In business, the value of your assets doesn’t stay the same. An asset’s market value might be higher or lower than its book value. If the value of your assets permanently changes for the worse, you need to record the impairment of assets.
What does impairment of assets mean?
An impaired asset is an asset with a lower market value than book value. Market value, or fair value, is what an asset would sell for in the current market. On the other hand, book value, or carrying amount, is the amount you paid for the asset, minus depreciation. An impaired asset would sell for less now than what it is theoretically worth (what you paid for it minus depreciation).
Business owners know that an asset’s value will fluctuate over the course of its life. But when the asset’s value is lower than its original cost minus depreciation, and you expect that it won’t recover, you must record it as an impairment.
An impairment loss is an asset’s book value minus its market value. You must record the new amount in your books by writing off the difference. Write the asset’s new value on your future financial statements. And, you may also need to record a new amount for the asset’s depreciation.
You will probably deal with the impairment of intangible assets (non-physical assets) as well as the impairment of fixed assets, which are long-term assets. Generally, you don’t need to worry about impairment of low-cost assets.
Indicators of impairment
Spotting the impairment of financial assets can be tricky. Here are some ways you might be able to tell that an asset’s decreased value is an impairment:
- Significant drop in the asset’s fair value
- Changes in the market
- Cash flow losses due to the asset
- Decrease in the asset’s functionality
- New technologies that decrease the asset’s value
Calculating and recording an impairment of financial assets
When an asset is impaired, you must update your accounting books and financial records. Otherwise, your records will be inaccurate and depict a false value of your business’s profitability.
Below, learn how to calculate and record an impairment loss.
Before recording the impairment loss of one of your assets, you need to calculate its fair market value. And, you need to know how much its carrying amount is.
Your asset’s carrying amount should be recorded on your financial statements. If you don’t have a record of its carrying amount, find receipts indicating how much you paid for it. And, calculate its depreciation.
Determine the asset’s fair market value. Then, subtract its carrying amount from the fair market value.
For example, you have a computer with a carrying amount of $1,000. After dropping it down a flight of stairs, it loses some functionality. Its market value suddenly plunged to $500. You must record an impairment loss of $500.
You must record your impairment loss by creating a new journal entry. Record the loss by increasing your Expense account. You can do this through a debit. And, you need to decrease the asset’s value. You can do this by crediting the corresponding Asset account.
This is how you would set up your journal entry for asset impairment:
Let’s say that you need to record an impairment loss of $7,000 for a company car. Your journal entry would be as follows:
|XX/XX/XXXX||Expense||Impairment Loss (Car)||7,000|
Creating a journal entry isn’t your only recordkeeping responsibility, though. You will also need to recognize the loss on your business’s income statement and balance sheet. This will show a loss in profitability.
Record the loss on your income statement, under the expenses section. Record the loss in asset value on your business balance sheet, under the assets section.
Reversal of impairment loss
If an asset’s impairment loss decreases, you can reverse the loss you previously recorded.
After an impairment loss, the asset’s value might improve because the asset’s value increases significantly, you use the asset more, or its performance increases.
You cannot reverse an impairment loss for goodwill (e.g., brand name, patents, etc.).
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This article is updated from its original publication date of August 23, 2018.This is not intended as legal advice; for more information, please click here.