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The market value of property and equipment often exceeds book value, especially for fixed assets that appreciate (rather than depreciate) in value or if your company uses accelerated depreciation methods.
But the reverse sometimes occurs, too. When book value exceeds market value, a write-off may be required under U.S. Generally Accepted Accounting Principles.
Understanding Book Value
What is the book value of property and equipment?
The book value of property and equipment is the cost that was paid for the individual piece of property and equipment, less the accumulated depreciation to date, on that piece of property or equipment.
How do you calculate the book value of property and equipment?
For GAAP purposes most property and equipment is depreciated on a straight-line basis.
For example, if a company purchases a car for $50,000 and determines that it will have a useful life of 5 years, the company would record $10,000 a year of depreciation expense.
At the end of three years, the book value of the car would be $20,000, the $50,000 purchase price less three years of depreciation of $10,000 a year.
Recording Impairment
Companies normally record fixed assets at historic cost and then depreciate them over their useful lives. But, sometimes an asset’s book value (historic cost less accumulated depreciation) overstates its fair value.
Fair value is “the price that would be received to sell an asset … in an orderly transaction between market participants at the measurement date,” according to Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 820, Fair Value Measurements and Disclosures.
To the extent that book value exceeds fair value, the value of an asset is “impaired.” And you must report the impairment loss as part of your income from continuing operations. Impairment losses also reduce the carrying value of the impaired asset on your balance sheet. Once impairment has occurred, the FASB prohibits the upward revaluation of the asset in subsequent periods.
Testing For Impairment
Companies aren’t required to test property and equipment for impairment every accounting period. Rather, testing should occur on a consistent basis — say, every three to five years. Possible reasons for interim testing include changing market conditions, inaccurate useful lives or overpaying for an acquisition.
Unfortunately, there are many reasons management may delay or deny impairment. An impairment loss lowers earnings and the value of fixed assets and, therefore, raises a red flag to investors and lenders. Additionally, impairment testing may be outside the comfort zones of some internal accounting personnel.
Beyond Impairment
Your balance sheet also may be “off” if the fixed asset ledger isn’t accurate. For example, you may no longer physically possess an asset that’s been stolen by an employee. Or an asset may be idle, damaged or obsolete.
Need Specific Advice? Our Tax Professionals Can Help
There are many nuances when it comes to reporting property and equipment. Our tax professionals can help you get a handle on managing, depreciating and reporting impairment for these valuable assets.
Whether you’re assessing purchases made in 2021 or planning for major purchases in the year ahead, our team is here to help advise you along the way and ensure that you’re reporting these expenses in a way that is most beneficial to your business tax liability.
Ready to simplify business tax planning and accounting? Contact us for more information.