Contents
What is Impairment of Equipment?
Impairment of equipment is a situation where the carrying amount of an asset (the amount recorded in the balance sheet) exceeds its recoverable amount (the higher of its fair value less costs of disposal and its value in use). When this happens, the asset is said to be impaired and the company has to recognize an impairment loss in the income statement. The impairment loss reduces the carrying amount of the asset to its recoverable amount.
Why is Impairment of Equipment Important?
Impairment of equipment is important because it reflects the economic reality of the asset’s value. If an asset is impaired, it means that the company has overestimated its future benefits or underestimated its future costs. By recognizing an impairment loss, the company adjusts its balance sheet and income statement to show the true value and performance of the asset. This helps the company to make better decisions about investing, disposing, or using the asset in the future.
How to Test for Impairment of Equipment?
According to International Accounting Standard (IAS) 36, a company has to test its equipment for impairment whenever there is an indication that the asset may be impaired. Some examples of such indications are:
- Significant decline in the asset’s market value
- Significant change in the technological, market, economic, or legal environment that affects the asset
- Evidence of obsolescence or physical damage of the asset
- Decrease in the asset’s usage, performance, or cash flows
- Plans to restructure or dispose of the asset
If there is no indication of impairment, a company does not have to test its equipment for impairment. However, some assets have to be tested for impairment annually, regardless of whether there is any indication or not. These are:
- Intangible assets with indefinite useful lives
- Intangible assets not yet available for use
- Goodwill acquired in a business combination
How to Measure Impairment Loss?
To measure impairment loss, a company has to compare the carrying amount and the recoverable amount of the asset. The recoverable amount is the higher of:
- Fair value less costs of disposal: This is the amount that can be obtained from selling the asset in an arm’s length transaction between knowledgeable and willing parties, minus any costs directly attributable to the disposal.
- Value in use: This is the present value of the future cash flows expected to be derived from the asset or the cash-generating unit (CGU) to which it belongs, using a discount rate that reflects current market assessments of the time value of money and the risks specific to the asset or CGU.
If the carrying amount is higher than the recoverable amount, then an impairment loss is recognized for the difference. The impairment loss is allocated to reduce the carrying amount of the asset or CGU in the following order:
- First, to goodwill
- Second, to intangible assets with indefinite useful lives
- Third, to other assets on a pro rata basis based on their carrying amounts
The impairment loss cannot reduce the carrying amount of an asset below its fair value less costs of disposal or its value in use.
How to Reverse Impairment Loss?
An impairment loss can be reversed if there is an indication that the impairment no longer exists or has decreased. This can happen if there is a change in the estimates used to determine the recoverable amount. However, some impairment losses cannot be reversed. These are:
- Impairment losses on goodwill
- Impairment losses on intangible assets with indefinite useful lives that are measured at fair value less costs of disposal
To reverse an impairment loss, a company has to compare the carrying amount and the recoverable amount of the asset or CGU as at the date of reversal. If the recoverable amount is higher than the carrying amount, then a reversal of impairment loss is recognized for the difference. The reversal of impairment loss cannot increase the carrying amount of an asset above its original carrying amount adjusted for depreciation or amortization that would have been recognized if no impairment loss had been recognized.
A Case Study of Suarez Company at December 31, 2017
Presented below is information related to equipment owned by Suarez Company at December 31, 2017.
Cost | $9,000,000 |
Accumulated depreciation to date | $1,000,000 |
Expected future net cash flows | $7,000,000 |
Fair value | $4,800,000 |
Suarez intends to dispose of the equipment in the coming year. It is expected that the cost of disposal will be $20,000. As of December 31, 2017, the equipment has a remaining useful life of 4 years.
Step 1: Test for Impairment
Suarez has to test its equipment for impairment because there is an indication that the asset may be impaired. The indication is the plan to dispose of the equipment in the coming year.
Step 2: Measure Impairment Loss
To measure impairment loss, Suarez has to compare the carrying amount and the recoverable amount of the equipment. The carrying amount is the cost minus the accumulated depreciation, which is $9,000,000 – $1,000,000 = $8,000,000. The recoverable amount is the higher of:
- Fair value less costs of disposal: This is $4,800,000 – $20,000 = $4,780,000.
- Value in use: This is the present value of the expected future net cash flows, using a discount rate that reflects current market assessments of the time value of money and the risks specific to the equipment. Assuming a discount rate of 10%, the value in use can be calculated as follows:
Year | Expected Future Net Cash Flows | Present Value Factor (10%) | Present Value |
1 | $2,000,000 | 0.909 | $1,818,000 |
2 | $2,000,000 | 0.826 | $1,652,000 |
3 | $2,000,000 | 0.751 | $1,502,000 |
4 | $1,000,000 | 0.683 | $683,000 |
Total | $7,000,000 | – | $5,655,000 |
The recoverable amount is the higher of $4,780,000 and $5,655,000, which is $5,655,000.
Since the carrying amount ($8,000,000) is higher than the recoverable amount ($5,655,000), an impairment loss is recognized for the difference. The impairment loss is $8,000,000 – $5,655,000 = $2,345,000.
Step 3: Record Impairment Loss
To record impairment loss, Suarez has to debit an expense account and credit an asset account for the amount of impairment loss. The journal entry is as follows:
Account | Debit | Credit |
Impairment Loss – Equipment | $2,345,000 | – |
Equipment | – | $2,345,000 |
This entry reduces the carrying amount of the equipment to its recoverable amount ($5,655,000).
Step 4: Reverse Impairment Loss (if applicable)
Suarez has to check if there is an indication that the impairment loss recognized in the previous year no longer exists or has decreased as at December 31, 2018. If there is such an indication, Suarez has to reverse the impairment loss. However, since Suarez intends to dispose of the equipment in the coming year and has not yet done so as at December 31, 2018, there is no indication that the impairment loss has reversed. Therefore, Suarez does not have to reverse the impairment loss.
Conclusion
Impairment of equipment is a situation where the carrying amount of an asset exceeds its recoverable amount. A company has to test its equipment for impairment whenever there is an indication that the asset may be impaired and measure and record impairment loss if any. An impairment loss can be reversed if there is an indication that the impairment no longer exists or has decreased. In this article, we have illustrated how to account for impairment of equipment using a case study of Suarez Company at December 31, 2017.