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 time span to become impaired assets are tested for impairment periodically 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 1 gaap also recommends that companies take into consideration events and economic circumstances 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 2an 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 assetsunder 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 that the asset can bring in for the remainder of its useful life 3the 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 that 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 45standard 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 3asset depreciation vs asset impairmenta 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 