What is an Impairment Test?
An
impairment test is a process used to determine whether the carrying value of a company's asset is greater than its recoverable amount. If the carrying value exceeds the recoverable amount, the asset is considered impaired, and a write-down is necessary. This process ensures that the
financial statements accurately reflect the current value of the company's assets.
A significant decline in the market value of the asset.
Adverse changes in the technological, market, economic, or legal environment.
Physical damage to the asset.
Worse-than-expected performance of the asset or
cash-generating unit (CGU).
Identify the asset or CGU that might be impaired.
Determine the
recoverable amount, which is the higher of the asset's fair value less costs of disposal and its
value in use.
Compare the carrying amount of the asset or CGU to its recoverable amount.
If the carrying amount exceeds the recoverable amount, recognize an impairment loss.
Fair value is the price that would be received to sell an asset in an orderly transaction between market participants.
Value in use is the present value of the future cash flows expected to be derived from the asset or CGU.
What Happens After an Impairment Loss is Recognized?
Once an impairment loss is recognized, it must be reported in the financial statements. The carrying amount of the impaired asset is reduced to its recoverable amount, and the loss is recognized immediately in the
income statement. Additionally, the company must disclose the impairment loss in its notes to the financial statements, including the reasons for the impairment and how the recoverable amount was determined.
Can an Impairment Loss be Reversed?
Under certain circumstances, an impairment loss can be reversed in subsequent periods if there is an indication that the impairment may no longer exist or has decreased. However, the reversal is limited to the amount that brings the asset's carrying amount to what it would have been had the impairment not been recognized. Reversals are recognized in the income statement and disclosed in the financial statements.
Conclusion
Impairment testing is a critical process for ensuring that a company's assets are accurately valued in its financial statements. It provides a clear and realistic picture of the company's financial health, ensuring transparency and compliance with accounting standards. Regular impairment tests help prevent the overstatement of asset values and enable companies to make informed business decisions.