Question

Describe what is meant by asset impairment and identify the sources of inherent risks related to asset

impairment.

Answer 1

ASSET IMPAIRMENT:

An impairment loss takes place when a company makes the judgment call that the carrying value of an asset on the company balance sheet is less than fair value, which is what an rational person would pay for the asset in an open marketplace. If the impairment loss isn’t recoverable, under U.S. generally accepted accounting practices (GAAP), the company has to adjust the books to reflect this lessening in value.

Do not mistake Asset impairment with lower of cost or market method for valuing inventory.

When the carrying value of an asset or group of assets, such as an operating segment, is more than its fair value, the company may have an impairment event on its hands.

SOURCES OF INHERENT RISK OF IMPAIRMENT:

• Market downturn: The market or market price of a long-lived asset experiences a significant downturn. For example, the company is holding a piece of raw land to develop whose fair value is currently less than cost.

• Change in use of asset: An event such as a natural disaster causes an adverse change in the manner in which a long-lived asset is used or changes its condition.

• Change in business or legal climate: A lawsuit or other adverse change in the general business or legal climate affects the value of the asset. Maybe a factory has been deemed unsafe and can’t be used for production until improvements are made.

• Premature disposal of asset: The company plans to dump an asset significantly before the end of its previously estimated useful life.

• Escalating costs: Costs to build or acquire an asset start to pile up and are significantly more than the company originally estimates.

• Souring investments: History of operating or cash flow losses demonstrates that the company will experience continuing losses from using the asset.