwill. Proper impairment accounting helps to prevent the overstatement of a company's assets and ensures that the financial statements provide users with a reliable and relevant assessment of the company's financial health and performance.

Related terms

Carrying Amount: The value at which an asset is reported on the balance sheet, calculated as the original cost less any accumulated depreciation or amortization.

Fair Value: The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

Recoverable Amount: The higher of an asset's fair value less costs to sell and its value in use, which represents the present value of the future cash flows expected to be derived from the asset.