Financial statements are written reports of a company's financial performance and position. These usually consist of the top three ones, the balance sheet, the income statement, and the cash flow statement. As implied by their name, each provides a different aspect of the company's performance or position. These financial statements also have some elements.

What do the Elements of Financial Statements mean?

The elements of financial statements are the primary components that make up a company's financial reports. Regardless of the type of company or organization, these elements are common. However, they may differ from one statement to another. On top of that, some have a higher importance than others due to how they work.

Companies can further classify the elements of financial statements into different categories based on the underlying report. In most cases, the components of the balance sheet and income statement are more important than others. The primary reason is that investors focus on these two financial statements due to their importance.

What are the Elements of Financial Statements?

As stated above, there are several elements of financial statements based on the underlying report. Among these, assets, liabilities, equity, income, and expenses are more prominent. The first three relate to the balance sheet, while the others come from the income statement. An explanation of each of these is as below.

Assets

Assets are resources that a company owns or controls that result in an inflow of economic benefits in the future. It is the accounting definition for the term. Typically, these resources include tangible or intangible costs that a company has acquired or produced over time and capitalized. These items help the company in running operations or generating revenues.

Some examples of assets include the following.

• Property, plant, and equipment
• Goodwill
• Investments
• Cash and cash equivalents
• Accounts receivable
• Inventory

Liabilities

Liabilities are the opposite of assets. These are obligations arising from past events that result in a probable outflow of economic benefits. In simpler words, it includes money or debt owed to third parties other than owners. Liabilities are one of the primary sources of finance for a company. These are part of a company's capital structure.

Some examples of liabilities include the following.

• Loans and mortgages
• Leases
• Accounts payable
• Short-term loans
• Accrued expenses
• Pension obligations

Equity

Equity includes any part of the business attributable to its owners or shareholders. In accounting, it is the residual interest of shareholders in a company after deducting its liabilities from its assets. Practically, it includes money the owners have contributed to the business and any profits or income attributable to them.

Some examples of equity include the following.

• Share capital
• Share premium
• Retained earnings
• Reserves

Income

Income includes the inflow of economic benefits during a fiscal year. Essentially, it consists of revenues and proceeds from sales and other activities. Income is a part of the income statement and is crucial in calculating profits. Usually, companies generate these from their primary activities, which fall under revenues. However, they may also get income from other sources.

Some examples of income include the following.

• Sales revenue
• Interest income
• Gain on sale of assets
• Rental income
• Royalty income
• Foreign exchange gains

Expenses

Expenses are the opposite of income and include the outflow of economic benefits during a fiscal year. Primarily, the term refers to costs or expenditures a company incurs to run its operations. Like income, expenses are a part of the income statement and help calculate profits. Companies divide these expenses based on the activities to which they relate.

Some examples of expenses include the following.

• Cost of goods sold
• General and administrative expenses
• Sales and marketing expenses
• Interest expenses
• Taxes

Conclusion

Financial statements are reports of a company’s position and performance. These reports include various elements that are common for all companies. Usually, investors focus on the balance sheet and income statement. The primary elements of these financial statements include assets, liabilities, equity, income, and expenses.

Article Source Here: Elements of Financial Statements: Assets, Liabilities, Equity, Income, Expenses

The price of a bond is a crucial metric for investors to consider when making decisions about their investment. It represents the amount at which the bond gets bought or sold. However, it is not as straightforward to determine this price. Several factors play a role in establishing the bond price. One of these includes interest rates, interest payments, and accrued interest.

When purchasing bonds, companies may come across different prices. Each may represent aspects of the bond and its valuation. Two of these include the clean and dirty price. Before discussing the differences, it is crucial to understand what each is.

What is the Clean Price of a bond?

Bonds come with a face value (or par value), the amount the issuer repays for the bond at maturity. It also comes with a coupon rate, which represents the percentage of interest the holder receives on the face value. This interest accrues on the bond over time. The clean price of the bond is its value without the impact of the accrued interest.

The clean price of a bond is also its quoted price in the market. Market facts can impact this price, causing it to fluctuate over time. Usually, these factors include interest rates, economic conditions, and the issuer’s creditworthiness. The clean price is also the amount the buyer pays to purchase the underlying bond. The difference between this price and the face value is the accrued interest on the bond.

