What is an Impaired Asset?
An impaired asset is an asset that has a market value less than the value listed on the company's balance sheet. When an asset is deemed to be impaired, it will need to be written down on the company's balance sheet to its current market value.
- Assets should be tested for impairment on a regular basis to prevent overstatement on the balance sheet.
- Assets that are most likely to become impaired include accounts receivable, as well as long-term assets such as intangibles and fixed assets.
- When an impaired asset's value is written down on the balance sheet, there is also a loss recorded on the income statement.
How Impaired Assets Work
An asset is impaired if its projected future cash flows are less than its current carrying value. An asset may become impaired as a result of materially adverse changes in legal factors that have changed the asset’s value, significant changes in the asset’s market price due to a change in consumer demand, or damage to its physical condition. Another indicator of potential impairment occurs when an asset is more likely than not to be disposed prior to its original estimated disposal date. Asset accounts that are likely to become impaired are the company's accounts receivable, goodwill, and fixed assets.
Long-term assets, such as intangibles and fixed assets, are particularly at risk of impairment because the carrying value has a longer span of time to become impaired.
Assets are tested for impairment on a periodic basis to ensure the company's total asset value is not overstated on the balance sheet. According to generally accepted accounting principles (GAAP), certain assets, such as goodwill, should be tested on an annual basis. GAAP also recommends that companies take into consideration events and economic circumstances that occur between annual impairment tests in order to determine if it is "more likely than not" that the market value of an asset has dropped below its carrying value.
An impairment loss should only be recorded if the anticipated future cash flows are unrecoverable. When an impaired asset’s carrying value is written down to market value, the loss is recognized on the company’s income statement in the same accounting period.
Accounting for Impaired Assets
The total dollar value of an impairment is the difference between the asset’s carrying cost and the lower market value of the item. The journal entry to record an impairment is a debit to a loss, or expense, account and a credit to the related asset. A contra asset impairment account, which holds a balance opposite of the associated asset account, may be used for the credit in order to maintain the historical cost of the asset on a separate line item. In this situation, the net of the asset, its accumulated depreciation, and the contra asset impairment account reflect the new carrying cost.
Upon recording the impairment, the asset has a reduced carrying cost. In future periods, the asset will be reported at its lower carrying cost. Even if the impaired asset’s market value returns to the original level, GAAP states the impaired asset must remain recorded at the lower adjusted dollar amount. This is in compliance with conservative accounting principles. Any increase in value is recognized upon the sale of the asset.
Standard GAAP practice is to test fixed assets for impairment at the lowest level where there are identifiable cash flows. For example, an auto manufacturer should test for impairment for each of the machines in a manufacturing plant rather than for the high-level manufacturing plant itself. However, if there are no identifiable cash flows at this low level, it's allowable to test for impairment at the asset group or entity level. If an asset group experiences impairment, the adjustment is allocated among all assets within the group. This proration is based on the current carrying cost of the assets.
Asset Depreciation vs. Asset Impairment
A capital asset is depreciated on a regular basis in order to account for typical wear and tear on the item over time. The amount of depreciation taken each accounting period is based on a predetermined schedule using either straight line or one of multiple accelerated depreciation methods. Depreciation differs from impairment, which is recorded as the result of a one-time or unusual drop in the market value of an asset.
When a capital asset is impaired, the periodic amount of depreciation is adjusted moving forward. Retroactive changes are not required for adjusting the previous depreciation already taken. However, depreciation charges are recalculated for the remainder of the asset's useful life based on the impaired asset’s new carrying value as of the date of the impairment.
Real World Example of an Impaired Asset
In 2015, Microsoft recognized impairment losses on goodwill and other intangible assets related to its 2013 purchase of Nokia. Initially, Microsoft recognized goodwill related to the acquisition of Nokia in the amount of $5.5 billion. The book value of this goodwill, and therefore assets as a whole, reported on Microsoft's balance sheet were deemed to be overstated when compared to the true market value. Because Microsoft had not been able to capitalize on the potential benefits in the cellphone business, the company recognized an impairment loss.