Impairment

What is Impairment?

In Accounting, impairment can be described as the permanent decrease in the company assets’ value, generally an intangible asset or a Fixed Asset. When testing a specific asset to discover impairment, the total profit, cash flow or additional advantages anticipated to be generated by that asset get compared with its current Book Value.

If the book value is more than the benefits of the asset or its future cash flow, the difference is written off, and the asset’s value decreases on the Balance Sheet.

Explaining Impairment

Commonly, impairment is used to define a substantial decrease in the recoverable amount of the fixed asset. Impairment may take place when there is an alteration in the economic or legal situations surrounding a company; or a casualty loss from an unanticipated situation.

For instance, a Manufacturing company may face an impairment of its outdoor equipment and machinery in a natural disaster. It may appear as a sudden and significant decrease in the asset’s Fair Value, even below its carrying value.

An Accountant may evaluate assets for possible impairment on a periodic Basis. In case there is an impairment, the accountant will write off the difference between the carrying and the fair value.

Example of Impairment

Let’s understand this concept more with an impairment example. Suppose there is a company called XYZ, which has bought machinery several years ago at the cost of Rs. 250,000. It has taken Rs. 100,000 in the machinery’s Depreciation; thus, has Rs. 100,000 as of the accumulated depreciation.

The carrying value, on the balance sheet of the company, is Rs. 150,000. A major blast damaged the machinery to a great extent, and the company comprehends the situation is qualified for impairment testing.

After evaluating the damage, the company comprehends that the machinery is only worth Rs. 100,000. The machinery is impaired, and the asset value should be written-down to avert overstatement.

The accountant will make a debit entry in the Loss from Impairment section, which will go on the Income statement as a decrease of net income, as the total amount of Rs. 50,000. As a part of the entry, an Rs. 50,000 will be credited to the asset account of the machinery, to decrease the balance of the asset.