Impairment of Assets
What is impairment of assets?
Impairment of assets can be explained as a sudden or unexpected decline in an asset’s service utility, like factory, vehicle, or property. This might result from physical damage to the asset, changes to the legal code, or obsolescence resulting from technological innovation. It is, however, possible to write off impairment of assets.
According to IAS 36 "Impairment of assets", an impairment loss is the amount by which the carrying amount of an asset or a cash-generating unit exceeds its recoverable amount.
Scope of Asset Impairment
The concept of impairment of assets applies to all assets excluding:
- assets arising from construction contracts
- deferred tax assets
- financial assets
- assets arising from employee benefits
- agricultural assets carried at fair value
- investment property carried at fair value
- non-current assets held for sale
- insurance contract assets
Recognizing an asset eligible for impairment
On every balance sheet date, all assets are reviewed to look for any indication about an asset which is eligible for impairment. There are certain indications of impairment like:
1. External sources include
i. market value declines
ii. increase in market interest rates
iii. company stock price is less than the book value
iv. negative changes in technology, economy, laws, or markets
2. Internal sources include
i. Asset as a part of a restructuring or held for disposal
ii. Obsolescence or physical damage
iii. Worse economic performance than what is expected
Advantages and disadvantages of Impairment of Assets
The advantages of impairment of assets are explained in the following points:
- Impairment charges, if correctly applied, provide the analysts and investors with different ways to assess company management and its decision taking track record. Managers who write off or write down assets because of impairment have not made god investment choices.
- Many business failures are heralded by a fall in the impairment value of assets. Such disclosures act as early warning signals to creditors and investors.
The disadvantages of asset impairment are explained in the following points:
- It can be, sometimes, quite difficult to determine the measure of value which should be used while assessing an impairment. The most common options include current market value, current cost, NRV, or the sum of future net cash flows from the income-producing unit.
- The detailed guidance on accounting for impairment of assets is little, like when to recognize impairment, how to measure impairment, and how to disclose impairment.