Fixed Asset Impairments
Fixed assets can become impaired if their book value (i.e., historical cost) is likely not to be recovered during future operations. Multiple events can cause impairments of fixed assets to occur:
A substantial decline in market value, physical change, or usage of fixed assets
Significant legal or business climate change
Excessive costs associated with their operations
Expected operating losses or lower than expected profitability stemming from these assets
The conservatism principle dictates that once an asset has been written down (the lowered fair market value will become the new book value), it cannot be written up in the future. FASB 121 established a two-step process to determine if impairment has occurred:
Recoverability Test. Impairment has taken place if an asset’s book value exceeds the undiscounted cash flows expected from its use and disposal.
Loss Measurement. If impairment occurs, the book value of a fixed asset has to be written down to its lowered fair market value on the balance sheet:
Impairment Amount = Book Value – Fair Market Value
The loss associated with the write-down of an asset on the balance sheet must also be shown on the income statement as part of the unusual or infrequent item category (recall nonrecurring items!).
Remember: Since the value of a fixed asset is reduced, a corresponding decrease must occur on the liabilities and shareholders’ equity side. In this case, it’s retained earnings.