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Impairment (financial reporting)

January 01, 1970

Impairment of assets is the diminishing in quality, strength, amount, or value of an asset. An impairment cost must be included under expenses when the book value of an asset exceeds the recoverable amount. Fixed assets, commonly known as PPE (Property, Plant & Equipment), 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 edit

Asset impairment was first addressed by the International Accounting Standards Board (IASB) 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 (FASB) 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 assets 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 made 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 edit

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

Standard Title
IAS 2 Inventories
IAS 4 Insurance Contract assets
IAS 5 Non-current assets held for sale
IAS 11 Assets arising from construction contracts
IAS 12 Deferred tax assets
IAS 19 Assets arising from employee benefits
IAS 36 Impairment of assets
IAS 39 Financial assets
IAS 40 Investment property carried at fair value
IAS 41 Agricultural assets carried at fair value

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

Section Title
310 Receivables
320 Investments
323
325
330 Inventories
340 Other Assets & Deferred Costs
350 Goodwill & Intangibles
360 Plant, Property & Equipment

IAS 36 framework edit

Impairment is currently governed by IAS 36. The impairment cost is calculated using either the Incurred Loss Model or the Expected Loss Model.

Incurred Loss Model edit

An investment is recognized as impaired when there is no longer reasonable assurance that the future cash flows associated with it will be collected either 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 recoverable amount of investments. The impairment cost would then be calculated as follows:

 

The carrying value is defined as the value of the asset appearing 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 edit

Estimates of future cash flows used to determine the present value of an 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. 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 under the Incurred Loss Model.

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

 

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 edit

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

 

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

Consequential asset value increases edit

Reversal of impairment losses is required for investments in debt instruments, but no reversal is 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 edit

References edit

  1. ^ McKaig, Thomas. . qfinance.com. Bloomsbury Information Ltd. Archived from the original on October 28, 2011. Retrieved November 6, 2011.
  2. ^ a b Hamilton, Hyland & Dodd 2011, p. 57.
  3. ^ a b Hamilton, Hyland & Dodd 2011, p. 59.
  4. ^ EY 2014, p. 4.
  5. ^ a b EY 2014, p. 5.
  6. ^ EY 2014, p. 6.
  7. ^ EY 2014, p. 88.
  8. ^ "Project Update: Accounting for Financial Instruments—Credit Impairment". fasb.org. Financial Accounting Standards Board. May 20, 2015. Retrieved November 27, 2015.
  9. ^ Hamilton, Hyland & Dodd 2011, p. 56.
  10. ^ Hamilton, Hyland & Dodd 2011, p. 60.
  11. ^ Kieso, Donald; Weygandt, Jerry; Warfield, Terry; Young, Nicola; Wiecek, Irene (2010). Intermediate accounting (9th ed.). Toronto: John Wiley & Sons Canada, Ltd. p. 554. ISBN 978-0-470-16101-2.
  12. ^ "Recipe 5.16 Calculating Asset Appreciation (Future Value)". eTutorials.org. Retrieved April 3, 2013.
  13. ^ "IAS 36 — Impairment of Assets". IAS Plus. Deloitte. Retrieved April 3, 2013.
  14. ^ Nikolai, Loren A.; Bazley, John D; Jones, Jefferson P. (2010). Intermediate accounting (11th ed.). Australia: South-Western/Cengage Learning. p. 532. ISBN 978-0-324-65913-9.
  15. ^ "Impairment of Fixed Assets". accountingexplained.com.

Further reading edit

  • 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.

