Depreciation, Amortization, and Impairment of Assets

Depreciation and amortization systematically allocate the cost of tangible and intangible assets over their useful lives.

Impairment reflects a permanent decline in the value of assets, requiring immediate write-downs to fair value.

Proper accounting for asset reduction ensures accurate reporting of asset values, expenses, and profitability under US GAAP and IFRS.

Failure to apply these concepts correctly leads to overstated assets, understated expenses, and misleading financial statements.

Overview / Definition

✦ Depreciation applies to tangible assets (e.g., machinery, vehicles, buildings) and spreads their cost over their useful lives.

✦ Amortization applies to intangible assets (e.g., patents, software licenses, trademarks), allocating their cost systematically.

✦ Impairment occurs when the carrying amount of an asset exceeds its recoverable amount, requiring an immediate write-down.

These methods are critical for matching expenses to the periods in which assets generate revenue, following the matching principle.

Recognition and Measurement

Depreciation Methods (Tangible Assets):

✦ Straight-Line Method: Equal expense each year.

✦ Declining Balance Method: Accelerated depreciation recognizing higher expense in earlier years.

✦ Units of Production Method: Based on actual usage or output.

Example – Straight-Line Depreciation:

• Asset Cost: $50,000

• Residual Value: $5,000

• Useful Life: 5 years

Annual Depreciation = ($50,000 – $5,000) ÷ 5 = $9,000

Journal Entry:

debit Depreciation Expense – 9,000

credit Accumulated Depreciation – 9,000

Amortization Methods (Intangible Assets):

✦ Typically uses the straight-line method unless a better method reflects consumption of economic benefits.

✦ Intangible assets with indefinite lives (e.g., goodwill) are not amortized but tested for impairment annually.

Example – Amortization of a Patent:

• Cost: $120,000

• Useful Life: 10 years

Annual Amortization = $120,000 ÷ 10 = $12,000

Journal Entry:

debit Amortization Expense – 12,000

credit Accumulated Amortization – Patent – 12,000

Impairment of Assets:

✦ Under US GAAP (ASC 360) and IFRS (IAS 36), impairment testing is performed when indicators of impairment exist.

✦ For goodwill and indefinite-lived intangibles, impairment testing is performed at least annually.

Example – Impairment Calculation:

• Carrying Amount of Equipment: $100,000

• Recoverable Amount (Fair Value): $80,000

Impairment Loss = $100,000 – $80,000 = $20,000

Journal Entry:

debit Impairment Loss – 20,000

credit Accumulated Impairment – Equipment – 20,000

Journal Entry Examples

1. Depreciation Using Declining Balance (Double Declining, Year 1):

• Asset Cost: $50,000, Useful Life: 5 years

Depreciation Rate = 2 × (1 ÷ 5) = 40%

First-Year Depreciation = $50,000 × 40% = $20,000

debit Depreciation Expense – 20,000

credit Accumulated Depreciation – 20,000

2. Impairment of Goodwill (Under IFRS):

• Carrying Amount of Goodwill: $150,000

• Recoverable Amount: $100,000

Impairment Loss = $50,000

debit Impairment Loss – 50,000

credit Goodwill – 50,000

Disclosure Requirements

Companies must disclose:

✦ The depreciation and amortization methods used and their useful life assumptions.

✦ The total amounts of depreciation, amortization, and impairment losses recognized during the period.

✦ The carrying amounts of tangible and intangible assets.

✦ Details of significant impairment tests, including assumptions and discount rates used.

Disclosures typically appear in the notes to the financial statements under the Assets and Expenses sections.

IFRS Comparison

Criteria	US GAAP	IFRS
Depreciation Methods	Straight-Line, Accelerated	Similar Methods Allowed
Amortization of Intangibles	Over Useful Life	Over Useful Life
Goodwill Amortization	Not Allowed	Not Allowed
Impairment Testing	Trigger-Based for Most Assets	Annual for Indefinite-Lived Assets
Reversal of Impairment	Not Allowed	Allowed (Except for Goodwill)

IFRS allows impairment reversals for certain assets (excluding goodwill), while US GAAP prohibits reversals of previously recognized impairments.

Common Errors

✦ Incorrect Useful Life Estimates: Leads to misstated depreciation and amortization expenses.

✦ Failing to Test for Impairment Timely: Results in overstated asset values and delayed recognition of losses.

✦ Using Inconsistent Depreciation Methods: Applying different methods for similar assets without valid justification.

✦ Recording Impairment Losses Incorrectly: Not reducing the correct asset values or misclassifying the impairment expense.

✦ Insufficient Disclosures: Failing to provide clear information about asset valuations, impairment testing, and assumptions used.