Introduction
The following essay is concerned with the measurement of impairment of many types of assets in company reporting. It is considered that the measurement of the amount of impairment of many types of assets is so subjective as to be meaningless. This essay thus discusses the extent of this allegation with the aid of relevant examples. Impairment of assets is an accounting principle that holds the view that the financial assets should not appear in the balance sheets at the excessive variations and therefore there is need for specification of the value concept against the carrying minimum so as to determine whether or not the valuations are excessive.
The impairment of assets is thus the diminishing value of a given asset and this value is obtained by the comparison of the fixed assets’ value with the recoverable amount (The University of California, 2001, 20). The main benefits that arises from impairment are that, when applied appropriately, the impairment charges helps the shareholders and business analysts to evaluate the firm’s senior leadership so as to ensure that sound financial decisions are arrived at.Also,impairment charges helps the firm to determine the signs of business failure and thus take the appropriate actions.
However,Impaiment has some limitations which includes the following; It is hard to determine the value of measurement that should be applied when impairing the assets and also there is no guidance that provides the accountants with detailed information on how to measure impairments( International Accounting Standards Board, 2006, 65-67).
The following thus are the main reasons as to why the measurement of the amount of many types of assets is so subjective as to be meaningless;
Conditions necessary for the impairment of assets to occur
Decline of the asset fair value
Usually, the main aim of recognizing the assets impairment is to provide the company with better financial statements as loss is recorded when incurred and the fair value is reported for the productive assets. Asset impairments arise as a result of declining of fair value below its carrying amount and the recognition is important as it helps to reflect the firm’s investment value. The Generally accepted accounting principles provides that the management exercises significant flexibility i.e. the evaluation of the asset impairment is very subjective e.g. it provides that the assets should not be recognized for the impairment frequently because the Financial accounting standards board concludes that this is costly for the firm.
The senior leadership also has some significant flexibility of determining which assets should be included in and excluded in. Also, it is so subjective for a company to determine its future cash flows e.g. a firm may be required to use its current cost or expected cost. The management is also vested with the role of making discount rate decisions and therefore they may deem it necessary to recognize large losses so as to reduce the book balance to a lower amount. This will thus mean that the depreciation expense will be lower whereas the future’s net income will be higher.
Internal and external sources of information
The main indications of asset impairment are the internal and external sources of information. It is worth to note that the indication does not necessarily apply to each and every firm. The internal sources take in to account the physical damage reporting evidence, operating sources and other related information. The obsolescence and physical damage of assets are they easiest ways of identifying the impairment since one can physically observe the items.
The external sources of impairment information include a decline in the market value of an asset due to normal use or time lapse. This decline may be a as result of a decrease in asset’s market value e.g. building a head office or as a result of decrease of the item’s sales price. Other external sources of impairment information include an increase of the carting amount above the market capitalization and an increase in interest rates of the market on investments during a given period of time (Paul, 1997, 67).
Identifying the assets that may be impaired
Usually, there are numerous assets that may be recognized for impairment and the items comprises of all the asset projects. Basically, the presence of many assets for impairment is associated with complex causes from the management. The following are the assets that should be identified for impairment i.e. the trading financial assets, stock, held-to-maturity investments and intangible assets.
Trading financial assets
The trading financial assets are classified into three categories i.e. financial assets at fair value through profit or loss, available for sale and loans and receivables. According to the International Accounting Standards (IAS 39), the financial asset should only be impaired when the carrying amount is above the recoverable amount. However, recoverable amount requires to be estimated in order for the objective evidence to exist i.e. in order to show that an asset has been impaired (Spiceland & Tomassini, 2005, 26-29).
The main challenge with regards to impairment of financial assets at their fair value through profit and loss is that it is difficult to exclude the unrealized revaluation profits from the dividends distribution. The central banks therefore have the challenge of ensuring that their book balance is well classified in order to avoid the unnecessary volatility associated with reported income and thus subjective arises as a result. The available for sale financial assets, are the those that are not held to be traded and are thus the management may decide to sell them once they anticipates the need for the liquidity changes.
According to the International Accounting Standards(IAS 39) , the profits and losses that are as a result of the alterations in assets’ fair value should be regarded as comprehensive income and therefore, the objective evidence as to whether the financial asset is impaired or not does not exist( International Accounting Standards Board,2006, 65-67). Loans and receivables refer to the determinable payments and are thus recognized on contract signing date.
