Definition of reduction in carrying amount
What is the reduction in book value?
A reduction in the carrying amount lowers the value at which an asset is carried on the books. This reduction occurs because changes in the asset or market conditions have reduced its current market value.
Key points to remember
- A reduction in book value is the result of a decrease in the market value of an asset.
- Reductions in book value on an asset account are accompanied by a charge to an expense account, which decreases the net result of the income statement.
- Many companies will publicly present both GAAP earnings, with the book value reduction charge, as well as non-GAAP earnings, excluding the charge.
- When a company depreciates asset levels unexpectedly and with little economic justification, it can signal problems.
Understanding the reduction in book value
The reduction in the carrying amount is a non-monetary charge recorded in the general ledger. It includes a reduction in the value of an asset on the balance sheet, as well as a compensatory charge. As such, it also reduces the net income to the income statement for the same accounting period during which the reduction in accounting value is identified and recognized. Under certain circumstances, the write-down of the carrying amount and the related expenses may be a large number which may result in material losses for the reporting entity.
Because it is considered an unusual item, companies generally report net income (or loss) under generally accepted accounting principles (GAAP), taking into account the charge to write down the book value, as well as a âpro formaâ or non-GAAP result which excludes the charge. A reduction in book value is more commonly referred to as depreciation or impairment of assets in the popular press.
Requirements for the reduction of the book value
Although GAAP requires a reduction in the carrying amount of an asset if there has been a significant impairment, it would be impossible to test all assets for such impairment on a monthly or quarterly basis. Therefore, GAAP specifies guidelines on when these impairment tests should be performed. Specifically, property, plant and equipment and finite life intangible assets – which are amortized or amortized over time – should be tested for impairment when changes in the market or assets suggest that the carrying amount of the asset. assets may be overestimated and not be fully recoverable.
A test for possible reduction of the carrying amount may be indicated in a number of situations. These include a substantial drop in the market price, an unfavorable change in the physical condition of the asset, economic conditions, a negative political change in the country where the asset is located, etc.
Under GAAP, long-lived intangible assets that are not subject to amortization, such as goodwill, must be assessed for impairment at least annually.
Differences between GAAP and IFRS
The accounting rules for writing off book value write-downs differ between GAAP and International Financial Reporting Standards (IFRS). For example, US GAAP prohibits the reversal of prior inventory write-downs, but IFRS allows them in certain circumstances. On the other hand, both GAAP and IFRS prohibit reversals of goodwill impairment.
Example of book value reduction
A reduction in the book value is recorded in a newspaper a write-down in value on an asset account, a credit, and an increase on an expense account, a debit. For example, suppose ABC Company, a video streaming service, acquired XYZ Corp, a physical movie store chain, 10 years ago. ABC recorded $ 10 million in goodwill at the time of acquisition. Each year, under GAAP, it is required to reassess the value of its reported goodwill to determine whether it is still accurate or whether an impairment of goodwill has been incurred.
ABC Company performs its annual goodwill test and determines that the demand for physical video rentals and purchases has declined significantly since it acquired XYZ Corp. She also determines that a rebound in this market is unlikely to occur in the future. As goodwill is impaired, a reduction in the book value is required. ABC’s accountants will make a journal entry to credit the goodwill asset account and debit a goodwill impairment account. The expense will reduce ABC’s reported net income in its next income statement.
Financial analysts closely monitor changes in book value estimates. When a company depreciates asset levels unexpectedly and with little economic justification, it can signal problems. Public companies will go to great lengths to explain the adjustments through their corporate communications and investor relations teams.