Impairment losses correct the value of an asset with an inflated book value, creating a more accurate assessment of its current value. Impairment write-downs identify assets with a higher book value than their actual value, and calculating impairment losses involves subtracting the fair market value from the current book value. Owners can project future net cash flows to determine the future value of assets and adjust the book value accordingly. This helps track depreciation and determine reasonable sales prices if the assets are sold.
An impairment loss is a one-time or non-recurring type of charge that is recorded in the accounting records as a means of correcting the value of an asset that has an inflated book value. The idea is to reduce that book value to what is considered a fair value, taking into account the factors that have caused the change in the value of that asset. From this perspective, impairment losses can be viewed as accounting procedures that help create a more balanced and accurate assessment of the real and current value of assets owned by a company or other entity.
Impairment losses involve the creation of what is known as an impairment write-down. This basically means identifying assets that currently have a book value that is higher than their actual value. Determining whether this is the case generally involves deciding whether that current book value is higher than the future net cash flows that can reasonably be generated from owning and using those assets. If that book value is higher, the use of impairment losses helps reduce that book value to a level that is considered more realistic and closer to the current fair value of those assets.
Calculating impairment losses involves the use of a rather simplistic method. The first step is to identify the fair market value of the assets involved. Those amounts are subtracted from the current book value for those same assets. If there is no difference or the result is positive instead of negative, then it is not necessary to record any type of impairment loss for any of those assets at that time. There is the possibility of having to account for impairment losses in the future, depending on what the owner decides to do with those assets next.
From that point on, owners can also assess whether they intend to keep and use those assets in the future. For assets that will be held and used to generate income in the future, it is important to project those future net cash flows. This will help determine to determine the future value of assets. That future value can be subtracted from the book value of each asset. Any negative result indicates the need to adjust the book value of those assets, which in turn means that impairment losses need to be recorded.
The difference between that future value and the book value will constitute a loss in terms of the accounting process. For assets that will be held even with the loss, this makes it possible to track the depreciation that the assets incur over time. Doing so helps position the owner to determine reasonable sales prices for each of the assets, should a decision be made to offer any of those holdings for sale, and manage losses from selling those assets for less than current fair value.
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