Fixed Asset Impairment
Fixed assets are assets that have a long-term use and typically have a useful life of more than one year. Fixed assets are assets that are not intended to be held for sale or to be converted into cash in the current financial year. Examples of fixed assets include land, buildings, plant and machinery, and furniture. When the cost of a fixed asset exceeds its recoverable amount, the asset is impaired. This means that the asset’s book value is reduced and the loss in value is recognized.
Impairments of fixed assets can occur for a variety of reasons. For example, extended downtime due to technical problems or an economic downturn may cause an impairment in the value of a fixed asset, as the asset’s value is no longer sufficient to cover its cost of acquisition or current replacement cost. In addition, advances in technology can cause the cost of a fixed asset to become obsolete, and the asset may no longer generate sufficient revenue to justify its continued use.
When an impairment occurs, the asset’s book value is precisely calculated and is typically equal to the recoverable amount of the asset. The recoverable amount is the higher of the asset’s net selling price and its value in use. The net selling price would be the asset’s estimated value after deducting any costs necessary to transport, store, and market the asset, as well as any costs of dismantling and removal from the location in which it is currently situated and to which it is attached. The value in use is the present value of the future net cash flows expected to be generated by the asset.
When an impairment of a fixed asset occurs, it is recorded in the financial statements as a loss and is recognized in the period in which the impairment event occurs. The loss is classified as either an expense on the income statement or a reduction of the carrying value of the fixed asset on the balance sheet.
The loss is calculated as the difference between the asset’s book value and its recoverable amount. The effect of the impairment on earnings is reported on the income statement. This impairment loss can be a significant charge on the income statement and can have a dramatic effect on net income and earnings per share.
In addition to the effect on earnings, impairment of a fixed asset also affects the company’s cash flow. When an impairment occurs, the loss is recognized in the period in which the impairment event occurs; however, the cash outlay for the loss does not occur until the asset is either sold or disposed of. The impairment loss should therefore be added to the costs of disposal of the asset.
Fixed asset impairment can have significant implications for a company’s financial statements and should not be taken lightly. Companies should always be aware of the factors which could lead to an impairment of a fixed asset so that proper steps can be taken to ensure that the asset’s value is properly maintained.
