Pursuant to Generally Accepted Accounting Principles (GAAP), companies report their fixed asset balances using acquisition costs. A company’s fixed assets include real estate holdings, business equipment and raw materials. Accounting rules refer to these assets as “fixed” because they aren’t easily converted into cash and have useful lives beyond one year. However, under very limited circumstances, a company can impair a fixed asset, which allows it to report a balance that reflects current market value rather than cost.
Calculate the carrying value of a fixed asset. This is equal to its acquisition cost, less its accumulated depreciation. Accumulated depreciation of fixed assets equals the sum of the annual depreciation expenses the company takes on the asset since the date of acquisition.
Calculate the fixed asset’s fair value. The fair value of a fixed asset equals the future cash flow it will generate for the company plus the salvage value at the end of its useful life. For example, if a company anticipates that a piece of equipment that has a salvage value of $500 will help the company generate $2,000 over the next two years before it disposes of it, the fixed asset’s fair value is $2,500.
Compare the asset’s carrying value to its fair value. If the asset’s carrying value is greater than its fair value, the difference in the two values equals the impairment loss the company can record on its books.
Record a journal entry for the impairment loss. The company reports the impairment loss as an expense on the income statement, which ultimately reduces net income for the year. The impairment also reduces the asset’s net carrying value on the balance after reducing the balance of the accumulated depreciation account. The journal entry requires that you debit the impairment loss expense and credit accumulated depreciation for the same amount.
Recalculate future depreciation expenses. Because the value you report for the fixed asset decreases, so must its annual depreciation expense. Future depreciation expense for the asset will equal the asset’s fair value less its salvage value, divided by its remaining useful life.
There is no requirement that every fixed asset must have a salvage value. If there is no market for the asset at the end of its useful life, recording a zero salvage value is common.
Recording an impairment loss is not permissible for ordinary fluctuations in market price and demand. The Financial Accounting Standard Board (FASB) requires that you only record an impairment loss if the decrease in market price is significant, the company decides to use the asset for an entirely different purpose than when it was acquired or legal developments significantly restrict the usefulness of the asset.