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1. Introduction to Accounting1h 21m
2. Transaction Analysis1h 13m
3. Accrual Accounting Concepts2h 38m
4. Merchandising Operations2h 30m
5. Inventory1h 55m
6. Internal Controls and Reporting Cash1h 16m
7. Receivables and Investments3h 8m
8. Long Lived Assets5h 1m
9. Current Liabilities2h 19m
10. Time Value of Money1h 23m
- Time Value of Money Equations
  35m
- Using Time Value of Money Tables
  47m
11. Long Term Liabilities2h 45m
12. Stockholders' Equity2h 15m
13. Statement of Cash Flows2h 24m
14. Financial Statement Analysis5h 25m
15. GAAP vs IFRS56m

8. Long Lived Assets

Asset Impairments

8. Long Lived Assets

Asset Impairments: Videos & Practice Problems

Video Lessons Practice Worksheet

Topic summary

Assets must be tested for impairment annually to ensure their book value reflects future benefits. If the net book value exceeds estimated future cash flows, an impairment loss occurs, recorded as a debit on the income statement. The loss is calculated as the net book value minus fair value. Once an asset is impaired, it cannot be written back up, adhering to the conservatism principle in accounting. This process is crucial for accurate financial reporting and maintaining the integrity of the balance sheet.

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Asset Impairment

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Asset Impairment Video Summary

When assessing whether an asset is impaired, it is essential to understand that the value recorded on the balance sheet should reflect the future economic benefits the asset is expected to provide. According to Generally Accepted Accounting Principles (GAAP), both tangible and intangible assets must undergo an annual impairment test to ensure their recorded value aligns with their expected future benefits.

The impairment test involves comparing the net book value of the asset to its estimated future cash flows. If the net book value exceeds the expected future cash flows, the asset is considered impaired. This situation necessitates a write-down of the asset to its fair value, which is often referred to as market value or fair market value. The principle of conservatism in accounting dictates that losses should be recognized promptly, while gains are not recorded until realized. Therefore, if an asset is impaired, a loss must be recorded on the income statement.

The impairment process consists of two main steps. First, determine if the asset is impaired by comparing the net book value to the estimated future cash flows. If the net book value is greater, an impairment exists. The second step involves calculating the impairment loss, which is the difference between the net book value and the fair value of the asset. This loss is then recorded as a debit in the journal entry, reflecting a decrease in income, while the asset's value is credited to adjust it to its fair market value.

For example, consider a patent with a net book value of $65,000, estimated future cash flows of $53,500, and a fair value of $50,000. In this case, since the net book value ($65,000) is greater than the estimated future cash flows ($53,500), the asset is impaired. The impairment loss would be calculated as follows:

Impairment Loss = Net Book Value - Fair Value = $65,000 - $50,000 = $15,000.

This $15,000 loss would be recorded as a debit to the loss on impairment account and a credit to the patent account, reducing its value on the balance sheet to $50,000. It is crucial to note that once an asset has been written down due to impairment, it cannot be written back up, even if its fair value increases in subsequent periods. This policy reinforces the conservatism principle in accounting.

Problem

Sprinting Printers, Inc. purchased a patent on a high-tech laser printer for $750,000. The patent gives legal protection for twenty years, but Sprinting Printers believes that competitors will be able to mimic its capabilities in fifteen years. SP uses the straight-line method when amortizing the printer. After ten years, SP discovers that a competitor has created a more efficient holo-printer. At this point, SP determines that the estimated future cash flows of the printer are $200,000. The fair value of the patent is zero on the open market. The entry to record the discovery of the new holo-printer would include:

Credit to Patents for $175,000

Credit to Patents for $250,000

Credit to Patents for $375,000

Credit to Patents for $750,000

No entry is necessary related to these events

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What is asset impairment and why is it important?

Asset impairment occurs when the carrying amount of an asset exceeds its recoverable amount, meaning the asset is not expected to generate future economic benefits equal to its book value. This is important because it ensures that the financial statements accurately reflect the true value of the company's assets. By recognizing impairment losses, companies adhere to the conservatism principle, which prevents overstatement of asset values and ensures that potential losses are recorded promptly. This process helps maintain the integrity of the balance sheet and provides a more accurate picture of the company's financial health to investors and stakeholders.

How do you test for asset impairment?

Testing for asset impairment involves a two-step process. First, compare the asset's net book value (NBV) to its estimated future cash flows (EFCF). If the NBV is greater than the EFCF, the asset is considered impaired. Second, calculate the impairment loss by subtracting the asset's fair value (FV) from its NBV. The impairment loss is then recorded as a debit on the income statement. This ensures that the asset's book value reflects its true market value, adhering to the conservatism principle in accounting.

What is the difference between net book value and fair value in asset impairment?

Net book value (NBV) is the value of an asset as recorded on the balance sheet, calculated as the original cost minus accumulated depreciation. Fair value (FV), also known as market value, is the estimated price at which the asset could be sold in a current transaction between willing parties. In asset impairment, if the NBV exceeds the estimated future cash flows, the asset is impaired, and the impairment loss is calculated as the difference between the NBV and the FV. This ensures the asset's book value accurately reflects its market value.

Can an impaired asset be written back up if its value increases?

No, under Generally Accepted Accounting Principles (GAAP), once an asset has been written down due to impairment, it cannot be written back up, even if its fair value increases in the future. This adheres to the conservatism principle, which aims to prevent overstatement of asset values and ensures that potential losses are recognized promptly. If the asset's value decreases further, additional impairment losses can be recorded, but any subsequent increases in value are not recognized in the financial statements.

What journal entries are made for an asset impairment loss?

When an asset impairment loss is recognized, the following journal entries are made: Debit the 'Loss on Impairment' account to record the impairment loss, which reduces net income. Credit the specific asset account (e.g., 'Patent') to reduce its book value to its fair value. For example, if an asset with a net book value of $65,000 is impaired to a fair value of $50,000, the journal entry would be: Debit 'Loss on Impairment' $15,000 and Credit 'Patent' $15,000. This ensures the asset's book value accurately reflects its market value.

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