What is the Dirty Price of a bond?

The dirty price of a bond is the amount that factors in its accrued interest and its clean price. Usually, it includes the coupon that the instrument has accumulated since its last coupon payment date. The dirty price of the bond is relevant when it gets traded between interest payment dates. Since the bond gains coupon payments on those dates, the buyer must pay the dirty price of the bond.

The dirty price of the bond also represents its purchase price. However, it only applies when there is accrued interest on that bond. This price is lower than the bond's clean price but still requires the latter for calculation. The formula for the dirty price of a bond is as follows.

Dirty price = Clean price + Accrued interest

Clean Price vs Dirty Price: What’s the difference?

The primary difference between the clean and dirty prices of a bond comes from accrued interest. As mentioned above, the former value does not consider this interest when determining the bond's price. On the other hand, a dirty price requires a clean price and the interest accrued to evaluate the bond. The clean price represents the principal amount of the bond, while the dirty price is what investors pay for it.

Another difference between them also relates to the interest accrued. In the market, the clean price of the bond is the quoted price between investors and brokers. It is the value the bond receives at the next interest payment. On the other hand, the dirty price represents the bond’s current value in the market. It is the value of that bond between interest payment dates.

Conclusion

The price of a bond may differ based on various factors. One of these differentiations comes from whether it comes with accrued interest. If the price does not consider this interest, it is called the bond's clean price. However, if the bond's price includes the clean price and accrued interest, it is called the dirty price.

Originally Published Here: Clean Price Vs Dirty Price: What’s the Difference?

When it comes to the stock market, certain events can cause significant volatility in the markets and can lead to major losses for investors. One of the major events that can cause these kinds of losses is a black swan event.

The event can cause significant losses due to the occurrence of an unexpected event, which can cause a dramatic change in the markets. Black swan events are unpredictable and often have far-reaching consequences that can affect various aspects of the economy.

What is a Black Swan Event

A Black Swan event is an unpredictable and unforeseen event that has extreme consequences. It is typically a low-probability occurrence with potentially significant impacts on society or businesses.

The term was first coined by Nassim Taleb in his book The Black Swan: The Impact of the Highly Improbable, which explores the potential implications of highly improbable events.

The concept of a Black Swan event has subsequently been used in fields such as finance and economics to describe unexpected events that can have far-reaching effects on markets and economies.

For example, the 2008 financial crisis is often referred to as a Black Swan event due to its unexpected nature and devastating impact.

While it is impossible to predict a Black Swan event, it is important to prepare for one to minimize the risks of significant losses.

Understanding the Black Swan Event

The term ‘Black Swan’ is used to describe an event that is both unprecedented and highly improbable, yet has a significant impact on society or businesses.

These events are often attributed to “unknown unknowns” – things we didn’t know and weren’t expecting – but can also be caused by known risks that have been ignored or underestimated.

Most of the time, Black Swan events occur due to a combination of unforeseen circumstances coming together in dramatic and unpredictable ways, such as the 2008 financial crisis.

This event mainly hits the stock market and stock prices, but can also hit other areas such as the housing market, labor market, and technology sector.

The impact of the Black Swan events can be significant and long-lasting. It is therefore important to have strategies in place to identify potential risks and prepare for them.

Characteristics of a Black Swan Event

• Black swan events are unexpected and unpredictable
• The effects can last for extended periods
• Has a huge impact on the economy, markets, and society
• May cause global chaos or disruption
• Can have catastrophic consequences
• Difficult to detect and predict

Examples of the Black Swan Event

A good example of the Black Swan Event would be the 2008 Financial Crisis. This was caused by some factors such as high levels of debt, lax regulation, and excessive speculation in the housing market.

The event had a major global impact on economies, financial markets, and societies.

The terrorist attacks that occurred on September 11th, 2001 would also be considered to be an example of a Black Swan Event. This was an event that was not only unexpected and unpredictable but one that had a lasting effect on the world.

There are noticeable similarities between every Black Swan Event and the effects can be felt both in the short term and long term. They can have a devastating impact on society, economies, and financial markets.

