Impaired Assets Definition Example What Is Impairment Of Assets

Impaired Assets Definition

Example of Impaired Assets

Company A ltd purchased company B ltd and paid $ 19 million as the purchase price for buying company B ltd. When the purchase was made, the book value of the assets of Company B was $ 15 million. Over the year after the acquisition, the sales of Company B ltd. Fell by around 38 % because of some changes made by the management in the company’s working and due to the competitor’s entrance in the same line of business with the cheaper substitute. As a result, the fair market value of company B ltd fell to the level of $ 12 million from the $ 15 million when the acquisition was made. Analyze the impact of the impairment.

Solution

Company A ltd purchased company B ltd and paid $ 19 million as the purchase price for buying company B ltd. When the book value of the assets of Company B was $ 15 million, The extra amount of $ 4 million ($19 – $15 million) paid by the company A ltd above the book value of the assets of the Company B is to be recorded as the goodwill on the assets side of the company ‘s balance sheet. Over the year after the acquisition was made, the sales of Company B ltd. Fell by around 38 %, and as a result, the fair market value of company B ltd fell to the level of $ 12 million from the $ 15 million.

As per the Generally Accepted Accounting PrinciplesGenerally Accepted Accounting PrinciplesGAAP (Generally Accepted Accounting Principles) are standardized guidelines for accounting and financial reporting.read more, companies are required to test the goodwill and other certain intangible assetsIntangible AssetsIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can’t touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. read more every year for the impairments. So, after a year, Company A ltd. will compare the fair value of its subsidiary companySubsidiary CompanyA subsidiary company is controlled by another company, better known as a parent or holding company. The control is exerted through ownership of more than 50% of the voting stock of the subsidiary. Subsidiaries are either set up or acquired by the controlling company.read more B ltd., With the carrying amount present on its balance sheet and goodwillGoodwillIn accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company’s net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company’s net identifiable assets from the total purchase price.read more. In case the fair value of B ltd. is less than its carrying valueCarrying ValueCarrying value is the book value of assets in a company’s balance sheet, computed as the original cost less accumulated depreciation/impairments. It is calculated for intangible assets as the actual cost less amortization expense/impairments.read more of the A ltd, then it is liable for the impairment.

In the present case, after a year of the company’s fair market value, B ltd falls to the level of $ 12 million from the $ 15 million. Now, this fair market value of the B ltd, along with the goodwill, will be compared with the actual value recorded in the books of accounts, and with the differential amount, goodwill will be reduced.

Current Fair market value + Goodwill = $ 12 million + $ 4million = $16 million

This $ 16 million will be compared with the initial purchase price paid ($19 million), and the difference will be impairment of the goodwill.

Impairment =$19 million – $16 million =$3 million

This amount will be reduced from the Goodwill amount present in the books of accounts

=Goodwill initially recorded – $3 million = $ 4 million – $ 3 million = $ 1 million

Thus the goodwill, in this case, is the impaired assets, and on the balance sheet, the amount of new goodwill to be shown will be $ 1 million.

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Advantages

Impaired assets and impairment give the ways to the investors and analysts to assess the management of the company and their decision-making. The managers who have to write down the assets due to impairment might not have good investment decision power.Many business failures occurred after a fall in the impaired value. These disclosures can act as early warning signals for the creditors and investors of the company for their investment analysisInvestment AnalysisInvestment analysis is the method adopted by analysts to evaluate the investment opportunities, profitability, and associated risks in their portfolios. In addition, it helps them to determine whether the investment is worth it or not.read more.

Disadvantages

There is no detailed guidance on the treatment of impaired assets.Generally, it becomes difficult to know the measurement value, which should be used for ascertaining the impairment amount.

Important Points About Impaired Assets

Impairment should be recorded only if it is anticipated that the future cash flowsCash FlowsCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more in the company are unrecoverable.Journal entry for recording the impairment is the debit to the loss account or to the expense account with the corresponding credit to an underlying assetAn Underlying AssetUnderlying assets are the actual financial assets on which the financial derivatives rely. Thus, any change in the value of a derivative reflects the price fluctuation of its underlying asset. Such assets comprise stocks, commodities, market indices, bonds, currencies and interest rates.read more.When the carrying value of the impaired assets is adjusted, then the loss is to be recognized on the company’s income statement.

Conclusion

Impaired assets are those assets whose market value is below their book value. All assets, either intangible or tangible, are prone to impairment. It is required by the entities to conduct the impairment tests in case indications are there concerning impairment except for the goodwill and other certain intangible assets in the case in which the impairment test is to be done annually as per the requirement of the Generally Accepted Accounting Principles. Many business failures occurred after falling into the value of the impaired assets. These disclosures can act as early warning signals for the creditors and investors of the company for their investment analysis. Thus the impaired assets also help the different stakeholders in different ways for their analysis before making any decision concerning the company.