FAR CPA Practice Questions: Calculating Impairment Losses

In this video, we walk through 5 FAR practice questions teaching about calculating impairment losses. These questions are from FAR content area 2 on the AICPA CPA exam blueprints: Select Balance Sheet Accounts.

The best way to use this video is to pause each time we get to a new question in the video, and then make your own attempt at the question before watching us go through it.

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Calculating Impairment Losses for Long-Lived Assets

Impairment losses on long-lived assets are recognized when an asset’s carrying amount exceeds its recoverable amount, which is based on undiscounted future cash flows and fair value. This process ensures that assets are not overstated on the balance sheet. The following sections explain how impairment losses are calculated, whether they can be recovered for different asset types, and how they impact depreciation and carrying amounts.

How to Calculate an Impairment Loss

The impairment process begins by assessing whether the carrying amount of the asset exceeds the undiscounted future cash flows expected from its use and eventual sale. This is known as the recoverability test.

• Carrying amount: The current book value of the asset, which is the original cost minus accumulated depreciation.
• Undiscounted future cash flows: The estimated total cash flows the company expects to receive from the asset.
• Fair value: The market value of the asset if it were sold.

If the carrying amount exceeds the undiscounted future cash flows, the asset is considered impaired, and an impairment loss must be recorded. The impairment loss is calculated as: Impairment loss = Carrying amount − Fair value

Example Calculation:

• Original cost of the asset: $600,000
• Accumulated depreciation: $250,000
• Carrying amount: $600,000 – $250,000 = $350,000
• Undiscounted future cash flows: $200,000
• Fair value: $180,000

Since the carrying amount ($350,000) exceeds the undiscounted future cash flows ($200,000), the asset is impaired. The impairment loss = $350,000 – $180,000 = $170,000

Recoverability of Impairment Losses: Assets Held for Use vs. Assets Held for Disposal

• Assets Held for Use: Impairment losses for assets held for use cannot be reversed, even if the asset’s fair value later increases. Once an impairment loss is recorded, the carrying amount of the asset remains reduced, and further depreciation is based on this new lower value.
  • Example: If the fair value of the asset mentioned above increases to $220,000 in a subsequent year, the company cannot reverse the impairment loss.
• Assets Held for Disposal: For assets held for disposal, impairment losses can be reversed, but only up to the original carrying amount before the impairment. If the fair value of the asset increases after an impairment loss, part or all of the loss can be recovered, but the carrying amount cannot exceed what it was before the impairment.
  • Example Calculation:
    • Impaired carrying amount: $180,000If the fair value increases to $220,000, the recoverable amount is: Recoverable amount = New fair value − Disposal costs
  • If the carrying amount before impairment was $350,000, only up to $170,000 can be reversed, bringing the asset’s carrying amount back to $350,000.

Effect of Impairment on Depreciation and Carrying Amount

When an impairment loss is recognized, it impacts both accumulated depreciation and the carrying amount of the asset.

• Impact on Carrying Amount: The impairment loss reduces the asset’s carrying amount to its fair value. After impairment, the carrying amount is used to recalculate depreciation for the remaining useful life of the asset.
• Example:
  • Carrying amount before impairment: $350,000
  • Fair value after impairment: $180,000
  • New carrying amount: $180,000
• Impact on Accumulated Depreciation: An impairment loss is treated as an increase in accumulated depreciation. The asset’s new carrying amount is then depreciated over its revised remaining useful life.

Depreciation Calculation Example After Impairment:

• After impairment, assume the remaining useful life of the asset is revised to 4 years, and the salvage value remains $20,000.
• Depreciation after impairment = (Carrying amount after impairment – Salvage value) ÷ Remaining useful life
• Depreciation = ($180,000 – $20,000) ÷ 4 = $40,000 per year.

At the end of the next year, the total accumulated depreciation would include the original depreciation, the impairment loss, and the new depreciation: Accumulated depreciation = Original depreciation + Impairment loss + New depreciation

In this case: Accumulated depreciation = 250,000 + 170,000 + 40,000 = 460,000

Conclusion

Impairment losses are critical for ensuring that long-lived assets are accurately reflected on financial statements. They reduce the carrying amount of an asset, which also affects future depreciation. While impairment losses cannot be reversed for assets held for use, they can be partially or fully recovered for assets held for disposal, up to the original carrying amount before the impairment occurred.

Understanding how to calculate impairment losses and their impact on depreciation helps companies maintain accurate financial reporting and ensures assets are not overstated.