Fixed asset impairment occurs when the carrying value of an asset exceeds its recoverable amount, leading to a necessary write-down.
Impairment testing helps businesses ensure accurate financial reporting and compliance with accounting standards such as IFRS and GAAP.
This guide provides a step-by-step approach to performing a fixed asset impairment test.
What is Fixed Asset Impairment?
Fixed asset impairment refers to the reduction in an asset’s value due to factors such as obsolescence, damage, or market decline.
Companies must periodically assess assets for impairment to maintain accurate financial statements and prevent overstating asset values.
When Should You Perform an Impairment Test?
An impairment test should be conducted when:
- There is a significant decline in an asset’s market value.
- The asset is physically damaged or obsolete.
- The asset is no longer generating expected cash flows.
- Regulatory changes negatively impact the asset’s usability.
- The business undergoes restructuring or discontinuation of operations.
Step-by-Step Guide to Performing an Impairment Test
1. Identify Assets for Impairment Testing
- Review financial statements and asset registers for indicators of impairment.
- Focus on assets that have experienced market downturns or operational inefficiencies.
2. Determine the Asset’s Carrying Value
- The carrying value is the amount at which the asset is recorded in the books after deducting accumulated depreciation and impairment losses.
- Extract asset values from the company’s balance sheet.
3. Calculate the Asset’s Recoverable Amount
The recoverable amount is the higher of:
- Fair Value Less Costs to Sell (FVLCTS): The price the asset could fetch in the market minus selling costs.
- Value in Use (VIU): The present value of future cash flows expected from the asset.
4. Compare Carrying Value to Recoverable Amount
- If the carrying value exceeds the recoverable amount, an impairment loss must be recognized.
- If the recoverable amount is higher, no impairment is needed.
5. Recognize and Record the Impairment Loss
- Calculate the impairment loss as the difference between carrying value and recoverable amount.
- Adjust financial statements accordingly:
- Debit the impairment loss to the income statement.
- Reduce the asset’s value in the balance sheet.
6. Disclose Impairment in Financial Reports
- Clearly document the impairment rationale, affected assets, and financial impact in the company’s notes to financial statements.
- Ensure compliance with IFRS and GAAP disclosure requirements.
7. Monitor and Review Regularly
- Conduct periodic impairment reviews to keep asset valuations up to date.
- Reassess impairment indicators whenever significant changes occur in market conditions or asset usage.
Business Benefits of Regular Impairment Testing
- Accurate Financial Reporting: Ensures compliance with accounting standards.
- Informed Decision-Making: Helps management plan asset utilization and investments effectively.
- Risk Mitigation: Prevents financial overstatement and potential regulatory penalties.
Conclusion
Conducting regular fixed asset impairment tests is crucial for maintaining financial accuracy and transparency.
By following this step-by-step approach, businesses can ensure that their asset values reflect economic realities and comply with financial reporting standards.
Implementing these practices will enhance financial integrity and support better asset management decisions.
