Impairment expense is an accounting expense recognize on the basis of which a permanent reduction in assets value is justified in the books of account compare the recoverable amount of the assets at the end of the reporting date as per certain impairment conditions or factors.
The assets of the enterprise are tested for impairment each year and if impaired, it is recognized in the income statement and balance sheet accordingly.
Fixed assets are mainly tested for impairment. There are two categories of fixed assets: tangible and intangible fixed assets.
Over longer time-frame of business, a large number of impaired assets can make it difficult for business to grow and meet its financial obligations.
Cash Flow statement is not affected by impairment directly as there is no cash transaction taking place at the time of impairment. However, it directly affects the income statement and balance sheet directly.
Impairment of Assets under IFRS
Under International Financial Reporting Standards (IFRS), the company should consider assesses whether events or circumstances indicate impairment of assets or not.
This can be ascertained by the physical verification of the asset such as the look and calculation of output or productivity of the assets in a given period.
If there is major change in assets physical condition, the assets value must be tested for impairment.
If the carrying value of assets exceeds the recoverable amount, the asset in question can be impaired. The recoverable amount means the fair value of assets less selling costs or its value in use, whichever is higher.
In the following way, we calculate the value in use:
- Estimate the cash flows that are generated by the asset.
- Calculate the present value of future cash flows by applying a discount rate. The discount rate is taken by looking at the returns in the market.
- Other reasonable assumptions are to be made
The particulars that are to be ignored while projecting the future cash flows should include the overestimation of revenue growth rates, cost reduction that gets an exaggerated and unimaginable number of years of asset use.
Avoiding these items results in the inappropriate calculation of cash flows.
Likewise, an extreme growth rate recently should be assumed for near periods only and not for the longer period.
If the asset is impaired, the asset’s value must be written down on the balance sheet to the recoverable amount.
Further, the amount of carrying value exceeding the recoverable amount shall be recognized in the income statement.
Only in the IFRS, the company is given the choice to reverse the losses in the future, which should be however limited to original impairment loss.
Therefore, the carrying value of asset after reversal cannot exceed carrying value before impairment loss is recognized.
Presentation in Financial Statement:
We will look here how the impairment asset is disclosed in the financial statements as:
- Income Statement: If an asset is impaired, the impairment loss is recognized in the income statement just like any other operating expense. With impairment loss being recognized, the net profit is impacted negatively.
- Balance Sheet: The asset is written down by the amount equal to the impairment loss which is recognized in the income statement.
- Cash Flow Statement: As the cash movement does not happen or there is no impact on cash, the impairment of assets does not impact the cash flow statement.
Presentation in Cash Flow Statement:
Despite having no impact on cash flows, when we prepare the cash flow statement using the indirect method, we start with net profit and add back all the non-cash items included in the income statement.
Likewise, the impairment loss is added back as shown below in excerpts of the cash flow statement using the indirect method.
|Year ended March 31||2019|
|Cash Flows from Operating Activities|
|Net Profit (Loss)||XXX|
|Add: Loss from discontinued operations||XX|
|Add: Non-cash items|
|Depreciation and amortization||XX|
|Employee Benefit expenses||XX|
|Add/Less: Change in Assets and Liabilities||XXX|
|NET CASH FLOWS FROM OPERATING ACTIVITIES||XXX|
Logical Impact on Cash Flows:
If impairment loss is recognized in the income statement, the net profit will decrease and there will be lesser outflow towards income tax obligations which is more or less in cash.
Hence, impairment losses is although without any cash movement, it can decrease the tax liability of the enterprise in an indirect manner.