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Businesses require assets to function, generate cash, produce profits, and provide a return on investment for their investors, owners, and stockholders. Assets are a key element of each business’s net worth, meaning it may be time to undergo some asset impairment testing. 

A business asset is something of value that generates revenue and creates value for a business. Business assets fall into four categories: current assets, fixed assets, financial assets, and intangible assets. Current assets include cash and assets that can be turned into cash within a year including inventory and accounts receivable. Fixed assets include property, buildings, machinery, and equipment. Financial assets include stocks or bonds. Intangible assets include intellectual property including patents, trademarks, and copyrights. Goodwill, or the value of a business beyond its physical assets, includes the value of a business’s reputation, name recognition, and image. 

To be a verifiable asset, it must be under the ownership or control of the company. It must have economic value. And it has been or can be a resource for future positive cash inflows for the company. When accounting for assets, it is important to conduct impairment testing for all assets.

What is An Impaired Asset 

An impaired asset has a lower market value than the value presented on the company’s balance sheet. Asset impairment can happen to any company, and it has clear accounting consequences. When a company determines that an asset is impaired, generally accepted accounting practices (GAAP) require that the company reduce an asset’s value to current market value and book a loss. The assets that are most likely to be impaired are accounts receivable, notes receivable, goodwill, and fixed assets.

Why Do Impaired Assets Matter 

Assets undergo regular impairment testing because the true value of assets is important to provide a true picture of a company’s financial health. A record of asset impairment communicates to company leadership, financial institutions, and investors that an asset now has less worth than previously expected. Of course, some asset impairment is beyond the control of management, such as when a building catches fire or is damaged by a tornado. Other impairments such as those found in accounts receivable may signal bad decisions on the part of management.

Asset impairment is not the same as depreciation because depreciation is both expected and predictable. 

What is Asset Impairment Testing and When Does it Take Place 

Impairment testing is simply the process of evaluating if the fair value of a specific asset has fallen below its recorded cost. When an asset is judged to be impaired, it must be written down on the balance sheet from its carrying value to its current market value. 

Impairment testing should occur annually, and when a “triggering event” takes place. Companies need to be alerted to triggering events that indicate that the fair market value of an asset has declined below the amount carried on the balance sheet. Those triggering events can include macroeconomic changes including changes in equity and credit markets, industry and market changes, cost factors that have an unexpected negative effect on an asset, an unanticipated decline in a company’s financial performance, and other events such as a change in management strategies, and lawsuits. 

Once a triggering event has been identified, a company must evaluate how it will impact its impairment testing including how it will affect the company’s results outlook. Any impairment will be evaluated at the time that the triggering event or the probability that a decline in value took place. 

Accounting For Impaired Assets 

Recording an impaired asset can have a negative impact on the balance sheet and its related financial ratios due to the reduced value of an asset. It is important to review all impairments because they can signal misuse of assets, decrease in demand, damage to assets, and legal challenges. 

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