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Assets are the essence of a company’s operations. Every company has fixed assets that help them generate revenues. Unlike other resources, companies cannot charge the cost of these assets to one fiscal period. Instead, accounting standards require them to spread over several periods. This process occurs through depreciation. This expense represents the fall in the asset’s value over time.
Sometimes, assets may also lose value for other reasons. Accounting standards require companies to record those costs separately as impairment.
What is the Impairment of Assets?
In accounting, impairment of assets refers to a decrease in an asset’s value for several reasons. This situation occurs when a company’s balance sheet does not reflect that asset’s actual value. Usually, the impairment of assets occurs due to external factors. However, internal ones also decrease the asset’s value beyond its book value on the balance sheet.
Impairment of assets is crucial in presenting assets for their actual value. Accounting standards require companies to record an impairment when an asset’s recoverable amount is lower than its book value. However, companies must consider two amounts when calculating the former. These include the asset’s fair value minus the cost to sell and its value in use.
What is the accounting for the Impairment of Assets?
Impairment of assets relates to the conservatism principle in accounting. It requires companies to record losses as soon as they occur. Therefore, when an asset’s recoverable amount drops below its book amount, it falls under a loss. The company must treat the difference between the two amounts as an impairment on that asset.
The recoverable amount of an asset is the higher of two values, its fair value minus costs to sell and its value and use. Usually, this amount is the same as the book value or higher than it. If it is higher, there is no negative impairment charged. If the recoverable amount is lower, the company must create an impairment expense.
What is the journal entry for Impairment of Assets?
The journal entry for the impairment of assets involves two accounts. The first is an expense account, which decreases profits in the income statement. The other side relates to the asset for which the company charges the impairment. In this case, the amount also decreases the book value of that asset in the balance sheet.
Overall, the journal entry for impairment of assets is as follows.
| Dr | Impairment on asset |
| Cr | Asset |
The credit side goes to the specific asset account which has suffered an impairment loss.
Example
A company, Red Co., owns a vehicle that has a book value of $10,000 in its books. The asset’s fair value is $11,000, with a selling cost of $2,000. On the other hand, its value in use is $8,000. Based on these figures, the recoverable amount is the higher of these two values, which is $9,000 ($11,000 fair value – $2,000 selling cost).
Based on the above figures, the recoverable amount for the vehicle is $1,000 lower than its book value of $10,000. Therefore, Red Co. must charge impairment on the asset. The company uses the following journal entry to do so.
| Dr | Impairment expense | $1,000 |
| Cr | Vehicle | $1,000 |
Conclusion
Assets may suffer impairment for external or internal reasons. Companies must create an expense in their books to reflect this decrease in the asset’s value, known as impairment. In accounting, if the recoverable amount of a resource is lower than its book value, it is considered impaired. Companies must create an impairment charge on assets to comply with the conservatism principle.
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