What is meant by impairment of assets

hat is Impairment of Assets?
An asset is said to be impaired when the carrying amount of the asset is more than its recoverable amount. By standards at each reporting date, all assets are reviewed for impairments.

Carrying Amount and Recoverable Amount
The carrying amount is the book value at which an asset is recorded in the financial statements. For inventory, the carrying amount can be its purchase cost and carriage paid on it. Recoverable value is the amount that can be recovered by either using an asset or by selling an asset. So the recoverable amount is the higher of value in use, and fair value less cost to sell.

Indications of Impairment and Impairment Test
There can be multiple indications suggesting that the asset might be impaired. Whenever there is an indication that an asset might be impaired, the recoverable amount should be calculated and any impairment loss should be recognized in the income statement. Some common examples of events that may indicate that an asset might be impaired are physical damage occurred to the asset, decrease in the reselling value of old asset due to technological advancement, natural disaster causing damage to the asset, expiration of rights to use assets resulting in inability to use and recover the carrying amount, etc.

How to Record the Impairment of Assets?
The impairment loss on assets is treated as an expense and is charged in profit and loss account with the differential amount of carrying amount and recoverable amount. The following journal entry is passed:

Impairment loss A/c ----------------------------------(Debit)

Asset A/c-----------------------------------------------------(Credit)

Impairment of Fixed Assets
Fixed assets are owned by businesses with a view to generating future cash flows by generally using the asset. So normally the value in use is the recoverable amount of a fixed asset because it is generally higher than by selling the asset. If there is an indication that an asset might be impaired, the impairment test should be applied and the recoverable amount should be calculated considering the current circumstances.

Impairment of Intangible Assets
All intangible assets are subject to impairment test if there is an indication. However, goodwill is an intangible asset that is subject to annual impairment review regardless an indication of impairment exists or not at the reporting date.

Impairment of Assets Examples
The following are the examples of impairment of fixed assets and intangible assets.

Example of Fixed Asset Impairment

If a plant with carrying the amount of $5 million was damaged due to flood. Its production capacity has been reduced and its recoverable value has been assessed as $3.5 million, then the plant should be written down to its recoverable amount in the balance sheet and the impairment loss of $1.5 million should be recognized in the income statement.

Example of Intangible Asset Impairment

Suppose a software company is selling an OS named Windows A has a carrying amount of $13 million. A competitor software company has newly launched a technologically superior OS named Windows B. This has reduced the sales of Windows A and now the recoverable amount is only $5 million. In this case, the software’s carrying amount should be written down to $5 million in the balance sheet and the impairment loss of $8 million should be recognized in the income statement.