An impairment definition is a set of guidelines used to determine whether an asset is impaired and, if so, how to measure the impairment.
There are two types of impairment definitions:
1. those that focus on the asset itself (e.g. physical damage, obsolescence), and
2. those that focus on the entity's ability to generate cash flows from the asset (e.g. changes in market conditions, changes in the entity's business model).
The most common impairment definition is the former, as it is generally easier to identify when an asset is physically damaged or obsolete. However, the latter type of definition is becoming increasingly common, as it is more reflective of the true economic value of an asset.
The choice of impairment definition can have a significant impact on the reported value of an asset. For example, if an entity uses an impairment definition that focuses on physical damage, then an asset that is physically damaged but can still generate cash flows may be reported at its full value. However, if the entity uses an impairment definition that focuses on the ability to generate cash flows, then the same asset would be reported at its impaired value, which would be lower.
The impairment definition should be consistent with the entity's accounting policy. For example, if the entity uses historical cost accounting, then the impairment definition should be based on the asset's original cost.
How do you determine impairment?
The calculation of impairment losses typically involves estimating the future cash flows of the asset in question and discounting those cash flows back to present value. The present value of the future cash flows is then compared to the asset's current carrying value on the balance sheet. If the present value of the future cash flows is less than the carrying value, an impairment loss is recognized.
There are a number of different methods that can be used to estimate future cash flows, but the most common is the discounted cash flow (DCF) method. To calculate an asset's DCF, you first need to estimate its future cash flows. This can be done using a variety of methods, but the most common is the extrapolation method. With this method, you look at the asset's past cash flows and extrapolate them into the future.
Once you have estimated the asset's future cash flows, you need to discount them back to present value. This is done using the asset's discount rate, which is the rate of return that the asset is expected to earn. The higher the discount rate, the lower the present value of the future cash flows.
Once you have estimated the present value of the future cash flows, you compare it to the asset's carrying value on the balance sheet. If the present value is less than the carrying value, an impairment loss is recognized. The amount of the impairment loss is the difference between the carrying value and the present value.
How do you account for impairment loss?
Impairment losses are recorded when the carrying value of an asset exceeds its estimated recoverable amount. The recoverable amount is the higher of an asset's fair value less costs to sell and its value in use.
Value in use is the present value of the future cash flows expected to be generated by an asset. Fair value less costs to sell is the amount that could be realized from selling an asset in an orderly transaction minus the costs of disposal.
When an impairment loss is recognized, the carrying value of the asset is reduced to its recoverable amount. This reduction is recorded as a charge to earnings.
How do you treat impairment of assets? The International Accounting Standards Board (IASB) defines impairment as "a loss of value of an asset that is not fully recoverable." In order to determine whether an asset is impaired, an entity must first determine the asset's recoverable amount. The recoverable amount is the higher of an asset's fair value less costs of disposal, and its value in use. If the recoverable amount of an asset is less than its carrying value, the asset is considered impaired and must be written down to its recoverable amount.
Is impairment loss an asset?
The answer to this question depends on the jurisdiction in which the financial statements are being prepared. Generally speaking, if the impairment loss is considered to be an asset, it will be reported as a separate line item on the balance sheet. However, if the impairment loss is not considered to be an asset, it will not be reported on the balance sheet but will instead be reported in the income statement.
Is impairment the same as provision?
No, impairment is not the same as provision. Provision is an accounting term that refers to the setting aside of funds to cover a future liability, such as an expected loss. Impairment, on the other hand, is a term used in financial accounting to describe the reduction in value of an asset.