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Requirement
Write an essay about the Nature of “Impairment loss”
Solution
Impairment loss
The International Accounting Standards impairment of assets confirms that the assets are not carried for higher than the recoverable amount. The annual impairment test is needed for the exception of goodwill and intangible assets where there is an indication of impairment of assets. When the cash inflows are not mainly independent from other assets, then the test is conducted for cash generating unit. The International Accounting Standards 36 is applied to the goodwill and intangible assets which are attained in the business combination, and the agreement date is on 31 March 2004 (Vernimmen et al., 2014). Rendering to the accounting rules, the value of an asset is known as impaired when the amount of estimated future cash flow is lower than the book value of an asset. The variance between the book value and fair market value is known as an impairment loss. The impairment cost includes the expenses when the recoverable amount is lesser than the book value. It is the diminishing in quality, a value of an asset or strength amount. The fixed assets such as land and machinery are known as PPE. The fixed assets are most expected to experience impairment which is caused by various reasons.
The assets impairment was lectured by the international accounting standards board in International Accounting Standards 16 and it is replaced by International Accounting Standards 36. The international accounting standards board and Financial Accounting Standards Board together took efforts for the common impairment model. The scope of impairment in various international accounting standards includes International Accounting Standards 2, 4,5,11,12,19,36,39,40, and 41 (Amiraslani et al., 2013). The Financial Accounting Standards Board includes the six sections, namely, receivables, inventories, investments, goodwill & intangibles, plant & equipment's, and other assets.
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The International Accounting Standards 36 framework includes two models, namely, incurred loss model and expected loss model (Glaum et al., 2013). In the incurred loss model the investments are treated as impaired, and there is no practical assurance that the future cash flow is will be entirely paid or at the due date. The entities look for the evidence in the situations which indicate impairment. The triggering events include experiencing notable financial difficulty by an entity, entities making late interest payments, entity has undergone major financial problems, and entities facing negative economic change. The impairment cost is calculated by deducting the carrying amount from the recoverable amount. The carrying value is located on the balance sheet. The recoverable amount is more than the future value of assets or sales minus transaction costs.
In the expected loss model, the estimated future cash flows are used to calculate the present value of an investment which is prepared on continues basis and it does not consider activating events. There is no objective indication that the impairment loss occurs and the credit risk is indicated by the projection of revised cash flows. The revised expected cash flow is discounted at the similar effective interest rate when the instrument is developed firstly. The impairment cost is calculated similarly as in the incurred loss model. Such as the X Company has invested in the long term investment with a carrying amount of $55,000 and the market value of the bond reduces by $35,000. So, the impairment loss is $20,000. The loss is recorded in the income statement. The loss will be debited in the loss on impairment account, and the amount will be credited to the investment account. According to the principle of double entry book keeping the entry is justified.
The impairment is indicated by two sources, namely, internal sources and external sources. The internal sources include physical damage, ideal assets, worst economic performance, the carrying amount of investment in subsidies is higher than the carrying amount of investee's amount. The external sources include the decline in market value, technology changes negatively and market capitalization is lesser than the net assets of the company. The indication of the impairment must include the useful life of an asset, a method of depreciation, and scrap value of an asset. The recoverable amount can be resolute by three methods, namely when the fair value minus cost of disposal is higher than the carrying cost then it is mandatory to estimate the sum and the asset are not impaired. Secondly, when the determination of fair value is not possible, then recoverable amount is used. Thirdly, the recoverable amount is calculated by deducting disposable value from fair value at the time of disposal of assets. The fair value is calculated according to the International Financial Reporting Standards 13 (Hashim et al., 2016). The cost of disposal is the directly added cost.
The impairment loss can be recognized by three methods, firstly, when the recoverable amount is lower than the carrying amount, secondly, when the impairment loss is recognized as an expense and thirdly, adjusted depreciation for future periods. In cash generating units, the recoverable amount is calculated from individual assets and if it is not possible then recoverable amount is determined for the asset’s cash generating unit. The goodwill must be tested for the impairment yearly. The goodwill must be assigned to each of the acquirer’s cash producing units for the test of impairment. The test should be conducted annually for the impairment of goodwill (Johansson et al., 2016). The disclosure of assets includes impairment losses which are recognized in the profit and loss account. It also includes impairment losses reversed which is presented in profit and loss account, impairment losses in revalued assets and impairment losses reversed in revalued assets which are recognized in the comprehensive income statement. The other disclosures include the events which outcomes in impairment losses, loss amount, individual assets, cash generating unit and others (Foley et al., 2015).
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Vernimmen, P., Quiry, P., Dallocchio, M., Le Fur, Y., & Salvi, A. (2014). Corporate finance: theory and practice. John Wiley & Sons.
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Hashim, N., Li, W., & O’Hanlon, J. (2016). Expected-loss-based accounting for impairment of financial instruments: The FASB and IASB proposals 2009–2016. Accounting in Europe, 13(2), 229-267.
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Amiraslani, H., Iatridis, G. E., & Pope, P. F. (2013). Accounting for asset impairment: a test for IFRS compliance across Europe. Centre for Financial Analysis and Reporting Research (CeFARR).
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Johansson, S. E., Hjelström, T., & Hellman, N. (2016). Accounting for goodwill under IFRS: A critical analysis. Journal of International Accounting, Auditing and Taxation, 27, 13-25.
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Glaum, M., Baetge, J., Grothe, A., & Oberdörster, T. (2013). Introduction of International Accounting Standards, disclosure quality and accuracy of analysts' earnings forecasts. European Accounting Review, 22(1), 79-116.
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Foley, C. (2015). The Standard-Setting Process of International Financial Reporting Standards by the International Accounting Standards Board (IASB).
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