What is Book Impairment?
An impairment decreases the value at which an asset is carried in the books. This reduction occurs because changes in the asset or in market conditions have reduced its current market value.
The central theses
- An impairment is the result of the reduced market value of an asset.
- A decrease in the book value of an asset account is accompanied by a charge to an expense account, which reduces net income in the income statement.
- Many companies will publicly present both GAAP results with the book impairment fee and non-GAAP results without the fee.
- When a company writes down assets unexpectedly and with little economic justification, it may indicate trouble.
Understand book depreciation
The book value reduction is a non-cash charge that is recorded in the general ledger. It involves a reduction in the value of an asset on the balance sheet and an adjustment expense. As such, it also reduces net income in the income statement in the same accounting period in which the book impairment is identified and posted. In certain circumstances, the book value reduction and associated costs can be a significant number that can result in significant losses to the reporting entity.
Because this is an unusual item, companies typically report generally accepted accounting principles (GAAP) net income (or loss) after accounting for the book impairment charge, as well as a “pro forma” or non-GAAP income showing the this excludes the charge. Book impairment is more commonly referred to in the popular press as an asset write-off or impairment.
Prerequisites for the book value reduction
While GAAP requires a reduction in the carrying amount of an asset when there is a significant impairment, it would be impossible to test all assets for such impairment on a monthly or quarterly basis. Therefore, GAAP provides guidance on when such impairment tests should be performed. In particular, fixed-lived property, plant and equipment and intangible assets – which are subject to depreciation or amortization over time – should be tested for impairment when market or asset changes indicate that the asset’s carrying amount may be overstated and not fully recoverable.
A book impairment test may be appropriate in a number of situations. These include a significant drop in the market price, an adverse change in the asset’s physical condition, economic conditions, an adverse political change in the country where the asset is located, and so on.
Under GAAP, long-lived intangible assets that are not subject to amortization, such as goodwill, should be tested for impairment at least annually.
Differences between GAAP and IFRS
The accounting requirements for reversing book impairments differ between GAAP and International Financial Reporting Standards (IFRS). For example, US GAAP prohibits the reversal of prior inventory write-downs, but IFRS allows it in certain circumstances. On the other hand, both GAAP and IFRS prohibit reversals of goodwill amortization.
Example book value reduction
A book value reduction is recognized in a diary Entry as a decrease in value on an asset account, a credit, and an increase in value on an expense account, a debit. Suppose ABC Company, a video streaming service, acquired XYZ Corp, a brick-and-mortar chain, 10 years ago. ABC recorded $10 million in goodwill at the time of the acquisition. Under GAAP, it must reassess the value of its reported goodwill each year to determine whether it is accurate or whether an impairment of goodwill has occurred.
ABC Company conducts its annual goodwill test and finds that demand for physical video rentals and purchases has increased since acquiring XYZ Corp. has decreased significantly. They also note that the probability of a recovery of this market in the future is unlikely. As the goodwill is impaired, a book value reduction is appropriate. ABC’s accountants will make a journal entry to credit the goodwill asset account and debit a goodwill impairment expense account. The charges will reduce ABC’s reported net income in the next reported income statement.
Financial analysts closely monitor changes in book value estimates. When a company writes down assets unexpectedly and with little economic justification, it may indicate trouble. Public companies will go to great lengths to explain adjustments through their corporate communications and investor relations teams.