Asset impairment refers to a sudden decline in usability of a fixed asset. The impairment could be triggered by such issues as asset damage, obsolescence, or legal restrictions on asset use. When there is evidence of an asset impairment, use the following procedure to record a reduction in its carrying amount in the accounting records:
1. Select Assets to Test
- The fixed asset accountant sorts the fixed asset register by carrying amount, which is the original book value minus depreciation and any prior impairment charges.
- Use the Pareto principle to select the 20% of assets whose aggregate carrying amounts comprise 80% of the total recorded carrying amount of fixed assets. This concentrates attention on the highest-cost assets. All other assets can probably be ignored for impairment testing purposes (check with the company's auditors to be sure).
2. Determine Impairment Level
- The fixed asset accountant calculates the undiscounted cash flows expected from each of the selected fixed assets, and lists these amounts in the fixed asset register next to the selected items.
- Take note of any situations where the carrying amount of an asset is greater than its undiscounted cash flows.
- For the noted items, calculate the difference between the carrying amounts and undiscounted cash flows, and create a journal entry for the difference in the general ledger as an adjusting entry. Only create this entry if the value of a designated asset is not expected to recover.
3. Update Accounting Records
- The general ledger accountant enters the requested journal entry in the general ledger.
- Ensure that the recorded impairment is reflected in the fixed asset register for each of the indicated assets.
- Document the reasons for the various impairments.
4. Revise Depreciation Calculations
- Adjust the depreciation calculations for the indicated fixed assets to depreciate the new, reduced asset balances for the remainder of their useful lives.
Effects of Asset Impairment
The net effects of asset impairment on a business are:
- Asset reduction. The balance in the fixed asset line item is reduced by the amount of the impairment, which reduces the amount of assets and retained earnings shown in the balance sheet.
- Loss recognition. The impairment appears as a loss in the income statement. Depending on the size of the impairment, this may trigger a notable profit reduction for the reporting entity.
Over the long term, the impact of an asset impairment is to reduce the amount of depreciation recognized, so profits tend to improve over the periods in which depreciation has been reduced.