As the CFO of a company, what indicators would you look at to assess whether your firm's long-term assets were impaired? What approaches could be used, either by management or an independent valuation firm, to assess the dollar value of any asset

Question

impairment? As a financial analyst, what indicators would you look at to assess whether a firm's long-term assets were impaired? What questions would you raise with the firm's CFO about any charges taken for asset impairment?

Answer 1

Impairment is the loss of a significant portion of the utility of an asset through casualty, obsolescence, or lack of demand for the asset's service. A loss should be recognized when an asset suffers permanent impairment. A CFO should look for evidence of such potential impairment of the firm's assets.
Assessing the dollar value of an asset impairment:
If the current book value exceeds the sum of the expected undiscounted future cash flows, an asset impairment has occurred. The conservatism principle requires that a firm write down its asset to its then current fair value, which is the market value of the asset. The accounting transaction would show the asset and any contra-asset being written off, the new market value of the asset being recorded, and the residual amount recorded as a loss due to impairment of the asset. Hence, the loss amount that appears in the income statement is the difference between the old net book value and the current market value.
On the other hand, if the firm cannot assess the current market value of the asset, the impairment loss amount is calculated as the difference between the old net book value and the expected net present value of the future cash flows.
Example: Darden Restaurants Inc.
"Darden recorded asset impairment charges of $158,987 in 1997, representing the difference between fair value and carrying value of impaired assets. The asset impairment charges relate to low-performing restaurant properties and other long-lived assets. Fair value is generally determined based on appraisals or sales prices of comparable properties.".
A financial analyst should look for the same types of indicators that the CFO looks for, of course understanding that the CFO, as an insider of the company, has a great deal more information about such issues as casualty, obsolescence, or lack of demand of certain assets. Indicators of impairment include sustained declines in a firm's and/or industry's return on assets relative to its cost of capital, recognition of asset impairments by competitors, and the introduction of new technologies that make existing assets obsolete.
The financial analyst should question the CFO concerning the cause of the asset impairment. Was the loss due to casualty, obsolescence, or lack of demand? If not, what did cause the loss? The analyst should inquire about the method used to calculate the impairment of asset loss. If it was calculated using a fair market value, how was the fair value determined?