An asset impairment test relates to the market price drop of a company’s fixed asset. When an asset’s market price — or fair value — drops significantly, companies must record the difference as an impairment amount. Accountants do not conduct an impairment test every accounting period or on every asset. Testing each asset is not always necessary, either. Requirements for the test are typically dictated by national accounting standards.
A few rules exist for conducting an asset impairment test and recording an adjustment. These include a significant decrease in asset market price, a major change in the company’s use of an asset, or changes to legal factors on how a business uses assets. A few other less common rules also exist for asset impairment. High accumulation of costs, cash flow loss in the current period or for several past periods, and expectations that a company will sell an asset well before the end of its useful life complete the list.
Accountants measure asset impairment using a two-step process. First, accountants must compile the historical value for all assets recorded on the company’s general ledger. A fair value for all assets owned by the company comes from current markets where the company can sell the asset. A comparison between the two figures helps accountants identify impaired assets. An asset with a fair value higher than recorded book value — with the difference unrecoverable — will generally represent asset impairment.
The second part of the asset impairment test requires accountants to conduct a cash flow comparison against current asset cost. Accountants calculate the total unrecognized cash flows from future years; no discounting of the cash flows is necessary for this computation. The total of each asset’s cash flows represent the future benefits from each asset. Accountants look for any asset where the future cash flows exceed the recorded book value. The difference between the two figures is the amount a company records as asset impairment.
Companies usually need to write off asset impairment amounts as a loss against net income. Accounting systems have different rules for writing off impairments. In some cases, the company may be able to divide the impairment loss against several accounting periods. This prevents the company from having one accounting period with a significant reduction in net income. Companies need to disclose any asset impairments to stakeholders to inform them of these major business changes.
