What Is an Asset Impairment?
An impairment loss takes place when a company makes the judgment call that the carrying value of an asset on the company balance sheet is less than fair value, which is what an unpressured person would pay for the asset in an open marketplace. If the impairment loss isn’t recoverable, under U.S. generally accepted accounting practices (GAAP), the company has to adjust the books to reflect this lessening in value.
Be careful not to confuse asset impairments with the lower of cost or market method for valuing inventory. They are two different accounting events.
Now, you may be wondering about the criteria for measuring recoverability. Good question! In a nutshell, it means the asset’s carrying value isn’t recoverable from its undiscounted cash flows. Now, that’s clear, is it not? Not!
When the carrying value of an asset or group of assets, such as an operating segment, is more than its fair value, the company may have an impairment event on its hands.
U.S. GAAP in Accounting Standards Codification (ASC) 360-10-35 provides guidance to financial accountants on the type of events and circumstances to look for, as the first step in determining whether assets have to be evaluated for recovery and subsequent impairment loss.
Every GAAP guide discusses six biggies. However, this list doesn’t include all the events that can trigger the need to test for impairment:
Market downturn: The market or market price of a long-lived asset experiences a significant downturn. For example, the company is holding a piece of raw land to develop whose fair value is currently less than cost.
Change in use of asset: An event such as a natural disaster causes an adverse change in the manner in which a long-lived asset is used or changes its condition.
Change in business or legal climate: A lawsuit or other adverse change in the general business or legal climate affects the value of the asset. Maybe a factory has been deemed unsafe and can’t be used for production until improvements are made.
Premature disposal of asset: The company plans to dump an asset significantly before the end of its previously estimated useful life.
Escalating costs: Costs to build or acquire an asset start to pile up and are significantly more than the company originally estimates.
Souring investments: History of operating or cash flow losses demonstrates that the company will experience continuing losses from using the asset.
If a company has goodwill, which comes into play during business combinations when one business purchases another for a price greater than the fair market value of the net assets acquired during the sale, there’s an annual requirement to test it for impairment.
Accounting Glossary
accounting equation
The equation Assets = Liabilities + Equity, which demonstrates the two-sided nature of accounting and is useful for explaining the concept of double-entry accounting (or double-entry bookkeeping).
Accounting Glossary
accounting period
The time period for which financial information is being tracked in a business, such as monthly, quarterly, or annually.
Accounting Glossary
accounts receivable
An account that records the amounts that customers owe to a business.
Accounting Glossary
adjusting entry
A correction made to a bookkeeping account that adjusts for accounting errors or other necessary changes at the end of the accounting period.
Accounting Glossary
cash flows
Used to describe the source or sources of cash or how cash is used.
Accounting Glossary
Chart of Accounts
A list of all the accounts used by a business, including what types of transactions go into each account.
Accounting Glossary
debit
An accounting entry that increases an asset or expense account, and decreases a liability or income account.
Accounting Glossary
dividends
A portion of a company’s profits paid by share of common stock on a quarterly or annual basis.
Accounting Glossary
FASB
Financial Accounting Standards Board. FASB is the highest-ranking authority in the private (non-government) sector of the U.S. for making pronouncements on GAAP and for keeping accounting standards up-to-date.
Accounting Glossary
Federal Unemployment Tax
In the U.S., the fund that used to be known simply as Unemployment. Employers contribute to the fund, and states also collect taxes to fill their unemployment fund reserves. (The acronym FUTA means Federal Unemployment Tax Act.)
Accounting Glossary
fidelity bonds
A type of insurance — typically carried by employers for their employees — that helps guard against theft and reduce the risk of loss.
Accounting Glossary
FIFO
First-in, first-out. A method for costs of goods sold in which a business charges out product costs to cost of goods sold expense in the chronological order in which the goods were acquired.
Accounting Glossary
fungible
Describes a product that is interchangeable and virtually indistinguishable from another product.
Accounting Glossary
General Ledger
A summary of all of a business’s accounts and transactions.
Accounting Glossary
IASB
International Accounting Standards Board. The IASB (based in London) is the main authoritative accounting standards setter outside the U.S.
Accounting Glossary
Journals
The location in which bookkeepers keep records (in chronological order) of daily company transactions.
Accounting Glossary
LIFO
Last-in, first-out. A method for costs of goods sold that selects the last item you purchased first, and then works backward until you have the total cost for the total number of units sold during the period.
Accounting Glossary
LLP
Limited liability partnership. A legal structure that state laws offer to qualified professionals in which all the partners have limited liability.
Accounting Glossary
PC
Professional corporation. A legal structure that state laws offer to qualified professionals who otherwise would have to operate as an unlimited partnership liability.
Accounting Glossary
petty cash
A cash account that businesses keep on hand for unexpected expenses.
Accounting Glossary
revenue
Monies that are collected in the process of selling a company’s goods and services.
Accounting Glossary
salvage value
The amount that an asset is worth after it has been fully depreciated.
Accounting Glossary
statement of cash flows
A financial statement that summarizes a business’s cash inflows and outflows during an accounting period.
Accounting Glossary
transactions
Economic exchanges between a business or other entity and the parties with which the entity interacts and makes deals.
Accounting Glossary
worker’s compensation insurance
A type of insurance carried by employers that covers its employees in case they are injured on the job.
