Internal Control of Fixed Assets: A Controller and Auditor's Guide

CHAPTER FIVE 5

Impairment Testing

TESTING FOR THE IMPAIRMENT of assets (both tangible and intangible) is not only a generally accepted accounting principle (GAAP) requirement but absolutely essential in terms of internal control. It is critical that the real value of assets never be overstated. Keeping overvalued assets on the balance sheet misleads management, not to mention outside users of financial statements such as creditors and investors. Yet, as will be seen, there is often great reluctance to recognize impairment charges when they are required by GAAP and internal control.

The reason is simple. All impairment charges (with the possible exception of valuations of certain financial instruments which are not covered in this book) result in a charge to expense, which leads to a reduction in reported net income. We have yet to meet a CFO who wants to report less income to creditors and shareholders, disregarding for the moment the impact of impairment charges on taxable income and hence income taxes payable.

As a generalization while GAAP requires impairment testing at least annually, relatively few such charges made for financial statements have any effect on taxable income. So, in a sense, impairment charges when required and taken represent “All Pain, No Gain.” Nonetheless, no matter how painful, impairment testing is required and unfortunate results, no matter how unexpected, must be reflected in audited financial statements.

Controllers and CFOs, as well as CEOs and audit ...