Asset impairment represents a drop in current and future income for long-lived assets held by a business. When impairment occurs, business accounts report the diminished current and expected cash flows on a company's income statement and balance sheet. Over time, a large number of impaired assets can make it difficult for a business to sustain growth and continue meeting its financial obligations.
Asset Impairment Definition
Impairment of business assets occurs when the market value of these assets dips below the recorded values in the owning company's financial records. According to the Free Dictionary's website, impaired assets can include long-term assets and client/vendor credit accounts. Long-term assets include items the business holds for longer than one year, including real property, copyrights, patents and stock investments. According to Statement 144 issued by the Financial Accounting Standards Board, a business no longer includes goodwill in its long-term assets for impairment tests. Goodwill represents a company's value in terms of its intangible assets, including copyrights, patents and brand names.
Reporting Impaired Assets
Reporting of impaired assets occurs annually on a company's financial statement and balance sheet. Before reporting impaired assets, a business determines whether the value of these assets has the potential to recover sufficient value to remove impairment. According to the Financial Accounting Standards Board, a business recognizes impairment only if the assets show no ability to recover from its undiscounted cash flows and if the carrying amounts of these assets are less than fair market values. Undiscounted cash flows refer to the anticipated earnings of assets before any adjustments for interest. Carrying amounts are the values of assets recorded in the company's balance sheet before making adjustments for depreciation or amortization.
Conditions for Testing
Testing every asset a company owns each reporting period isn't expressly necessary to maintain compliance with accounting and financial reporting standards. According to the "Journal of Accountancy," testing of an asset for impairment occurs when an long-term asset suffers a significant drop in its market value, a business greatly changes the way it uses a long-term asset, restrictive legal/business ramifications arise surrounding an asset, costs to maintain a long-term asset rise sharply or the business plans to sell a long-term asset well before the end of its useful life. A history of cash flow losses compounded by current cash flow drops in a long-term asset can prompt a business to test the asset for impairment.
Disclosing Impairment Details
Disclosing the circumstances surrounding the impairment of a long-term asset is a necessary element in creating a company's income statement. This information allows investors to view the events responsible for the drop in cash flows for that asset and determine who is responsible. For example, the reason for a drop in cash flows for a long-term asset could be widespread economic instability or the result of internal failures by executives. The business also discloses the method for determining the long-term asset's fair value in arriving at the conclusion that the asset is suffering impairment.
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