Assets are a crucial part of any company or business. These are financial resources that companies own or control and can result in future economic inflows. In accounting, companies cannot charge an asset’s total costs to a specific period. Instead, they must distribute the cost using depreciation. However, assets may also suffer due to impairment.
What is Impairment?
Impairment is a term that is crucial in accounting and often associated with assets. It describes a permanent reduction in an asset’s value. Impairment applies to all types of assets that companies own. The only exception is assets that have specific rules for impairment, for example, inventory. Impairment may come due to several external and internal factors.
Essentially, impairment represents the difference between an asset’s book value and its recoverable amount. The recoverable amount usually refers to any asset’s fair value after deducting any selling costs. In some circumstances, it may also refer to an asset’s value in use. When both are available, the recoverable amount is the higher of both amounts.
How to calculate Impairment Loss?
As mentioned, impairment loss represents the difference between an asset’s carrying value and recoverable amount. Therefore, the calculation of impairment loss requires companies to calculate their asset’s carrying value first. Usually, it is available in their Balance Sheet under the respective balance.
Once companies determine the carrying value, they must establish a recoverable amount. Determining a recoverable amount may require some calculations. However, once they conclude the asset’s recoverable amount, they must compare it with its carrying value. If the carrying value is lower than the asset’s recoverable amount, then there is an impairment loss.
Companies can use the following formula to calculate the impairment loss.
Impairment Loss = Asset’s Recoverable Amount – Asset’s Carrying Value
In the above formula, the asset’s recoverable amount will be as follows.
Asset’s Recoverable Amount = Higher of Asset’s Fair Value Less Cost to Sell or Value in Use
If the impairment loss formula above returns a negative amount, the company must record an impairment loss on its income statement. If it is positive, then there is no accounting treatment for it.
How do companies present Impairment Loss on Income Statement?
An impairment loss is a non-cash expense for companies. Therefore, they must record it accordingly. Similarly, they must report the impairment loss on the Income Statement. The double entry to record impairment loss is as follows.
The impairment loss part of the double-entry will get reported on the Income Statement. The classification may depend on the company’s preferences. Usually, however, companies may present it as an administrative or production expense. The other side of the entry will impact the company’s Balance Sheet, reducing the asset’s value.
A company, Red Co., has an asset with a carrying value of $100,000. The asset’s recoverable amount in the market is $80,000. Therefore, there is an impairment loss of $20,000 ($80,000 – $100,000) on it. Red Co. must report the impairment loss on its Income Statement. Therefore, the treatment will be as follows.
Impairment loss represents the negative difference between an asset’s recoverable amount and carrying value. It is a crucial concept in accounting that companies must follow for almost every asset. An impairment loss is an Income Statement item as it represents an expense for companies. It also results in a decrease in the asset’s value in the Balance Sheet.