What Are Impairment Losses?
An impairment loss is a type of one-time or nonrecurring charge that is entered into the accounting records as a means of correcting the value of an asset that has an overstated book value. The idea is to reduce that book value down to what is considered a fair value, allowing for whatever factors have caused the change in the worth of that asset. From this perspective, impairment losses can be seen as accounting procedures that help to create a more balanced and accurate assessment of the true and current value of any assets held by a company or other entity.
Impairment losses involve the creation of what is known as an impairment write-down. This basically means identifying assets that are currently carrying a book value that is higher than their actual worth. Determining if this is the case typically involves deciding if that current book value is higher than future net cash flows that can reasonably be expected to be generated from the ownership and use of those assets. If that book value is higher, the use of impairment losses helps to reduce that book value back to a level that is considered more realistic and closer to the current fair value of those assets.
Calculating impairment losses involves the use of a fairly simplistic method. The first step is to identify the fair market value of the assets involved. Those amounts are then subtracted from the current book value for those same assets. If there is no difference or the result is positive rather than negative, then there is no need to record any type of impairment loss on any of those assets at that time. There is the possibility of needing to account for impairment losses in the future, based on what the owner chooses to do with those assets next.
From that point, owners may also want to evaluate if they intend to hold and use those assets in the future. For assets that will be held and used to generate revenue in the future, it is important to project those future net cash flows. This will help determine to determine the future value of the assets. That future value can then be subtracted from the book value for each asset. Any negative results indicates the need to adjust the book value of those assets, which in turn means there is a need to log impairment losses.
The difference between that future value and the book value will constitute a loss in terms of the accounting process. For assets that will be held even with the loss, this makes it possible to track the depreciation that the assets incur over time. Doing so helps to position the owner for determining a reasonable sale prices for each of the assets, in the event a decision is made to offer any of those holdings for sale, and manage to any losses stemming from selling those assets for less than the current fair value.
Though many people may find accounting to be confusing, it is important to understand complex concepts like impairment losses, especially for businesses owners who must keep track of losses and gains. Impairment loss calculation helps in understanding the true value of assets.
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