What Is Book Value Reduction?
A book value reduction lowers the value at which an asset is carried on the books because changes in the asset or market conditions have reduced its current market value. Book value reduction is a non-cash charge that is reported as an expense and thus reduces net income. In some cases, it can be a very significant number that can result in huge losses for the reporting entity. Since it is regarded as an extraordinary item, companies usually report GAAP net income (or loss), taking into account the book value reduction charge, as well as "pro forma" or non-GAAP net income or loss that excludes the charge. A book value reduction is more commonly called a write-down or impairment in the popular press.
Understanding Book Value Reduction
While GAAP requires a reduction in book value of an asset if there has been significant impairment, it would be impossible to test all assets for such impairment on a quarterly basis. GAAP specifies guidelines about when such impairment tests should be made.
Specifically, property, plant, and equipment and finite-life intangible assets — which are depreciated or amortized over time — should be tested for impairment when market or asset changes suggest the book value of the asset may be overstated and not fully recoverable. Intangible long-lived assets that are not subject to amortization — like goodwill should be evaluated for impairment at least annually.
A test for possible book value reduction may be indicated in a number of situations. These include a substantial decrease in market price, an adverse change in the physical condition of the asset, economic conditions, a negative political change in the country where the asset is located, and so on.
The accounting rules regarding the reversal of book value reductions may differ between GAAP and International Financial Reporting Standards (IFRS). For example, U.S. GAAP prohibits reversal of previous inventory write-downs, but IFRS permits them under certain circumstances. Both GAAP and IFRS prohibit reversals of goodwill write-downs.
Financial analysts keep a close eye out for changes in book value estimates. When a company unexpectedly and with little economic justification writes down asset levels, it can be a sign of trouble. Public companies will go to great lengths to explain adjustments through their corporate communications and investor relations teams.