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Suppose that a firm bought an asset last year for $500 and it was being depreciated...

Suppose that a firm bought an asset last year for $500 and it was being depreciated at a rate of $100 per year. It is now expected to have cash flows of $125 for the next three years with a theoretical market value of $333. How do firms decide whether or not an asset is impaired?

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Answer #1

Whether or not an asset is impaired is decided by a firm by comparing the asset's carrying value with the expected future cash flows to be derived from the asset.

If the carrying value of the asset is greater than the expected future cash flows, the asset is impaired. If the expected future cash flows are greater than the carrying value the asset is not impaired.

In the given example, the carrying value of the asset is $400 ($500 - $100). The expected future cash flows from the asset are $375 ($125 x 3). Here, the carrying value of the asset is greater than the expected future cash flows. Therefore, the asset is impaired.

Impairment loss is calculated by subtracting the market value of the asset from its carrying value.

Therefore,

Impairment loss on the asset = $400 - $333 = $67

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