Loss on impairment

Definition

Loss on impairment occurs when the carrying amount of an asset exceeds its recoverable amount, leading to a write-down in the asset's value. This situation is particularly relevant when dealing with intangible assets like goodwill, as it signifies a reduction in the expected future economic benefits from those assets. Recognizing a loss on impairment is crucial for accurate financial reporting and ensures that financial statements reflect the true value of a company's assets.

5 Must Know Facts For Your Next Test

1. Loss on impairment must be assessed at least annually for goodwill and other indefinite-lived intangible assets, ensuring timely recognition of any declines in value.
2. The impairment test compares the carrying amount of an asset to its recoverable amount, and if the carrying amount is higher, a loss on impairment is recorded.
3. Once an impairment loss is recognized, it cannot be reversed for goodwill, meaning the reduced value remains until the asset is disposed of or further tested for impairment.
4. Reporting a loss on impairment can significantly affect a company's financial ratios, including return on assets and equity, by reducing net income and asset values.
5. Impairment losses are reported as operating expenses in the income statement, which can influence investor perception and market valuation.

Review Questions

• How does the recognition of a loss on impairment affect a company's financial statements?
  • Recognizing a loss on impairment reduces the carrying amount of the affected asset and results in a decrease in net income, as the loss is recorded as an operating expense. This can lead to lower earnings per share and impact financial ratios such as return on assets and equity. Additionally, it provides more accurate information to stakeholders about the company’s financial position by reflecting the true value of its assets.
• Discuss the criteria used to determine whether goodwill has suffered a loss on impairment.
  • To determine if goodwill has suffered a loss on impairment, companies must perform an annual impairment test that compares the carrying amount of a reporting unit to its fair value. If the carrying amount exceeds the fair value, an impairment loss is recognized. This process involves estimating future cash flows, considering market conditions, and determining appropriate discount rates to calculate fair value. Accurate assessment ensures that any decline in goodwill’s value is promptly reflected in financial statements.
• Evaluate the long-term implications for a company that frequently reports losses on impairment related to goodwill.
  • Frequent reporting of losses on impairment for goodwill can signal underlying issues within a company, such as poor acquisitions or declining market conditions, potentially eroding investor confidence. It may lead to increased scrutiny from analysts and investors regarding management's strategic decisions and ability to generate future cash flows. Over time, this trend could result in a decreased stock price, challenges in raising capital, and difficulties in achieving growth objectives as stakeholders reassess their expectations based on repeated impairments.

Related terms

Goodwill: An intangible asset that represents the excess value of a company over the fair value of its identifiable net assets at the time of acquisition.

Recoverable Amount:

The higher of an asset's fair value less costs to sell and its value in use, used to determine if an asset is impaired.

Asset Write-Down: The process of reducing the book value of an asset on the balance sheet when its market value falls below its carrying amount.