Impairment and Derecognition of PPE and Intangible Assets

The impairment and derecognition of a company’s property, plant, equipment, and intangible assets can significantly affect its financial statements and the resulting ratios.

The Effect of Impairment and Derecognition on Financial Statements and Ratios

Impairment of Finite Life Intangible Assets

Intangible assets that have a finite lifespan are amortized, leading to a gradual reduction in their value over time. These assets may also face impairment. As with physical assets like property and equipment, intangible assets aren’t assessed for impairment annually; assessment only occurs when significant events warrant it.

The company evaluates if any substantial events that indicate potential impairment have arisen by the conclusion of each reporting period. Such events might involve a noteworthy drop in market value or a significant adverse shift in legal or economic circumstances. The process of accounting for impairment in intangible assets of finite life mirrors that of tangible assets. An impairment loss lessens the asset’s recorded value on the balance sheet, reducing net income on the income statement.

Impairment of Indefinite Life Intangibles

Intangible assets of an indefinite lifespan are not subject to amortization. They’re recorded on the balance sheet at historical cost and are evaluated for impairment at least once a year. Impairment occurs if the carrying amount exceeds the asset’s fair value.

Impairment of Long-Lived Assets Held for Sale

When management intends to sell a long-lived asset and its sale is highly likely, the asset is reclassified as “held for sale” instead of “held for use.” This reclassification requires the asset to be immediately sale-ready in its current state. For instance, if a company plans to sell a building it no longer requires and meets the accounting criteria, the building is moved from property, plant, and equipment to non-current assets held for sale.

Upon reclassification, assets previously held for use undergo an impairment test. If, upon reclassification, the carrying amount is higher than the fair value minus selling costs, an impairment loss is acknowledged. The asset’s value is then adjusted to fair value minus selling costs. Assets held for sale are no longer subject to depreciation or amortization.

Reversals of Impairments of Long-Lived Assets

When an impaired asset’s recoverable amount rises, it might result from factors like a successful lawsuit appeal. For instance, a patent previously devalued due to infringement claims could regain value. IFRS allows the reversal of impairment losses if an asset’s recoverable amount increases, regardless of its use or sale classification. Note this is only for reversals, not revaluations surpassing prior carrying amounts. In contrast, US GAAP treats reversals differently based on use or sale classification. Once impaired under GAAP, assets held for use can’t be reversed. Increased fair value can reverse an impairment loss for assets held for sale.

Derecognition

An asset is derecognized whenever it is disposed of or is expected to provide no future benefits from its use or disposal.

Gains or losses from the sale of assets are disclosed on the income statement, either as a component of other gains and losses or in a separate line item when the amount is material.

When an asset is retired or abandoned, its value is reduced by the carrying amount at its retirement or abandonment. A loss equal to the asset’s carrying amount is then recorded.

When an asset is exchanged, its carrying amount is removed, the fair value of the acquired asset is added, and any difference between the carrying amount and the fair value is reported as a gain or loss.

Question

Which of the following statements is the most accurate?

1. Impairment losses reduce the carrying amount of assets and increase the net income reported on the income statement.
2. If revaluation increases an asset’s carrying amount, the increase in the asset’s value will appear as a gain on the income statement.
3. When an asset is retired, the carrying amount is removed from the balance sheet, and a loss (or gain) is recorded for the difference between the carrying amount and any proceeds received from the disposal of the asset.

Solution

The correct answer is C.

When an asset is retired or sold, its carrying amount is removed from the balance sheet, and any difference between the carrying amount and the proceeds from the disposal is recorded as a gain or loss in the income statement.

A is incorrect. Impairment losses reduce the carrying amount of assets and decrease, not increase, the net income reported on the income statement.

B is incorrect. Under IFRS, increases in the carrying amount from revaluation are generally recognized in other comprehensive income and accumulated in equity under the heading of revaluation surplus, not as a gain in the income statement (unless it reverses a previous revaluation decrease that was recognized in profit or loss).