Asset impairment is a result of external events where a company’s assets are affected significantly. Some of these events include decreased demand for products or services, government restrictions that limit sales, or deterioration of the economic activities. All of these can trigger the impairment of assets, and thus, leading to an impairment loss. For instance, countries applying strict measures during COVID-19 may prove this to be true. However, despite the seemingly downward spiral of some assets’ values, they are also depreciated naturally during the course of the company’s lifetime.
Have a look at our previous article on Why Asset Depreciation is Important to Business Owners
What is asset impairment and what is the company management ought to do with impaired assets? How important is it for maintaining and reassessing the company’s assets in light of the COVID-19 pandemic?
Impairment of an asset
Impairment of assets applies to non-financial assets; i.e. property, plant and equipment (PPE), intangible assets, investment properties, etc. Although the Chinese Accounting System (CAS) requires fixed assets to be valued at historical cost, it is notable to highlight that PPE may become impaired. This is true especially for foreign companies that would eventually need to translate their financial statements to International Financial Reporting Standards (IFRS). When assets become impaired, it does not necessarily mean physical deterioration.
An impaired asset is a company property that has a market value (literally meaning the price the asset would fetch in the marketplace) which is less than the value listed on the company’s balance sheet. To prevent misstatement of the balance sheet, companies must regularly complete the assessment of their assets’ values. If an impaired asset’s value is recorded, it is then “written down”. There would then be company loss; since the asset’s value is lesser than the balance sheet, the excess amount would be charged to an account like “impairment loss”.
Technically, an impairment loss is defined as a decrease in the net carrying value of an asset greater than the future undisclosed cash flow of the same asset. Impairment should not be confused with write-down through impairment loss.
Impairment occurs when the company sells or abandons its property because it no longer expects future benefits from the asset. On the other hand, write-down through impairment losses is an assessment made by management to reflect the current market value of an asset
Asset impairment and the impact of COVID-19
The recent pandemic has caused economic deterioration in many industries including travel, tourism, and retail. If recent events have altered the utility of any of the company’s properties (especially non-financial ones), then management should reassess and review whether the useful life and residual value of assets and the depreciation methods previously used are still currently applicable and remain appropriate.
What management should do
It is imperative that managers and business owners take note of industry standards for impairment testing. Basically, the management should be ready at any point in time for the assessment of:
- The impact of measures taken to contain COVID-19;
- Risks involved in any choice to be undertaken;
- Consequences of those risks.
Tangible asset impairment can be a product of the following:
- Management’s decision and prerogative to adopt regulatory changes;
- Technological deviations;
- Significant shifts in consumer preferences or community outlook;
- Change in the asset’s usage rate, etc.
On the other hand, intangible assets impairment may go through other factors, depending on the decision-maker. Due to COVID-19, businesses need not wait until an event or “circumstantial change” signals that any asset’s particular carrying amount (balance sheet figure) might not be recoverable. COVID-19 in itself, with the restrictions involved and economic downfall, is a trigger event in and of itself. Groups of similar assets should be tested together as it is impractical, especially for companies with several assets, to test each piece of property individually.