 Hello and welcome to the session in which we'll discuss the concept of impairments, specifically the impairments of asset. What is the big idea about impairment? Well, what happened is this, you do have an asset. Somehow this asset lost utility. What does that mean? It means the asset is not serving you as much as it was originally intended. Something happened to the asset. Now you purchased the asset at a million dollar. Now it's not really because you thought it's going to provide a certain benefit. Now it's not going to provide that benefit anymore. It has a loss of utility. What's going to happen? You have to write down the asset. Why do you have to write it down? Because of conservatism. This is a deviation from the historical cost principle. When you let's assume you bought property, plant and equipment. What we learn is you reported at cost through unless this asset lost utility. If it lost utility, you have to write it down. And this is what we say in accounting conservatism. Also, why do we have to write it down? Because of the matching principle is if this asset is no longer serving us. And because of this asset, now we might be incurring a loss. Record the loss now. This is what the matching principle is matching the loss in the proper period. Now how do impairment works? Well, what happened is there are certain event that could trigger or that that could indicate impairment. Something happens and the company on a yearly basis, what they have to do, they have to sit down and ask themselves that anything happened that could have impaired our assets. And if it did, let's do the impairment test, which we'll talk about. So what are some events that could trigger or indicate impairment? One thing could be there was a major drop in the fair value of the asset. What does that mean? It means the value of your asset suddenly dropped. Why? There must be a reason it could be your asset becomes obsolete because new technology came out. Well, that's that's an event for an impairment. It means your asset is not as good as you thought it was originally. It lost some utility. Another reason could be the asset is suddenly being used for an alternative purpose while you purchase the asset to produce certain units. Now, you're no longer producing those units. Why not? Did the asset lost utility? And if so, it could be a possible impairment. It could be an adverse legal or administrative decision. A good example of this Uber in the city of London or let's assume the FDA in America said your your drug is no longer can no longer be on the market for safety reasons. Well, guess what? The assets that are related to that drug could be impaired or your inventory. If you have inventory of that drug, but the Uber case is a good example where the city of London, what they did, they strip away the license for Uber to operate. So if Uber has any assets in the city of London, what's going to happen? Those assets becomes impaired. They have to write them down, assuming they cannot use them somewhere else because the transport for London, the TFL says, guess what? You can no longer operate in our city. Therefore, the assets that are allocated to that city, they are impaired. Another reason will be or another indication. The cost incurred for that asset is we are buying or many or manufacturing the asset is much larger than originally anticipated. It means that the asset is not as useful as it was before because for an asset to be useful, the cost has to be lower. So the benefit is greater. Or if you are doing projection and forecast, this asset is projecting losses. It's constantly projecting losses in the foreseeable future. So what happened is there are other events that could trigger impairment, but this is some typical events. So the company would look would look at those events. And once an event has been identified, what they do next, they go through a two-step process. Now, the best way to illustrate this two-step process is to show you the two-step process, then we work an example. Before we do so, I would like to let you know that this topic is covered in intermediate accounting as well as the CPA exam. Whether you are an accounting student or a CPA candidate, I strongly suggest you take a look at my website, farhatlectures.com. I don't replace your CPA review course. I'm a useful addition to your CPA review course. I explain the material differently. I explain the theory behind the concept. I'm slower than your CPA review course. I go a little bit more in depth by doing so, I can help you understand the material better, fill those gaps for you, which will help you with your CPA review course. Your risk is one month of subscription. Take a look at it. Give it a try. Your CPA is a lifetime investment. Don't shortchange yourself. If it's helping you, good. If not, cancel. And this is a list of all my accounting courses that I have resources for lectures, multiple choice questions and other resources. And my CPA review, review modules are aligned with your Becker, Wiley, Gleam and Roger. So it's very easy to go back between your CPA review course and my material. If you have not connected with me on LinkedIn, please do so. Take a look at my LinkedIn recommendation, like this recording, share it with other connect with me on Instagram, Facebook, Twitter and Reddit. Let's talk about the two step process. Step one is called Recoverability Test. What do we do in step one? Step one is basically we look at the expected future net cash flow, undiscounted, basically raw cash flow from this asset. And if that cash flow is less than the book value or the carrying value of the asset, then we might have an issue. If the answer is no, if the answer is no, what does that mean? No means the expected future cash flow is greater than the book value. Simply put, if you're going to be bringing enough money from this asset, that's greater than the book value, then you have no impairment. You stop. We stop there. But if the expected future cash flow, the undiscounted amount is less than the book value, if the answer is yes, then you go to step two. So step one, it's either the answer to step one, either a yes or a no. If the answer is no, what