Procedures of Asset Impairment
Asset impairment means that the usability of a fixed asset has experienced a sudden decrease. The issues that may cause impairment include legal restrictions on that particular asset, obsolescence or asset damage. This is different from the depreciation of assets, which is the gradual decrease in the value of that asset (Also see Accounting – Impairment versus Depreciation of Fixed Assets). When the asset is proved to have experienced impairment, you should record the reduction of its carrying amount in your company’s accounting records. Listed below are the guidelines on how you can do so.
Choose the assets that you need to test
Firstly, the fixed asset accountant should sort the company’s fixed asset register (FAR), which is the list of fixed asset the company owns. They should complete this according to the carrying amount of the assets, which is the asset’s original book value less its depreciation and previous impairment charges if there is any.
Then, they need to use the Pareto principle when they choose the 20% of assets that their combined carrying amounts will contribute to 80% of the carrying amount of all fixed assets the company owns. This focus on the company’s highest-cost assets. The company probably may not need to carry out impairment testing on all other assets. However, the management should check this with the company’s auditors.
Identify the level of impairment
In this stage, the fixed asset accountant need to calculate the undiscounted cash flows they expect from the assets they have chosen before listing these amounts beside the selected assets in the fixed asset register. They should be aware of any asset which has a higher carrying amount when compared to its undiscounted cash flows and record them down.
Then, they should calculate the difference between the undiscounted cash flow and carrying amounts for the assets they have recorded. The next step is to create a journal entry to record the difference as an adjusting entry in the general ledger (Also see What are the Differences Between a Trial Balance and a General Ledger?). The fixed asset accountant should only do so when he does not expect the value for that particular asset to recover.
Update your accounting records
The company’s general ledger accountant is responsible for entering the journal entry into the general ledger. He also needs to make sure that the fixed asset register has shown the recorded impairment for every designated asset. Then, he should record the reasons for impairments.
Amend the calculations related to depreciation
The accountant should make adjustments on the calculations of depreciation for the designated fixed assets (Also see Accounting for Intangible Asset). By doing so, they can ensure that they will depreciate the assets based on the reduced, new asset balances according to their remaining useful lives.
Consequences of Asset Impairment
The impairment of asset will result in:
– Asset reduction: The impairment amount will reduce the balance of the fixed asset line item. This will cause a decrease in the amount of retained earnings and the amount of assets in your balance sheet.
– Loss recognition: In the profit and loss statement, the impairment will appear as a loss. If the amount of impairment is significant, the reporting entity may experience a substantial profit reduction.
In the long run, asset impairment will result in a reduction in the amount of depreciation the company needs to recognise. Thus there will be an increase in profits throughout the accounting period that has lower depreciation. If you find it challenging to understand the procedures you need to take for asset impairment, you should consider engaging a bookkeeping service in Singapore and leave the work to the experts.