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Asset Impairment Procedure
Asset impairment is a sudden decline in the usability of a fixed asset, such as machinery or a building. Impairment may be caused by such factors as damage to the asset, its technological obsolescence, or changes to the local laws that no longer allow an entity to use the asset. When asset impairment occurs, you should write down the value of the asset, which is detailed in the following procedure:
1. Select Assets for Testing (Fixed Asset Accountant)
- Sort the fixed asset register by declining net book value (e.g., original purchase price less accumulated depreciation).
- Select for impairment testing those 20% of the listed assets containing 80% of the total book value of the asset register.
2. Determine Level of Impairment (Fixed Asset Accountant)
- Determine the total undiscounted cash flows expected to be generated from each of the selected assets (including net salvage value), and list this amount next to their net book values.
- Compare the net book value figure to the undiscounted cash flow figure, and highlight those assets for which the book value is higher.
- For the highlighted assets, determine the amount of the variance between the net book value and the undiscounted cash flow figure, and record an adjustment in the general ledger for this amount.
3. Update Accounting Records (General Ledger Accountant)
- Enter in the general ledger the reduction in value of the impaired assets.
- Reduce the net book values of all adjusted assets in the fixed asset register to match the amount of their undiscounted cash flows.
4. Revise Depreciation Calculations (Fixed Asset Accountant)
- Calculate depreciation based on the new reduced book value figures, and adjust any recurring depreciation journal entries to include these changes.
Effects of Asset Impairment
When an asset is impaired and the impairment effect is recorded in the accounting records, this has the following effects on the reported results and condition of the business:
- Asset reduction. The amount of the impairment is a reduction in the fixed asset line item on the balance sheet, as well as in retained earnings. This makes the balance sheet look less robust.
- Loss recognition. The amount of the impairment may be substantial, so the amount of reported profits may be severely reduced or even eliminated.
- Ratios. The debt to equity ratio will look worse, since the amount of retained earnings (a form of equity) will have been reduced as a result of the impairment.
Though the impact on current-period results is clearly not good, recognition of an impairment tends to make future results look better, since the impairment reduces the amount of depreciation that would otherwise have been recognized in future periods.
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