Impairment (financial reporting)

An Impairment cost must be included under expenses when the book value of an asset exceeds the recoverable amount. Impairment of assets is the diminishing in quality, strength amount, or value of an asset. Fixed assets, commonly known as PPE, refers to long-lived assets such as buildings, land, machinery, and equipment; these assets are the most likely to experience impairment, which may be caused by several factors.^[1]

History

Asset impairment was first addressed by the International Accounting Standards Board in IAS 16, which became effective in 1983.^[2] It was replaced by IAS 36, effective July 1999.^[2]

In United States GAAP, the Financial Accounting Standards Board introduced the concept in 1995 with the release of SFAS 121.^[3] SFAS 121 was subsequently replaced by SFAS 144 in August 2001.^[3]

The issue of impairment of financial instruments exposed deficiencies in the IAS 36 framework during the 2008 financial crisis, and the IASB issued an exposure draft in November 2009 that proposed an impairment model based on expected losses rather than incurred losses for all financial assets recorded at amortised cost.^[4] The IASB and FASB undertook joint efforts to devise a common impairment model, but the FASB eventually decided to propose an alternative scheme in January 2011.^[5] The IASB issued a new exposure draft in January 2013,^[5] which later led to the adoption of IFRS 9 in July 2014,^[6] effective for annual periods beginning on or after January 1, 2018.^[7] The FASB is still considering the matter.^[8]

Scope

Impairment is discussed in several international accounting standards:^[9]

The FASB Accounting Standards Codification addresses impairment in the following sections:^[10]

IAS 36 framework

Impairment is currently governed by IAS 36. The impairment cost is calculated using two methods:

• The Incurred Loss Model;
• Expected Loss Model

Incurred Loss Model

Under the incurred loss model, investments are recognized as impaired when there is no longer reasonable assurance that the future cash flows associated with them will be either collected in their entirety or when due. Entities look for evidence of situations that would indicate impairment, such triggering events include when the entity:^[11]

• is experiencing notable financial difficulties,
• has defaulted on or is late making interest payments or principal payments,
• is likely to undergo a major financial reorganization or enter bankruptcy, or
• is in a market that is experiencing significant negative economic change.

If such evidence exists, the next step is to estimate the investments recoverable amount. The Impairment cost would then be calculated by using the formula:

The carrying value is defined as the value of the asset as displayed on the balance sheet. The recoverable amount is the higher of either the asset's future value^[12] for the company or the amount it can be sold for, minus any transaction costs.^[13][14]

Expected Loss Model

Under an expected loss impairment model, estimates of future cash flows used to determine the present value of the investment are made on a continuous basis and do not rely on a triggering event to occur. Even though there may be no objective evidence that an impairment loss has been incurred, revised cash flow projections may indicate changes in credit risk. Under the expected loss model, these revised expected cash flows are discounted at the same effective interest rate used when the instrument was first acquired, therefore retaining a cost-based measurement. Calculating the Impairment cost is the same as the Incurred Loss Model.

For example, assume a company has an investment in Company A bonds with a carrying amount of $37,500. If the market value of the bonds falls to $33,000, an impairment loss of $4,500 is indicated. Therefore an Impairment cost is calculated:

This is recorded as a loss of $4,500 in the income statement. Using the 'T' account system, there will be a debit in the Loss on Impairment account and a credit in the Investment account. This will mean the double-entry bookkeeping principle is satisfied.

Debit: Loss on Impairment $4,500

Credit: Investment $4,500^[15]

Effect on depreciation

To calculate depreciation on the asset, the new non-current asset value is considered. Continuing with the previous example, if using the Straight line Depreciation method at say, 20%, then depreciation would be:

Therefore there is a smaller depreciation charge than if the original non-current asset value had been used.

Consequential asset value increases

Reversals of impairment losses are required for investments in debt instruments, but no reversals are permitted under IFRS for any impairment changes recognized in net income for equity instruments accounted for in OCI; however, subsequent changes in the equity investment's fair value are recognized in OCI.

See also

• Lower of Cost or Market
• Impaired Asset

References

Further reading

• Hamilton, Kallie; Hyland, Brett; Dodd, James L. (2011). "Impairment: IASB-FASB Comparison" (PDF). Drake Management Review. 1 (1): 55–67. 
• "IFRS in practice: IAS 36 Impairment of assets" (PDF). BDO International. December 2013. 
• "Impairment of financial instruments under IFRS 9" (PDF). Ernst & Young. December 2014.