Impairment of Assets: Meaning, Example And Accounting Treatment

Key Takeaways 

• Impairment of assets occurs when the carrying amount of an asset is higher than its recoverable amount. This means the asset is overstated in financial statements and needs correction.
   
• Impairment loss is calculated as the difference between carrying value and recoverable value. It is recorded through the impairment loss journal entry to reflect the actual asset value.
   
• Businesses must identify signs like market decline, damage, or poor performance early to calculate impairment loss on time and maintain accurate financial reporting.

Asset values do not always remain the same over time. Let’s learn step by step how it changes. 

Impairment of assets is a situation where the carrying amount of an asset in the books exceeds its recoverable amount. It means the asset is recorded at a value higher than what it can actually recover through use or sale.

This concept is governed by impairment of assets IAS 36, which ensures assets are not overstated in financial statements.

I purchased machinery for ₹8,00,000, but due to new technology, its recoverable value dropped to ₹5,50,000. I recorded an impairment loss of ₹2,50,000 to reflect its actual worth in my financial statements.

Bonus Tip: IASB proposed improved goodwill impairment disclosures to increase transparency in financial reporting, which helps investors better assess company performance.

How to calculate impairment loss?

The calculation of impairment loss is essential for accurate financial reporting. This process makes sure that assets are not recorded at values higher than their actual recoverable amount.

Step 1: Identify the Carrying Amount
The carrying amount refers to the book value of the asset recorded in the balance sheet after depreciation. 

Step 2: Determine the Recoverable Amount
The recoverable amount is the higher of fair value (minus selling costs) and value in use. 

Step 3: Compare Carrying Amount and Recoverable Amount
The next step is to compare both values. Impairment occurs when the value recorded in the books is higher than the amount the asset can actually recover.

Step 4: Calculate the Impairment Loss
The difference between the two values is the impairment loss. At this stage, businesses calculate impairment loss to quantify the reduction in asset value.

Step 5: Record the Journal Entry
Once the loss is calculated, it is recorded through the impairment of assets journal entry, where impairment loss is debited, and the asset account is credited.

Businesses follow these steps to calculate impairment loss accurately and ensure that financial statements reflect the true value of assets.

Why Should Impaired Assets be Reported in Financial Statements?

The reporting of impaired assets is essential to maintain transparency and accuracy in financial records.

The reporting of impaired assets is necessary to ensure financial accuracy, maintain compliance, and support better decision-making.

Causes of Impairment of Assets 

These causes can arise from both internal and external factors that reduce the recoverable value of assets:

These causes early help maintain accurate reporting and ensure that financial statements reflect the true value of assets 

Real-Life Examples of Impaired Assets

These examples show how different assets lose value in actual business situations and why companies need to calculate impairment loss.
 

Businesses record the loss using the impairment of assets journal entry after they calculate impairment loss, ensuring accurate financial reporting.

Conclusion

Impairment of assets ensures that financial statements show the true value of assets. Businesses can stay transparent and reliable by identifying signs early, calculating losses correctly, and recording them properly. 

FAQs Related to Impairment of Assets 

1. What is the journal entry for impairment loss of fixed assets?

The journal entry for impairment loss involves debiting the impairment loss account and crediting the asset account. This reduces the value of the asset in the books and records the loss in the profit and loss statement.

2. Can you give a simple example of impairment of assets?

A simple example is when a machine becomes outdated due to new technology. If its book value is higher than the amount it can recover, the difference is treated as impairment loss.

3. What do you mean by impairment of assets?

Impairment of capital assets means that long-term assets, such as buildings or machinery, lose their value and are no longer able to generate the expected benefits or returns.

4. How do you calculate impairment loss easily?

Impairment loss is calculated by subtracting the recoverable amount of an asset from its carrying amount. If the carrying amount exceeds the cost, the difference is recorded as a loss.

5. When should a company check for impairment of assets?

A company should check for impairment whenever there are signs such as a fall in market value, physical damage, or poor financial performance of the asset.