Introduction

Calculating impairment loss is a vital process for businesses to maintain accurate financial records and determine the true value of their assets. The purpose of an impairment loss is to recognize the decrease in an asset’s value when its carrying amount exceeds its recoverable amount. In such cases, the business needs to write down the asset in its financial records to reflect the decline in value accurately. This article provides a step-by-step guide on how to calculate impairment loss.

Step 1: Identify the Assets for Impairment Testing

The first step in calculating impairment loss is identifying which assets are subject to impairment testing. Assets that may be subject to impairment include both tangible and intangible assets, such as property, plant, or equipment, goodwill, and patents.

Step 2: Determine the Carrying Amount of Each Asset

The carrying amount of an asset is the book value recorded in the financial statements, which includes the original cost of an asset minus any accumulated depreciation or amortization. Consult your company’s balance sheet to find this information.

Step 3: Find the Recoverable Amount of Each Asset

The next step is to determine an asset’s recoverable amount—the higher value between its fair value (less costs to sell) and its value in use.

– Fair Value Less Costs to Sell: To determine this value, estimate the market price for your asset and subtract any estimated costs needed to sell it, such as brokerage fees or legal expenses.

– Value in Use: This refers to an asset’s estimated future cash flows discounted at a rate that reflects current market assessments of time and risks involved. In simpler terms, it is the net present value (NPV) of future cash flows from using that asset.

Choose the higher among these two values as the recoverable amount.

Step 4: Compare Carrying Amount and Recoverable Amount

Compare each asset’s carrying amount to its recoverable amount. If the carrying amount is higher than the recoverable amount, it indicates that the asset is impaired and a loss must be recognized.

Step 5: Calculate and Recognize Impairment Loss

To calculate the impairment loss, subtract the recoverable amount from the carrying amount of the asset. This difference represents the impairment loss that should be recognized on the business’s income statement.

Step 6: Adjust the Carrying Amount of Impaired Assets

After recognizing an impairment loss, adjust the carrying amount of impaired assets accordingly. To do this, subtract the impairment loss from the original carrying amount. The new figure will be your asset’s adjusted carrying amount, which should also appear on your balance sheet.

Conclusion

Calculating impairment loss helps businesses accurately reflect their assets’ worth in financial records. By following these six steps, you can correctly identify assets eligible for impairment testing, determine their carrying and recoverable amounts, calculate any associated losses, and make relevant adjustments in your financial statements. Periodically evaluating your assets for impairment ensures a more accurate depiction of your company’s financial health and allows for better decision-making processes.