The loans and receivable items are comprised of the debt instruments that have similar characteristics and interest is normally recognized on accrual basis.Usually, loans and receivables are considered to be impaired when they are believed that it is impossible to recover the unpaid amounts.Thus, the impairment of loans and receivables entails the management to come up with complex judgments which in most cases are subjective (Revsine &Johnson, 2005, 30).
Stock
The impairment of stock is subjective in that there are changes in the accounting standards that have the effect of significantly changing the reported financial condition of a firm. These changes includes the inventories e.t.c. that calls the senior leadership team to come up with complex estimates as well as judgments which are very subjective in most occasions( International Accounting Standards Board ,2006,93).
Investments held to maturity
The held-to-maturity entails the long-term securities that a firm holds as it waits for the maturity date and therefore, the impairment of held-to-maturity is subjective in that these investments are not significant individually implying that the management can decide to evaluate them individually or to evaluate them as a group (Weygandt et.al.,2004,104).
Intangible assets are the assets that should be identified for impairment.Usually, the International Accounting Standards requires that the impairment loss to be allocated to goodwill first and then to intangible assets.
Intangible assets
The impairment of intangible assets is subjective in that not all the intangible assets are similar with the goodwill e.g. franchise rights and licenses and therefore their value are always subjective as opposed to that of the tangible assets (Financial Accounting Standards Board,1990, 45).
How impairments should be disclosed
Management usually makes various judgments as they apply the accounting policies of an entity. This judgment can affect the recognized amounts in the company’s financial statements. The management also faces uncertainty in estimating the assets’ carrying amount. In order to determine the assets’ carrying amount, the management should estimate the effects of uncertainty of the future events. According to the International Accounting Standards (IAS1 (116), the management should disclose notes whenever they estimate uncertainties that can cause significant risk to the assets’ carrying amount over the coming financial year.
The notes that should be disclosed are the information concerning the assumptions relating the future as well as the main estimation sources of uncertainty at the end of an accounting period. These disclosures are however different form the estimates that are arrived at by management as they apply the accounting policies. The judgments thus require assumptions and uncertainty and this renders the judgments to be considered as subjective. The complex judgments increase with the increase in the amounts of assumptions and variables that affects the future resolutions (Spiceland & Tomassini, 2005, 26-29).
Conclusion
The measurement of the amount of impairment of many types of assets does not seem to be very objective and may not be meaningful. The conditions necessary for the impairment of assets to occur, identifying the assets that may be impaired and how impairments should be disclosed supports this assertion. The management thus is vested with complex decisions about the assets impairment and in most cases, their judgments tend to be subjective rather than objective.
It is very hard to agree on which value of measurement should be taken no as to assess the impairment of the assets. For instance, the management has the choice of opting for replacement cost, market fair price among others. There is slight complete guidance that exists concerning the assets to be impaired. It is also difficult to determine when impairment should be recognized and how the measurement of impairments should be done. It is often very challenging to determine the fair value as various professionals have varying valuations and this implies that the mere definition of impairment lies in the beholders’ eye.
Therefore, the meaning of the term impairment is just but an individual judgment and so, the measurement of the amount of impairment of many types of assets may not achieve any specific objective. The processes involved should be revamped in order to make sense.
Reference List
Financial Accounting Standards Board. 1990. An Analysis of issues related to Accounting for the impairment of long-lived assets and identifiable intangibles. Norwalk: Financial Accounting Standards Board.
International Accounting Standards Board., 2006. FRS 2006. London: Pearson/Prentice Hall.
International Accounting Standards Board., 2008. International Financial Reporting Standards IFRS 2008. London: Pearson/Prentice Hall.
Paul, J., 1997. International review of accounting standards specifying a Recoverable amount test for long-lived assets. Norwalk: Accounting Standards Board.
Revsine, L.J. & Johnson, B., 2005. Financial reporting and analysis. London: Pearson/Prentice Hall.
Spiceland, D & Tomassini, L., 2005. Intermediate Accounting. New York: McGraw-Hill/Irwin.
The University of California., 2001. Business week, Issues 3744-3746.New York: McGraw-Hill.
Weygandt, et.al. 2004. Accounting Principles, Chapters 1-13. Hoboken: John Wiley & Sons.