Impairment of Fixed Assets Essay Examples & Outline
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Impairment of Fixed Assets
Impairment of a fixed assets results in an abrupt change in the fair value of an asset such that the value of the fixed assets decreases in an unprecedented manner. Impairment arises from the rapid obsolescence or damage among other reasons. Impairment of a fixed assets means that the business be it in international market will have a reduced balance sheet value. It also has to recognize the loss of the asset in the income statement. However, the impairment of the value of the asset may lead to the recovery of some percentage of the total value of the fixed asset. The recoverable amount refers to the value of the asset that can be obtained from the fixed asset (Arcady & Stone, 1998). The value of the economic benefits can be attained in the event the company uses the asset or sells it to another party. Calculation of the recoverable amount is arrived at through by deduction the costs of selling the asset and the value gained from use of the asset from the higher fair value of the asset.
The fair value less costs to sell is the deduction of the cost of selling the product from the current market value of the product if it was sold in the normal market. Some of the costs that are incurred in selling an impaired asset include the commissions to sales people or and registration fees. This is calculated if the impaired asset is sold to a third party. In the event that the product is used by the entity in the obsolete or impaired states, value in use is used to calculate the impairment of the asset.
The value in use is the present value of the future cash flows that the firm anticipated to receive after the continued use of the impaired fixed asset (Arcady & Stone, 1998). In the event that the carrying amount of a fixed asset is more than the recoverable amount, there is an incurrence of the impairment expense that amounts to the difference between the two amounts. This difference has to be recognized in the period in agreement with the matching principle. In the event that the carrying amount is less than the amount recoverable from the asset, there is no recognition of the impairment.
Codification in the accounting standards defines two instances when a fixed asset can be impaired. An impaired fixed asset can result from the prolonged use leading to less that the projected term use of the asset. This means that the asset that is impaired performance does not meet the threshold (Obaidat & Al-Hajaia, 2013). Therefore, the projected useful life of an asset is reduced to a lower level leading to the realization of the full utility of the asset. An asset could be impaired if it is exposed to less than the designed uses.
Subjection of the asset to an environment that is not suited for it could be a cause of the impairment. The impairment of an asset is different from conventional grounds for disposal. In the conventional disposal, the asset must have attained its term use or it could be could be sold as a part of the management’s decision (Arcady & Stone, 1998). Therefore, the residual value is a salvage because the total utility from an asset has been fully met. However, in the recovery value, the total utility or use of the product has not been met and the firm is trying to recover the capital invested.
There are various estimations methods used to evaluate the future cash flows that the held impaired asset could bring to the organization. One of the approaches used in the estimation of the cash flows is the cash flow period approach (Arcady & Stone, 1998). This approach uses the time that the held impaired fixed asset is going to be of value to the organization. Cash flow period could be assessed using the condition of the asset and the policies of the company on the use of impaired fixed assets. The second approach is the cash flow estimation approach. This approach looks at the objective cash flows that the impaired asset can bring to the organization. Estimation of the recoverability of an asset can also use the types of the expenditures related to the impaired asset that have to be considered in the development of estimates for the future cash flows.
Impairment of the fixed assets does not apply to all fixed assets. The specifications described in the accounting codes demand that the impairment. Capital leases are affected by the impairment codification. Capital leases are the lease on long-term assets commonly used in the high value assets such as ships and planes. The impairment can also apply to the long-lived assets belonging to the lessors that are also subject to operating leases. The impairment can be used in accounting for the natural properties such as gases and oil deposits that are normally accounted for using the successive approach of accounting (Obaidat & Al-Hajaia, 2013).
Finally, impairment also applies to the long term assets that are used under the prepaid method. Some activities relation to the assets and liabilities are also classified under the asset group or the liable group for disposal (Seow, n.d.). This means that if long-lived asset(s) is in a group that is also comprised of other assets or liabilities that are not traditionally covered by the impairment or disposal specifications of the codification. The assets and liabilities in this group are also covered by the impairment and disposal of the fixed assets code. In this case, the unit of accounting is the group as opposed to the individual long-term asset. In the event that a long-lived asset is meant to be held for use, the entire group is known as the asset group.
In the event that the group of assets is mean to be sold or disposed in any other method, it is known as the disposal group. Some of the liabilities that may be included in a disposal group include the legal obligations attached to the long-lived asset. Such legal obligations include the environmental obligations and any other obligations that a buyer may wish to settle as part of the disposal group. Some of the obligations that a buyer may accept and settle include the warranty obligations to the customer base that comes with the purchase of the long-lived asset (Obaidat & Al-Hajaia, 2013).
The standards for the impairment of assets do not affect the GAAPs applicable in the normal assets and liabilities that are not affected by the impairment codes. Impairment does not apply to assets such as , goodwill, unamortized intangible assets held for use, servicing assets, financial instruments, deferred tax assets or unproven natural resources in gas and oil using successful efforts accounting method, proven natural resources that are accounted for using the fixed accounting method or the deferred policy acquisition assets.
Impairment could lead to the outright disposal of the asset through selling. In other cases, the impaired fixed asset could still be used by the firm. The long-lived or fixed asset that is held and used by the entity is contributes to the firm. The value of the inflow is the present value of the future cash flows from the continued use of the product. When a firm decides to use the impaired asset, it has to report the discontinued operations from the continuing operations in a separate document. This is a requirement of the IFRS reporting framework. The reporting of the discontinued use of the impaired product has to be reported. Specifications ought to be made on the mode of disposal applied. An impaired asset could be disposed though numerous ways such as through the sale, abandonment or redistribution to the owners. The distributed impaired item has to mention the recipient of the distributed asset. Reports of discontinued use of the asset could also be held by the reporting entity for sale.
In the event that the impaired fixed asset has an appreciation in value or regains the original value due to any event, the gain in value is recorded in the income statement to up to the extent of the original loss due to the impairment. If the gain in value is so large such that it is in excess of the original value, the excess gain is treated in the same way a reevaluation is leading to a reevaluation surplus.
Arcady, A., & Stone, C. (1998). The FASB takes another look at impairment of assets. J. Corp. Acct. Fin., 10(1), 1-11. doi:10.1002/(sici)1097-0053(199823)10:1
Obaidat, A., & Al-Hajaia, M. (2013). The Reality of Implementing International Accounting Standard 36 “Impairment of Assets” in Jordanian Industrial Companies Shareholders. Arab Economic And Business Journal, 8(1-2), 21-30.
Seow, I. Impairment Loss of Tangible Assets. SSRN Journal.