Indicators of impairments of assets
Recognition of losses from impairment of long- lived assets is an effort of declaration of fair value of such assets on a reporting date. An asset is said to be impaired when the carrying amount of the assets at a reporting date exceeds its fair value. The accounting bodies word over as well as the IASB have introduced standards prescribing principles and procedures for measuring the impairment of assets. Statement no.144 issued by FASB represents US GAAP on the issue of impairment of assets. The objective of FASB statement no.144, Accounting for Impairment or Disposal of Long- Lived Assets, is to state impaired assets at no more than their fair values, i.e., recoverable undiscounted future cash flows. A carrying amount is not recoverable if it is greater than the sum of the cash flows expected from the asset’s use and eventual disposal. FASB defines impairment loss as the amount by which the carrying value exceeds an asset’s fair value that is undiscounted. The standard seeks recognition of the impairment loss of long- lived assets.
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FASB statement no. 144 states that “a long- lived asset (asset group) shall be tested for recoverability whenever events or changes indicate that its carrying amount may not be recoverable” (Para 8 of Statement of Financial Accounting Standards No.144, page 9). Entities should assess the impairment in the long- lived assets on the reporting date. For making such an assessment, entities are required to establish appropriate systems to find out whether long- lived assets have indications of impairment at a particular reporting date. When there are no indications of impairment, entities need not assess the impairment loss. When indications are there entities should assess the value of concerned assets using future cash flows in an effort to find out net fair value of such assets. A few examples of such indicators of impairment of long- lived assets are as under:
- Inventions destroy the market value of earlier acquired assets. For example with the invention of computers the use of typewriters reduced greatly. Thus introduction of computers was an indicator of impairment in value of plants manufacturing typewriters.
- Whenever a new vehicle moves out of a showroom, its market value gets hugely reduced. Thus carrying value of vehicles purchased few days earlier than reporting date would always be much higher than their fair market value on such reporting date.
- Significant changes with an adverse effect on an enterprise. For example steep decline in property prices is a perfect indicator of impairment in value of properties purchased during peak prices.
- Evidence of obsolescence or physical damage of an asset indicates impairment in value of the asset. For example a building damaged in a natural disaster or a fire.
- Permanent construction stoppage of a building due to lack of funds renders the part constructed building impaired.
- Evidence from internal reporting indicating reduced performance of an asset is another example of impairment.
It is however not necessary to check every asset for impairment in each reporting period. “A test may be called for when one or more of these events occur:
- a significant decrease in the market price of long lived asset,
- a significant change in how a company uses a long lived asset,
- a significant change in legal factors or in the business climate that could affect an asset’s value,
- an accumulation of cost significantly greater than the amount originally expected to acquire or construct a long lived asset,
- a current period or cash flow loss combined with a history of such losses, and
- an expectation the entity will sell or otherwise dispose off a long lived asset significantly before the end of its previously estimated useful life.”(David T. Meeting and Randall W.Luecke, March 2002)
Evaluation of FASB’s recognition criterion of impairment of assets
Statement no. 144 seeks to “ (a) recognize an impairment loss only if the carrying amount of long- lived asset is not recoverable from its undiscounted cash flows and (b) measure an impairment loss as the difference between the carrying amount and fair value of assets.” (Statement of Financial Accounting Standards No.144, page no. 4). Accordingly, impairment loss as per FASB is the amount by which an asset’s carrying amount exceeds its fair value, and for calculating such fair value FASB uses an asset’s undiscounted cash flows. Undiscounted cash flows do not reflect current market assessments of the time value of money. Discounting makes adjustments in the cash flows to reflect the way the market would assess the specific risks associated with the projected cash flows. It also excludes the risks that are not relevant to projected cash flows. Risks that are relevant to future cash flows are country risk, currency risk, and price risk among others. Discounting is important as future cash flows from an asset do not depend on the way assets are financed by the entity; and discounting at an independent rate provide the risk free present value. This is a big drawback in FASB measuring of impairment loss, which is not so with International Accounting Standard (IAS) 36 dealing with assets’ impairment subject. As per IAS 36 an assets is impaired when its carrying amount exceeds recoverable amount, which is the “higher of an asset’s fair value less cost to sell”; and fair value is “the discounted present value of estimated future cash flows expected to arise from the continuing use of an asset, and from the disposal at the end of its useful life”. (Deloitte. IAS Plus, Summary of IAS 36). With discounting the future cash flows the impairment losses are recognized under IAS 36 sooner than under US GAAP; and late recognition defeats the very object of the FASB standard.
The FASB standard does not provide for a continuous monitoring of impairment of assets, as there are no provisions for reversal of impairment losses. Continuous monitoring of assets for impairments increases the volatility of amounts reported under the standard.
FASB statement 144 does not apply to all long- lived assets. It does not cover goodwill, intangible assets, financial instruments, deferred policy acquisition costs, deferred tax assets, and unapproved oil and gas properties. (Para 5 of Statement of Financial Accounting Standards No.144, page no. 8)
While evaluating FASB’s standard a comparison with IAS 36 is inevitable, and in that respect IAS 36 provides detail guidance on cash flow estimates, the discount, identification of cash generated units, and reversal of impairment losses. US GAAP does not provide comparable guidance. Therefore, US GAAP needs further revisions in respect of determination and recognition of impairment losses of long- lived assets.
- David T. Meeting and Randall W.Luecke, 2002, Asset Impairment and Disposal, Journal of Online Accountancy.
- Deloitte. IAS Plus, Summary of IAS 36, 2007. Web.
- Statement of Financial Accounting Standards No. 144, 2001, Accounting for Impairment or Disposal of Long Lived Assets, page 4, 8, and 9, Financial Accounting Standard Board. Web.