8. Long Lived Assets
Asset Impairments
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Alright, so now let's discuss a special test that comes up when an asset might be impaired. Let's check it out. So the value of an asset on the balance sheet, remember that the balance sheet is going to show a number for the asset, right? There's this much of the asset. Well, this should represent the future benefits for the company, right? The future benefits that the company is going to receive from this asset. So what GAAP requires for both tangible and intangible assets is we have to test for impairment. What if it doesn't The number that it shows on the balance sheet, well what if it doesn't represent those future benefits? We have to test for this impairment and we do this test annually. Okay? So we generally have to test for impairment annually. So remember that if we've got these expected future benefits, and if they're greater than the net book value, so those future benefits are more than what it says on the book. We're good. We have no impairment. We can move on. But in the other case, if those expected future benefits are less than what it says on the balance sheet, well, in that case, then we do have to do an impairment, right? Because it's not because what it says on the balance sheet doesn't properly reflect what we're gonna get in the future. And notice how we only do it one way and not the other way. This is related to the rule of conservatism, okay? So we usually don't want to write things up when something good happens. We usually only want to We usually only want to look on the bad side, right? If something good has happened, well, leave it as it is just in case that good thing goes away. But if something bad happens, well, we want to take care of that immediately. Okay? So this is the rule of conservatism that we use in accounting. Alright? So if an asset is deemed impaired, well, then we're going to have to take a loss. Okay? And that loss is going to show up on the income statement and it will be a loss from impairment and we'll make a journal entry for this loss to write down the asset to the correct value. And that write down, so it will be at, let's say, a value of 10,000 and we need to bring it down to 8,000. Well, that difference, it's going to be a loss on the on the income statement. Okay? So when we do have an impairment, well, what we do is we impair the asset and we mark it down to its market value, which is sometimes called fair value. Okay? Fair value, market value, fair market value, these terms are used interchangeably throughout accounting. Okay? So we're going to call it fair value here. So this is a 2 step process when we do our test for impairment and it's very easy. When you have to do this in real life, you know, in practice, this can be kind of a convoluted process because you have to find these fair values, expected benefits. And that can be a little tricky, right? But when we do it in an accounting class, it ends up being pretty easy because they have to tell you these numbers. It's not like you're going to be going out and doing some research on the internet. What is going to be worth? No, they're just going to tell you. These are the expected benefits. This is the net book value. This is the fair value. They're just going to give you numbers and you have to know what to do with them. So here we go. The first step in the test for impairment is the actual test. Is this asset impaired? And then the second step is to do the entry that marks it down to fair value. Alright? So let's go ahead and check this out. Test for impairment. So the test for impairment, what we need to check is that net book value greater than those future benefits. So in this case, when we think about future benefits, we're going to think about the future cash flows, right? That's a good estimate of our future benefits, is the cash flows that we're going to receive from this asset in the future. Well, what are those going to be? So if that net book value, remember what we say on the balance sheet, we say that some certain amount, well, if it's greater than those estimated future cash flows, well, we've got an impairment here, right? We're saying it's worth more than it actually is going to be worth to us. So the asset is going to be impaired in this case. So the first step is to check these two numbers. Generally, in a question about an impairment test, they're going to give you three numbers. They're going to give you the net book value. They're going to give you the estimated future cash flows. And then they're going to give you the market value, that fair value. Okay? So the first thing is to check those two numbers. Net book value versus estimated future cash flows. So if what we say on the books is more than those estimate future cash flows, well, we have an impairment. So then we go on to step 2. If not, there's no impairment. No journal entry needs to be made. We can move on with our lives. So if we do see that there is an impairment, then we got to do step 2 and that's to take the impairment loss. Okay? Then we're going to have to make a journal entry to write down that asset and, take this loss. Okay? And the amount of that loss, notice, this is where the fair market value comes in. The amount of the loss