January 01, 1970
impairment, financial, reporting, impairment, assets, diminishing, quality, strength, amount, value, asset, impairment, cost, must, included, under, expenses, when, book, value, asset, exceeds, recoverable, amount, fixed, assets, commonly, known, property, pla. Impairment of assets is the diminishing in quality strength amount or value of an asset An impairment cost must be included under expenses when the book value of an asset exceeds the recoverable amount Fixed assets commonly known as PPE Property Plant amp Equipment 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 Contents 1 History 2 Scope 3 IAS 36 framework 3 1 Incurred Loss Model 3 2 Expected Loss Model 3 3 Effect on depreciation 3 4 Consequential asset value increases 4 See also 5 References 6 Further readingHistory editAsset impairment was first addressed by the International Accounting Standards Board IASB 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 FASB 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 assets 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 made 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 editImpairment is discussed in several international accounting standards 9 Standard Title IAS 2 Inventories IAS 4 Insurance Contract assets IAS 5 Non current assets held for sale IAS 11 Assets arising from construction contracts IAS 12 Deferred tax assets IAS 19 Assets arising from employee benefits IAS 36 Impairment of assets IAS 39 Financial assets IAS 40 Investment property carried at fair value IAS 41 Agricultural assets carried at fair value The FASB Accounting Standards Codification addresses impairment in the following sections 10 Section Title 310 Receivables 320 Investments 323 325 330 Inventories 340 Other Assets amp Deferred Costs 350 Goodwill amp Intangibles 360 Plant Property amp EquipmentIAS 36 framework editImpairment is currently governed by IAS 36 The impairment cost is calculated using either the Incurred Loss Model or the Expected Loss Model Incurred Loss Model edit An investment is recognized as impaired when there is no longer reasonable assurance that the future cash flows associated with it will be collected either 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 recoverable amount of investments The impairment cost would then be calculated as follows Impairment Cost Recoverable Amount Carrying Value displaystyle mbox Impairment Cost mbox Recoverable Amount mbox Carrying Value nbsp dd dd The carrying value is defined as the value of the asset appearing 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 edit Estimates of future cash flows used to determine the present value of an 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 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 under the Incurred Loss Model For example assume a company has an investment in Company A bonds with a carrying amount of 37 500 If their market value falls to 33 000 an impairment loss of 4 500 is indicated and the impairment cost calculated as follows 37500 33000 4500 displaystyle 37500 33000 4500 nbsp dd dd 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 dd Effect on depreciation edit To calculate depreciation on the asset the new non current asset value is considered Continuing with the previous example and using the Straight line Depreciation method at say 20 depreciation would be 33000 0 2 6600 displaystyle 33000 cdot 0 2 6600 nbsp dd dd The depreciation charge is smaller than if the original non current asset value had been used Consequential asset value increases edit Reversal of impairment losses is required for investments in debt instruments but no reversal is 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 editLower of cost or market Impaired assetReferences edit McKaig Thomas Understanding Impairment Accounting What It Is and When It Is Used qfinance com Bloomsbury Information Ltd Archived from the original on October 28 2011 Retrieved November 6 2011 a b Hamilton Hyland amp Dodd 2011 p 57 a b Hamilton Hyland amp Dodd 2011 p 59 EY 2014 p 4 a b EY 2014 p 5 EY 2014 p 6 EY 2014 p 88 Project Update Accounting for Financial Instruments Credit Impairment fasb org Financial Accounting Standards Board May 20 2015 Retrieved November 27 2015 Hamilton Hyland amp Dodd 2011 p 56 Hamilton Hyland amp Dodd 2011 p 60 Kieso Donald Weygandt Jerry Warfield Terry Young Nicola Wiecek Irene 2010 Intermediate accounting 9th ed Toronto John Wiley amp Sons Canada Ltd p 554 ISBN 978 0 470 16101 2 Recipe 5 16 Calculating Asset Appreciation Future Value eTutorials org Retrieved April 3 2013 IAS 36 Impairment of Assets IAS Plus Deloitte Retrieved April 3 2013 Nikolai Loren A Bazley John D Jones Jefferson P 2010 Intermediate accounting 11th ed Australia South Western Cengage Learning p 532 ISBN 978 0 324 65913 9 Impairment of Fixed Assets accountingexplained com Further reading editHamilton 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 amp Young December 2014 Retrieved from https en wikipedia org w index php title Impairment financial reporting amp oldid 1158511096, wikipedia, wiki, book, books, library,

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