Impaired Asset

What Is an Impaired Asset?

An impaired asset is an asset that is no longer able to generate the amount of cash flow that was originally projected to or is no longer worth the amount that was recorded on the company’s balance sheet.

This can occur for a variety of reasons, such as a decline in market conditions, changes in technology, or increased competition.

For example, a company may have invested in a piece of equipment that was expected to generate a certain amount of revenue, but due to changes in the market or technology, the equipment is no longer able to generate that same amount of revenue.

Impairment can also occur when the fair value of an asset is less than its carrying amount.

For example, if a company owns a building that is recorded on its balance sheet at a certain value, but the fair market value of that building is now less than the recorded value, the building is considered impaired.

When an asset is considered impaired, the company must recognize the impairment loss by reducing the carrying amount of the asset to its fair value.

This will result in a loss being recognized on the company’s income statement, which reduces the company’s net income and can also affect other financial statements, such as the balance sheet and cash flow statement.

Key Takeaways – Impaired Asset

• Asset impairment occurs when the carrying value of an asset exceeds its fair value, indicating that the asset has lost some or all of its value.
• It is an important consideration for traders/investors as it can have a significant impact on a company’s financial statements and overall performance.
• The recognition of an impairment loss on the income statement can decrease the company’s net income, which can in turn affect stock price and investor sentiment.
• An impairment loss also reduces the value of the asset on the balance sheet, which can affect the company’s overall asset value and balance sheet strength.
• Investors/traders should be aware of potential impairment issues when evaluating a company’s financial performance and potential risk factors. By monitoring the company’s impairment testing and impairment losses, they can gain insight into the firm’s financial health and make better informed investment decisions.

How Do Impaired Assets Work?

Impaired assets are assets that have a value that is less than the book value (the value at which they are recorded on a company’s balance sheet).

This can happen for a variety of reasons, such as changes in market conditions, changes in tech, or obsolescence.

When an asset is impaired, it must be written down to its fair market value, which reduces the company’s assets and can result in a loss on the income statement.

The impairment loss is typically recorded as a non-operating expense, and the asset remains on the balance sheet at its new, lower value. In some cases, the impaired asset may be sold or otherwise disposed of if it is no longer useful to the company.

Impairment Testing

Impairment testing is a process to identify impaired assets, and it’s usually done on an annual basis.

The impairment test compares the carrying amount of an asset to its fair value and if the fair value is less than the carrying amount, an impairment loss is recognized.

Impairment of Intangible Assets

Impairment of intangible assets refers to the process of assessing the value of an intangible asset, such as a patent, trademark, or license, and determining if its carrying value on the balance sheet is greater than its fair value.

If the carrying value is found to be greater than the fair value, an impairment loss is recognized, and the asset is written down to its fair value.

The purpose of impairment testing is to ensure that the value of intangible assets on the balance sheet is reflective of their current market value, and to prevent overstating the value of a company’s assets.

The impairment of intangible assets is typically triggered by an event such as a change in the company’s business strategy, a decline in market conditions, or a significant change in the asset’s expected future cash flows.

An impairment loss is recognized in the income statement, which can have a negative impact on the company’s earnings.

The impairment of intangible assets is an accounting process that is required under generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS) for all companies that have intangible assets on their balance sheets.

It is typically performed annually, but can also be performed more frequently if there is a significant change in the asset’s expected future cash flows.

Asset impairment explained

FAQs – Impaired Asset

How do you know if an asset is impaired?

An asset is considered impaired if its carrying value on the balance sheet exceeds its fair value.

This can be determined by comparing the asset’s expected future cash flows to its current book value, or by performing an impairment test such as the income approach, the market approach, or the cost approach.

If the asset’s fair value is less than its carrying value, the difference is recognized as an impairment loss on the income statement.

What type of assets are impaired?

Assets that are commonly considered for impairment include long-lived assets such as property, plant and equipment, intangible assets, and goodwill.

Long-lived assets, such as buildings and equipment, may become impaired due to physical damage, obsolescence, or changes in technology.

Intangible assets, such as patents, trademarks, and copyrights, may become impaired due to changes in the market or legal developments.

Goodwill, which is the difference between the purchase price of a company and the fair value of its net assets, may become impaired if the value of the company’s assets and earnings decline.

Also, financial assets such as loans and investments are evaluated for impairment as well.

For example, if a borrower defaults on a loan, the lender will need to evaluate the loan for impairment and may recognize a loss if the loan’s recoverable amount is less than its carrying amount.

Similarly, if the fair value of an investment declines, the investor will need to evaluate the investment for impairment and may recognize a loss if the investment’s recoverable amount is less than its carrying amount.

Conclusion – Impaired Asset

Asset impairment occurs when the carrying value of an asset on the balance sheet exceeds its fair value.

This can happen due to physical damage, obsolescence, changes in technology, market conditions, legal developments, among other reasons.

Long-lived assets like property, plant and equipment, intangible assets, and goodwill are commonly considered for impairment.

When an asset is impaired, an impairment loss is recognized on the income statement, which reduces the asset’s value on the balance sheet.

Additionally, financial assets like loans and investments are also evaluated for impairment if there is a decline in their recoverable amount or fair value.

In short, an impaired asset is an asset that is no longer able to generate the cash flow that was originally projected, or is no longer worth the amount that it was recorded on the company’s balance sheet, this will be recognized by an impairment loss which will affect the company’s financial statements.