Definition
An impairment review is a procedure mandated by accounting standards where entities evaluate the recoverability of the carrying amount of their fixed assets and goodwill. This review is triggered by specific events or changes in circumstances that could indicate a potential impairment. If the carrying amount exceeds the recoverable amount, an impairment loss is recognized.
Examples
- ** Machinery Breakdown**: If a company’s machinery experiences severe malfunction and loses value, an impairment review is conducted to determine if the carrying amount exceeds the machinery’s recoverable amount.
- Goodwill in Acquisitions: After acquiring a company, changes in market conditions may lead to a reassessment of the goodwill’s value. An impairment review ensures the goodwill on the balance sheet reflects its true value.
- Economic Downturn: A retailer experiencing a decline in sales due to an economic downturn may need to perform an impairment review on store assets.
Frequently Asked Questions
What triggers an impairment review?
Events like significant declines in market value, changes in market conditions affecting the asset’s use, and internal changes affecting the business’ cash flows can trigger an impairment review.
How is the carrying amount determined?
The carrying amount is typically the book value of the asset, which includes the cost of acquisition minus accumulated depreciation and any previous impairment losses.
What is a recoverable amount?
The recoverable amount is the higher of an asset’s fair value less costs to sell and its value in use, which is the present value of future cash flows expected from the asset.
What are the consequences of an impairment loss?
When an impairment loss is recognized, it reduces the carrying amount of the asset on the balance sheet and affects the entity’s income statement by reducing net earnings.
How often should impairment reviews be conducted?
Impairment reviews should be conducted annually for assets with indefinite useful lives, such as goodwill, or whenever there is an indication that an asset might be impaired.
Related Terms
- Carrying Amount: The value of an asset as reported on the balance sheet, calculated as acquisition cost minus accumulated depreciation and impairment losses.
- Fixed Asset: Long-term tangible property used in the operation of a business, not expected to be consumed or converted into cash within a year.
- Goodwill: An intangible asset arising from the acquisition of one company by another, representing the excess purchase price over the fair value of identifiable net assets.
- IFRS: International Financial Reporting Standards, a set of accounting standards developed by the International Accounting Standards Board (IASB) that provide guidelines for financial reporting.
Online References
- IASB - Conceptual Framework for Financial Reporting
- FASB - Accounting Standards Codification
- International Accounting Standard (IAS) 36 - Impairment of Assets
Suggested Books for Further Studies
- International Financial Reporting Standards (IFRS) 2018 by the International Accounting Standards Board (IASB)
- Intermediate Accounting by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
- Accounting for Impairment by Jeffrey R. Garaventa
Accounting Basics: “Impairment Review” Fundamentals Quiz
### What is the primary purpose of an impairment review?
- [ ] To assess company's profitability
- [ ] To verify inventory levels
- [x] To determine if the carrying amount of an asset is recoverable
- [ ] To forecast future sales
> **Explanation:** An impairment review is conducted to determine if the carrying amount of an asset is recoverable, and if not, to recognize an impairment loss.
### What happens if an asset's carrying amount exceeds its recoverable amount?
- [x] An impairment loss is recognized
- [ ] The asset is disposed of immediately
- [ ] The asset's value is increased
- [ ] The depreciation schedule is revised
> **Explanation:** An impairment loss is recognized when the carrying amount of an asset exceeds its recoverable amount. This loss is reported on the income statement.
### How is the recoverable amount of an asset determined?
- [ ] By its original purchase price
- [ ] Via market value alone
- [x] As the higher of fair value less costs to sell or value in use
- [ ] Only through future sales projections
> **Explanation:** The recoverable amount is the higher of an asset's fair value less costs to sell and its value in use, which includes future cash flows expected from the asset.
### What events could trigger an impairment review?
- [x] Significant declines in market value
- [ ] Increased production costs
- [ ] Downtime of machinery for routine maintenance
- [ ] Stable economic conditions
> **Explanation:** Significant declines in market value and other major adverse events can trigger an impairment review. Routine events like maintenance are generally not applicable.
### When must entities perform an impairment review by mandate?
- [ ] Quarterly
- [x] Annually for indefinite-lived assets or when indicators of impairment exist
- [ ] Only when there are changes in management
- [ ] Monthly
> **Explanation:** Impairment reviews are mandated annually for assets with indefinite useful lives (like goodwill) and whenever there is an indication that an asset might be impaired.
### In impairment review, what must be assessed for a fixed asset?
- [ ] Its original depreciation rate
- [ ] Its book value against historical cost
- [x] Its carrying amount versus its recoverable amount
- [ ] Its salvage value
> **Explanation:** The core assessment involves comparing the carrying amount of the asset to its recoverable amount to determine impairment.
### Why is the carrying amount significant in impairment reviews?
- [ ] It reflects the asset’s original purchase price
- [ ] It shows the potential resale value
- [x] It combines historical cost with depreciation and prior impairments
- [ ] It predicts future cash flows directly
> **Explanation:** The carrying amount is significant as it incorporates the initial cost of an asset minus all accumulated depreciation and prior impairment losses, serving as a basis for assessing impairment.
### How does an impairment review affect financial statements?
- [ ] It influences tax liability only
- [ ] It causes asset disposal immediately
- [ ] It decreases expense accounts
- [x] It reduces total assets and reported earnings
> **Explanation:** An impairment review can lead to a reduction in the carrying amount of assets, impacting the balance sheet and reducing net earnings on the income statement.
### What accounting standards provide guidelines for impairment reviews?
- [ ] Solely U.S. GAAP
- [ ] Federal tax guidelines
- [x] IFRS and U.S. GAAP
- [ ] Economic principles primarily
> **Explanation:** Both IFRS and U.S. GAAP provide comprehensive guidelines for conducting impairment reviews to ensure income statements and balance sheets accurately reflect asset values.
### Which type of asset typically undergoes an annual impairment review?
- [ ] Short-term investments
- [ ] Inventories
- [x] Goodwill and other indefinite-life intangible assets
- [ ] Long-term liabilities
> **Explanation:** Goodwill and other intangible assets with indefinite useful lives must undergo annual impairment reviews or more frequently if indicators suggest impairment.
Thank you for joining us in exploring the fundamentals of impairment reviews. This content ensures a solid understanding of how entities maintain accurate financial statements by assessing the recoverability of their asset values.umeric-action:_expandAll
