If one of your company’s fixed assets drastically lost value, you might be able to write off the difference as an impairment loss to save a few bucks. But before you do, complete a few simple calculations to ensure your situation is actually an impairment loss, not just normal depreciation.
What Is an Impairment Loss?
An impairment loss happens when the value of a fixed asset abruptly falls below its carrying cost. Basically, that means if the value of an asset decreases so much that the recoverable amount is less than the carrying cost, you can write off the difference.
How to Determine an Asset’s Depreciation and Carrying Cost
Put simply, an asset’s carrying cost is how much it costs you to keep it. To determine the carrying cost, take the acquisition cost (purchase price) and subtract any depreciation.
To calculate depreciation, divide the asset’s purchase price by its lifespan. Then, multiply your answer by the number of years you’ve already used the asset. For example, if you purchased a rental property for $1 million, it has a usable lifespan of 20 years, and you’ve owned it for five years, you:
- Divide 1,000,000 by 20 to get 50,000
- Multiply 50,000 by 5 to get 250,000 — your depreciation amount
- Subtract the depreciation amount from the acquisition amount to get the carrying cost, so subtract $250,000 from $1 million to get a carrying cost of $750,000
How to Determine an Asset’s Recoverable Amount
An asset’s recoverable amount is the higher dollar amount of its fair value less cost to sell or its value in use. The cost to sell is exactly what it sounds like — the amount it costs you to sell the asset. This might include things such as brokerage fees, advertisement costs, and the cost to transfer ownership.
The value in use refers to the present value of future cash flows — basically, how much money you could make if you kept the asset. You need to calculate both of these things to determine the recoverable amount, because it’s the lesser of the two.
To determine the fair value less the cost to sell, add up how much it would cost you to sell the asset and subtract that from your carrying amount. For example, if it cost you $250,000 to sell the property in the above example, the cost to sell would be $500,000 — $750,000 minus $250,000.
To determine the value in use, calculate the net income the asset brings in for the remainder of its lifespan. For example, if you rented out the building for $3,500 per month, but it cost you about $500 per month to maintain it, you would calculate your value in use on $3,000 not $3,500. So using the previous example, multiply $3,000 by 12 (number of months in the year) to get $36,000. Then, multiply $36,000 by 15 (the number of years left on the asset’s lifespan) to get $540,000.
So for this example, use the fair market value less costs to sell as your recoverable amount because $500,000 is less than $540,000.
Calculating the Amount of an Impairment Loss
Once you know the carrying cost and recoverable amount of an asset, it’s easy to determine an impairment loss. All you need to do is subtract the recoverable amount from the carrying cost to determine the amount you can list as a loss. So using the previous example, subtract $500,000 from $750,000 to get $250,000. This is your total impairment loss and the amount you can write off for the asset.
Writing off an impairment loss along with other common deductions helps reduce the amount of taxes your company has to pay. So you should keep track of all of your company’s assets, the amount you paid for them, and the value of them on an annual basis.
As a small business owner, you need all the tools you can get to see a complete picture of your company’s financial health. Using an accounting system, such as QuickBooks Online, you can generate a Profit and Loss statement automatically. Learn how today.