When should a business recognize an asset loss?
- Floyd Paguio
- 10 hours ago
- 3 min read
WE often think of an asset as something that adds value to a business. A company buys a building, a machine or another business because it expects to benefit from it for many years.
But owning an asset does not mean that its value stays the same forever.
A machine that was once highly productive may become outdated. A busy branch may start losing customers. New technology may change the way an industry operates. A business acquired with high expectations may eventually fail to deliver the results that management had hoped for.
Yet the asset may still be sitting in financial statements at an amount based on expectations from better days.
So, when should a business accept that an asset is no longer worth as much as what is recorded in its books?
This is where IAS 36, Impairment of Assets, comes in. The idea behind the standard is quite simple: an asset should not remain in the financial statements at an amount higher than what the company can reasonably recover from it.
Watch for warning signs
Not every bad month or decline in sales means that an impairment loss should be recorded. But there are warning signs that management should not ignore.
Some come from outside the business. The market value of an asset may have dropped significantly. New technology may make existing equipment less useful. Higher interest rates, weaker customer demand, stronger competition or changes in laws may also affect an asset’s value.
Other signs can be seen inside the company. A machine may be damaged or rarely used. A store or branch may repeatedly fail to meet its targets. Management may decide to close, restructure or reduce part of the business.
These situations should lead management to ask whether the amount recorded for the asset can still be recovered.
Putting value to the test
IAS 36 requires a comparison between the asset’s carrying amount and its recoverable amount.
The carrying amount is basically the amount at which the asset is currently reported in financial statements after considering depreciation or amortization and previous impairment losses.
Recoverable amount, meanwhile, is the higher of value in use and fair value less costs of disposal.
Simply put, management considers two possibilities: What can the business recover by continuing to use the asset? What can it recover by selling it? The higher amount is used in determining whether there is impairment.
Consider a machine with a carrying amount of P10 million. The products made by the machine are no longer selling as well as before and newer technology has entered the market. After performing an impairment test, the company determines that the machine’s recoverable amount is only P7 million.
The difference of P3 million is recognized as an impairment loss.
This does not mean that the machine has become worthless. It simply means that keeping it at P10 million in the books can no longer be supported by what the company expects to recover from it.
When assets work together
In real business situations, assets do not always generate cash on their own.
Think of a restaurant. Its ovens, refrigerators, furniture and other equipment work together to serve customers. It would be difficult to determine how much cash one refrigerator or one dining table generates by itself.
For this reason, IAS 36 uses the concept of a cash-generating unit, or CGU. When an asset cannot be tested on its own, it may be tested together with the smallest group of assets that generates largely independent cash inflows.
Goodwill also requires special attention. Goodwill commonly arises when a company buys another business and pays more than the fair value of its identifiable net assets.
Instead of being amortized, the CGU or group of CGUs to which goodwill is allocated must be tested for impairment every year, and whenever there are signs that impairment may exist.
This is important because the expectations made when a business was acquired may not always happen. Customers may leave, competition may become stronger or the expected growth may simply not come.
Keeping the numbers grounded
No business wants to recognize an impairment loss. It reduces reported profit and may affect financial ratios watched by investors, lenders and management.
But delaying a loss does not bring back the value of an asset.
That is perhaps the practical lesson behind IAS 36. Financial statements should not simply hold on to yesterday’s expectations when today’s business conditions tell a different story.
In the end, computing an impairment loss may be the easier part. The harder part is sometimes accepting that an asset that once looked promising is no longer worth what the books say it is.
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Floyd C. Paguio is the chairman of Paguio, Dumayas & Associates, CPAs, the Philippine member firm of PrimeGlobal International and the president of KCD College of Accountancy in Alaminos, Laguna.
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