Tata Steel was in news this week, for the wrong reason. The company announced that it expects a $1.6 billion write-down of goodwill and assets for 2012-13 based on its impairment review for the year.
So what is impairment? It is a term used in the context of an asset, the value of which has declined.
An asset gets impaired when the value at which it is stated in the balance sheet exceeds its resale value. And the difference between the two values gives the impairment loss on account of that asset.
A company by booking an impairment charge is then simply aligning the book value of assets (as given in the balance sheet) to their market value.
How is the impairment loss worked out? The carrying value of an asset is arrived at by subtracting from its acquisition cost, the accumulated depreciation on it. This is the value at which an asset is recognised or carried in the balance sheet.
When it comes to calculating the recoverable amount, taking the asset’s fair value is one way to go about it. It is the amount that would be obtained from the sale of that asset.
An impairment assessment can be done with respect to tangible assets – plant, equipment and building or intangible assets – goodwill, patents, and brand value.
Most assets do not have to be tested for impairment on a regular basis unless certain circumstances such as a negative change in technology, economy or laws warrant it.
But intangible assets with an indefinite life such as goodwill have to be put to an impairment review regularly.
If the review indicates an impairment loss, an adjustment for that is made in the profit and loss account for that year.
On the balance sheet, the asset is carried at the reduced value and the equity is reduced by the amount of the loss.
WHAT IT MEANS
Impairment could indicate that there are concerns with regard to a company’s earnings in the near future. For instance, Tata Steel has estimated impairment charges for FY13 mainly due to weaker macroeconomic and market conditions in Europe.
The fact that Tata Steel’s European operations have been a drag on its overall performance was however already known. The latest exercise will simply help it adjust its balance sheet in tune with market reality.
Accounting for an impairment charge would reduce the net worth or book value (assets minus liabilities) of a company.
This would give investors a truer picture of a company’s worth, one that is more in accordance with times.
Also, when a company writes off substantial amounts on account of asset impairment, doubts can be raised about the management’s decision making.
For instance, if a company takes massive goodwill write offs in years subsequent to an acquisition, it could mean that the price paid for the assets acquired was probably too high, one not justified by future returns.
