Definition
Impaired Assets are company assets that have a market value less than the value listed on the company’s balance sheet. This could be due to underperformance, changes in market conditions, or economic downturns. Adjustments are made to reflect this decrease in value, which reduces the asset’s book value and impact on the company’s overall financial health.
Key Takeaways
- Impaired assets are company assets that have a market value less than the value listed on the company’s balance sheet. They are considered as “impaired” because the potential of these assets to generate returns is less than their book value.
- Under International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP), companies are required to conduct regular reviews of asset values, and if an asset is found to be impaired, its value must be written down to reflect this decrease.
- Impairment of assets can be temporary or long term. It’s permanent when the market value continuously remains below the carrying value. In such cases, the company needs to recognize an impairment loss in its income statement. This will reduce the company’s net income, but it also creates a more accurate and reliable picture of the company’s financial health.
Importance
Impaired Assets is a critical finance term as it directly affects a company’s financial health and overall valuation.
It refers to assets that have a market value less than the value listed on the company’s balance sheet.
This situation usually occurs when the actual cash flows or the potential earnings capacity from an asset significantly underperform than projected, which could be as a result of several factors such as unfavorable market conditions, damage to physical property, or legal complications.
It’s crucial to acknowledge impaired assets as they may lead to a write-down or impairment loss, significantly affecting a company’s profit and loss statement.
Furthermore, identifying and dealing with impaired assets reflects transparent financial reporting, aiding investors and stakeholders in understanding the company’s true financial position.
Explanation
Impaired assets are commonly associated with a company’s balance sheet and are utilized as a key marker to evaluate an organization’s financial health and management effectiveness. The purpose of identifying and recording impaired assets is to reflect a more accurate and fair value of the company’s assets.
This becomes essential when an asset’s market value decreases significantly and the chances of recovering its cost in the future are minimal. Recognizing these assets as impaired protects investors and stakeholders by offering a transparent view of the company’s actual value, reinforcing the principle of conservatism in financial reporting.
The impairment of assets serves crucial functions in a market setting, especially in maintaining investor confidence and managing risk. It bolsters appropriate decision-making in investments by accurately depicting the depreciating value of assets.
Furthermore, it encourages efficient management of resources by prompting review and reevaluation of assets, specifically those generating insufficient returns or incurring losses. Therefore, impaired assets, though unwelcome, facilitate better financial management and plays a vital part in the overall business economy.
Examples of Impaired Assets
Lehman Brothers: One of the most famous examples of impaired assets happened during the 2008 financial crisis. Among the financial institutions that essentially collapsed during this period was the investment bank – Lehman Brothers. The assets in their balance sheet, such as mortgage-backed securities, became impaired because those assets declined significantly in value as a result of the housing market’s collapse. Lehman Brothers held onto a massive amount of these impaired assets that they were unable to sell, leading to the company’s bankruptcy.
General Electric (GE): In 2018, GE had to take a $22 billion impairment charge due to their power business’s poor performance. This resulted from miscalculations in the company’s evaluation of goodwill associated with acquisitions made in previous years. Essentially, the assets acquired were not generating the expected cash flows, leading to asset impairment.
BP Oil Spill: In one of the worst marine oil spill disasters, BP had to impair their assets worth several billions of dollars in the aftermath of the 2010 Deepwater Horizon oil spill in the Gulf of Mexico. BP needed to account for the loss in value of their drilling rights, cleanup costs, and impending legal fees and fines, which significantly devalued their assets.
FAQs about Impaired Assets
What are Impaired Assets?
Impaired assets are company assets that have a market price less than the value listed on the company’s balance sheet. This typically happens when the expected return from the asset drops due to a sudden and significant decrease in its market value, changes in laws or regulations, or damage to the physical condition of the asset.
How are Impaired Assets Identified?
Impaired assets are often identified during a company’s routine review of its assets. When an asset’s market price drops significantly or the asset is not generating the expected revenue, it is likely to be identified as impaired.
What’s the impact of Impaired Assets on a Company’s Financial Statements?
An asset impairment can cause a significant impact on a company’s balance sheet. The loss incurred due to the impairment decreases the company’s net income on its income statement. At the same time, the value of the impaired asset on the balance sheet reduces, lowering the company’s overall asset value.
How is the Impairment of an Asset Recorded?
Asset impairment is generally recorded as an expense on the income statement, which subsequently reduces the item’s net book value on the balance sheet. The amount of impairment is calculated as the difference between the asset’s carrying value and the sum of its expected future cash flows.
How Does Asset Impairment Affect Cash Flow?
Although asset impairment is a non-cash expense and doesn’t directly affect a company’s cash flow, it does decrease the income before taxes. This, in turn, reduces the cash inflows from operating activities, affecting the overall cash flow of a company.
Related Entrepreneurship Terms
- Depreciation
- Amortization
- Asset Valuation
- Recoverable Amount
- Write-Off
Sources for More Information
- Investopedia – A comprehensive financial education website that offers a wide array of information on various financial topics, including impaired assets.
- Accounting Tools – A helpful resource for auditing, financial, and tax materials, including detailed explanations of finance terminology like impaired assets.
- Corporate Finance Institute (CFI) – A provider of online finance courses and financial analyst certification programs. They offer an extensive online library of resources.
- My Accounting Course – A free online accounting course that houses a comprehensive dictionary of accounting and finance terms. They often provide examples in their explanations.