is the net book value, so what it's currently valued on the balance sheet, minus the fair market value. Okay? And that's what it's actually worth now. So the net book value minus fair market value, that is the impairment loss. And that's what's going to be going to the income statement. Alright? So let's go ahead and do a really simple example. You'll see how easy these impairment test actually are, when we do it in a question. So on December 31st, Opso Corp tested its long term assets for impairment. A patent with a net book value of 65,000, so there we go. There's net book value, Was determined to have estimated future cash flows of 53,500. There's our estimated future cash flows, which are those expected future benefits and a fair value of 50,000. So there we go. Those are the three numbers, right? These questions are going to be pretty simple because they just give you those numbers, but then the trick is to remember what to do with the numbers. So record any necessary entries related to this impairment test. So let's go ahead and do step 1 of our test. This is where we're going to, compare the net book value, what we currently say it's worth, to the estimated future cash flows. What it could probably get us in the future. So our net book value is 65,000. Let me do this on the side so I can do my journal entry on the left. I'll do this over here. So the net book value is equal to 65,000 and those future cash flows, I'm gonna say FCF is 53500. Okay. So remember, what is that impairment test? Is if the net book value is greater than those estimated future cash flows, well, we have an impairment. So what do you think? Do we have an impairment here? Yeah. The net book value is greater, right? This one is greater than those estimated future cash flows. So since the net book value is greater, well, we have to move on to step 2 and we are going to make a journal entry. So if it had not been greater, we would be done. This would be the test. We would have done the test, said no impairment, no journal entry needed. Okay? But since we did find an impairment, now we need to write down that asset to its fair market value. Okay? So to write it down to its fair market value, our loss is gonna equal what we currently say it's worth, 65,000 minus the fair market value of 50,000. So the loss is gonna be 15,000. Okay? So the loss is 15,000 and that's the number that's going to go into our journal entry. All right? So remember, it's just this 2 step process and all we got to do is find this loss and now let's go ahead and make the journal entry. So the loss on impairment, that's going to be our debit, right? Loss on impairment because losses I like to compare losses with expenses, right? Expenses go up with debits. Well, losses also go up with debits, right? Just like with revenues, revenues are the good things for our company. They go up with the credits and the gains, which is the opposite of a loss, a gain, those go up with credits as well. So remember, the reason we use losses and gains, that's when they're not related to our core business. Our core business is not owning patents, buying and selling patents. No, Opso corp does something else, right? And it just has this patent that it uses in its business. And since we have to write down this this asset, it's not going to be impairment expense. No, it's a loss on impairment because it's not part of the business, right? So loss on impairment and that's going to be in the amount of the 15,000, right? That we found over here. The 15,000 impairment, so that's the debit. And that's going to decrease our income, right? Because it's a debit, it lowers our income. And what's gonna be the credit? Well, the credit is the patent itself, right? The patent had a value of 65,000. Well, we're trying to bring that value down to its fair market value of 50 1,000. So by doing that, right? Let's look at the T account right quick for the patent. Well, it had a value of 65,000, right? And that was a debit because it's an asset, and then we just took 15,000 out with this credit through the loss, and it's left at that fair market value of 50,000. Right? So that's what we have going on here. So what happened? Our assets went down, right? The patent went down by 15,000, And we had a loss, right? The loss goes to equity because it's gonna go on to the income statement and it's gonna lower our equity there, right? So loss is 15,000, patent 15,000. We still work here. One note I want to make before we move on to this practice problem, is notice this. Once an asset has been written down for impairment, so just what we did right now, we wrote down the patent down to 50,000, you can never write it back up. Okay? We're never going to write it back up. That's part of that rule of conservatism. Even if it increases in value, even if we find that the fair market value has gone up to 60,000 next period, too bad. You already wrote it down to 50, it's going to stay there. Okay? If it gets impaired even further, well, we can take another impairment loss, but we're never going to have like, a recovery of the impairment. Nothing like that happens in gap, okay? So let's go ahead and pause here and you guys try a practice problem related to impairment. Let's check it out.
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