we do is we stop. If the answer is yes, that means there's a possible impairment. Now we have to measure the impairment. How do we measure the impairment? We measure the impairment by comparing the fair value of the asset versus the book value or the carrying value of the asset. So the first thing I want you to notice that the book value is on both equation. The book value is in step one and the book value is in step two. In step one, you compare the future cash flow. Simply put, you're asking yourself, can I generate enough cash, raw cash, undiscounted cash to recover my book value? If the answer is no, you could possibly have an impairment. That's when you go to step two. In step two, you would look at your fair value, compare the fair value to the book value. That's the same thing in step one, the book value in step one. And the difference between them is your impairment loss. We're assuming that your fair value is lower. Now, sometimes the fair value may not be giving. You might be giving the present value of the expected future cash flow. So what happens is to find the fair value, you discount the future cash flow. And now maybe you understand why I kept emphasizing the word undiscounted. So in step one, you would use the undiscounted future cash flow. In step two, if you are giving the discounted cash flow, it means that's the fair value of the asset. So you compare the fair value to the book value. And the difference between them is actually your loss. Now, the best way to illustrate this is to work an example. So let's assume Aram company had a machine that it reviews for a possible impairment. The machine carrying amount is 700,000, which is a million dollar of a cost minus 300 of accumulated depreciation. Aram determined that the expected future net cash flow from the use of this asset and its eventual disposal is 750. Let's see what we have here. We have expected future cash flow 750. We have an asset with the book value of 700,000. Guess what? The expected future cash flow is less, is greater than the book value. We stop. We have no impairment. That's it. We don't, we don't proceed any further because we have no impairment. Now let's assume, let's change the example a little bit and let's assume rather than 750, let's assume the expected future cash flow and its eventual disposal is 600,000. Let's do this test now. Well, expected future cash flow is 600,000. Book value is 700,000. The expected future cash flow is less than the book value. We cannot recover our book value. Guess what? There is a possible impairment. Do we have an impairment? Yes. How much? A lot of students would say it's 100,000. Wrong. The, to find out the impairment, you go to step two. Step two, you have to know the fair value of the asset. Well, the fair value of the asset, let's assume it has 525. So hold on a second. You're telling me that the expected cash flow is 600,000, but the fair value is 525. Yes, because you need to discount the future cash flow. Also, you might be breaking 600,000, but if you want to sell the asset, you are only going to net 525. Now we compare 525, the fair value to the book value of 700,000. Now we have the loss. Well, the difference, hopefully you can see the difference. The difference is 175,000. We have 175,000 in impairment loss. We're going to debit loss on impairment and basically loss and impairment is part of other expenses, part of continuing operation. The company incur experience loss on impairment on a regular basis. It's part of business. You buy an asset, it's no longer as good as you thought it will be. So you debit loss, you credit accumulated depreciation. So this is the journal entry and it goes into regular, into your regular expenses, other expenses, your continuing operation. Now what happened post impairment? You impaired an asset. What's going to happen next? Well, what's going to happen next, depending whether the asset is held for use, it means it's used in operation or the asset is held for sale. Simply put, you're holding this asset to sell it. Well, if it's used in operation, the new lower cost becomes the cost basis because you reduce the book value. You took a loss. The new lower cost is the cost basis. Now also here, you could have also reduced the asset itself, by the way. You could also reduce the asset itself in some textbook. They reduce the asset or you could lose by reducing accumulated depreciation. You basically reduce the asset than the net book value of the asset. So you have a new lower cost becomes the new cost basis. You have no depreciation or if it's an intangible asset, a new amortization and no restoration of impaired losses. So although the asset went back up in value, let's assume the city of London allowed Uber to operate again, it does not matter. They cannot write up their asset if those assets are held for operation. If the asset held for sale, which is basically inventory type of set, something you're going to sell, you would report at LCM or net realizable value, how much you can get for it. And for asset held for sale recover, you can recover the impairment back to the original book base, book basis. So simply put, if your book value was a million, you write it down to 800,000, you took a loss and some something happened and now your your value is more than a million. You could only recover up to a million. And any gain or loss for those type of losses and gains are part of continuing operation. Once again, impairment losses are part of business. That's fine. Part of life of the company. Let's live with it. Now, the best way to understand this work better is to visit my website and take MCQs, multiple choice questions to solidify your knowledge. At the end of this recording, I'm going to remind you again, whether you are an accounting student or a CPA candidate, I cannot remind you enough, invest in yourself. Your CPA is a lifetime investment. It's worth it. Don't shortchange yourself. Give me a try. I can help you understand the material better. My resources can help you prepare for the exam. You need to pass the exam so you can focus on your career. The CPA exam is worth it. Once again, good luck, study hard and, of course, stay safe.