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Impairment analysis is an accounting process used to assess the accuracy of goodwill, physical assets, and financial instruments. Under new accounting standards, accountants must determine the fair value of business units and compare it to the book value to identify impairment. Impairment results in an adjusted entry that reduces the goodwill account on the balance sheet and places an extraordinary loss on the income statement. Disclosures are necessary to explain these impediments to interested parties.
Impairment analysis is an accounting term most often applied to goodwill. In short, goodwill is the amount an individual pays for a business above the book value of the business. Accountants must review this figure for accuracy and assess whether it is impaired, often resulting in a write-off of the company’s earnings. Other items in a company’s accounting processes may be part of the impairment analysis, for example, physical assets or financial instruments held as investments.
Historically, companies were able to amortize goodwill over a long period of time, usually around 40 years total. However, accounting standards have changed, requiring accountants to perform an impairment test to assess whether or not historical goodwill is currently correct. When accountants determine that goodwill impairment exists, it is necessary to enter it for adjustment in order to present a more accurate balance sheet to interested parties. The entry reduces the goodwill account on the balance sheet and places an extraordinary loss on the company’s income statement. This usually happens at least once a year for most companies.
Goodwill impairment is a bit more technical under the new accounting standards. Accountants must determine the fair value of all business units of the company using the net present value for future cash flows. They then compare this figure to the company’s book value based on information from the company’s balance sheet. Book value is the book value of total assets plus goodwill less liabilities. Fair value, as derived from net present value, that is less than book value results in impairment and requires an adjusted entry.
Impairment analysis of physical assets often involves reviewing a company’s cash, more commonly called equity in accounting terms. There can be two types of capital impairment in a company. The first is when there is a significant reduction in the company’s capital for a single use, which may not be related to the use of cash in normal operations. Second, total capital less than the face value of the capital stock is also an impairment. Accounting standards also provide instructions for handling entries for these impairment scenarios.
Financial instruments can also be part of a company’s impairment analysis. Investments that are worth less today than in a prior period are subject to this review. Accountants must perform similar depreciation for these assets. The amount impaired, calculated using standard accounting techniques, reduces the balance of assets and net income for a specified period. Disclosures are necessary to explain these impediments to interested parties.
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