In: Accounting
Answer : Impairment: In accounting, impairment describes a permanent reduction in the value of a company's asset, typically a fixed asset or an intangible asset. When testing an asset for impairment, the total profit, cash flow, or other benefit expected to be generated by that specific asset is periodically compared with its current book value. If it is determined that the book value of the asset exceeds the future cash flow or benefit of the asset, the difference between the two is written off and the value of the asset declines on the company's balance sheet
Business assets should be tested for impairment when a situation occurs that causes the asset to lose value. An impairment loss is recognized and accrued to record the asset’s revaluation. Once an asset has been revalued, fluctuations in market value are calculated periodically. Certain intangible assets, such as goodwill, are tested for impairment on an annual basis. Impairment losses can occur for a variety of reasons:
A loss on impairment is recognized as a debit to Loss on Impairment (the difference between the new fair market value and current book value of the asset) and a credit to the asset.The loss will reduce income in the income statement and reduce total assets on the balance sheet.
Answer 3. Yes. Klax should perform impairment test given the scenario.
Under generally accepted accounting principles (GAAP), assets are considered tobe impaired when the fair value falls below the book value. Any write-off due to an impairment loss can have adverse affects on a company's balance sheet and its resulting financial ratios. It is, therefore, very important for a company to test its assets for impairment periodically. Certain assets, such as the intangible goodwill, must be tested for impairment on an annual basis in order to ensure the value of assets are not inflated on the balance sheet.
GAAP also recommends that companies take into consideration events and economic circumstances that occur between annual impairment tests in order to determine if it is "more likely than not" that the fair value of an asset has dropped below its carrying value. Specific situations where an asset might become impaired and unrecoverable include when there is a significant change to an asset's intended use, decrease in consumer demand, damage to the asset, or adverse changes to legal factors that affect the asset. If these types of situations arise mid-year, it's important to test for impairment immediately.\
Answer 4. Recoverable Amount
In simple terms, the recoverable amount is the highest value that can be obtained from an asset. We can think of two general ways we can obtain value from an asset: (a) from using that asset in the business or (b) by selling it to someone else. The value of (a) is the present value of expected future cash flows from using the asset. The value of (b) is the fair value of the asset less costs to sell the asset. The higher amount from these two alternatives is the recoverable amount.
The recoverable amount is used in the test for impairment. The reason that the recoverable amount is the higher figure from the two alternative estimates is that we presume that the company’s management will choose the best (value-maximizing) option.
Fair value is an asset's purchase or sale price in a current transaction between willing parties. The best evidence of fair value is prices quoted in active markets, such as the price for a stock listed on a stock market.
Alternative Methods of Estimating Fair Value
Market approach. Uses the prices associated with actual market transactions for similar or identical assets and liabilities to derive a fair value. For example, the prices of securities held can be obtained from a national exchange on which these securities are routinely bought and sold.
Income approach. Uses estimated future cash flows or earnings, adjusted by a discount rate that represents the time value of money and the risk of cash flows not being achieved, to derive a discounted present value. An alternative way to incorporate risk into this approach is to develop a probability-weighted-average set of possible future cash flows.
Cost approach. Uses the estimated cost to replace an asset, adjusted for the obsolescence of the existing asset.