Conclusion

The Black Swan is an unpredictable event that can have far-reaching consequences. While it is impossible to predict these events, it is important to be prepared for them to minimize the risks of significant losses. Understanding the characteristics of a Black Swan event and having strategies in place can help protect businesses from potential disasters.

Post Source Here: Black Swan Event: Definition, Meaning, Examples, History

Return is the income an investor receives on their investment. It can be in the form of fixed income generated from the underlying asset. For example, dividends and interest receipts are a form of fixed income on instruments. However, a return can also come as capital gains or losses. Companies also use a return to calculate the wealth generated for their shareholders.

Companies use different metrics to understand how much resources go into generating income. One of these includes the return on net operating assets.

What is the Return on Net Operating Assets?

This term, return on net operating assets, refers to the income companies get from their net operating assets. As discussed in this article, these assets refer to the resources invested in a company's core operations. Its calculation involves subtracting non-operating assets and non-operating liabilities from total assets and liabilities.

Return on net operating assets measures a company's financial performance by using its net operating assets. While companies can calculate their returns on total assets, this metric provides a more relevant measure of profitability. Essentially, return on net operating assets gives better insights into the use of operating resources to generate profits.

What is the formula for Return on Net Operating Assets?

The formula for return on net operating assets is straightforward. It involves dividing operating income over net operating assets. However, it requires calculating the latter first. As previously discussed, the formula for net operating assets is as follows.

Net Operating Assets = Operating Assets - Operating Liabilities

Once companies calculate the net operating assets, they can use it in the formula for return on these assets. Alternatively, they can also put the above equation into the calculation directly. The first return on net operating assets formula is as below.

Returns on Net Operating Assets = Operating Income / Net Operating Assets

Similarly, companies can also use the following alternative formula for return on net operating assets.

Return on Net Operating Assets = Operating Income / (Operating Assets - Operating Liabilities)

Regardless of the return on net operating assets formula, the calculation provides the same ratio. The operating income in both comes from the income statement, usually as a separate line item. On the other hand, the operating assets and liabilities come from the balance sheet and may require additional calculations.

Example

A company, Red Co., generated an operating income of $100,000 during a fiscal period. At the same time, the company had net operating assets of $500,000. Based on the above, the return on net operating assets for Red Co. is as follows.

Returns on Net Operating Assets = Operating Income / Net Operating Assets

Returns on Net Operating Assets = $100,000 / $500,000

Returns on Net Operating Assets =0.2 or 20%

Interpreting the above metric is not as straightforward since it does not provide insights into Red Co.'s operations. The company must use the ratio comparatively to interpret the results better. Usually, it requires comparisons with past periods, competitors, and industry standards.

Conclusion

Return on net operating assets is metric companies use to measure their operating efficiency. Unlike other ratios, it focuses on net operating assets, which provides better insights into how a company utilizes its resources. However, companies cannot use the ratio on its own. Instead, they must compare it with others to understand it better.

Originally Published Here: Return on Net Operating Assets (RNOA): Definition, Formula, Calculation, Example, Analysis, Meaning

Accounting standards require a company to record inventory when the risks and rewards associated with the goods get transferred to it. Sometimes, the company may not be in physical possession of those goods. However, they may still need to record the inventory they have not yet received. In most cases, this inventory falls under goods in transit.

The accounting for goods in transit may be complex due to its nature. However, it can be more straightforward through understanding what these goods are.

What are Goods in Transit?

Goods in transit refer to items that have not reached the final destination yet. It includes products that a company has purchased but not yet received. Technically, these goods are in possession of the carrier, i.e., the shipping company. However, it has not reached the buyer or the final recipient. Goods in transit may also have insurance set out against them.

Goods in transit can be complex to understand due to their nature. In short, these goods are neither with a supplier nor the customer. Instead, they include items that have left the supplier's location but have not yet reached the customer. However, the risks and rewards associated with these goods have been transferred to the customer. It usually means that the supplier has passed the legal ownership to the customer.

What is the accounting for Goods in Transit?

Accounting standards require the company that owns goods in transit to consider them as inventory. Therefore, they are a part of the company's balance sheet as a current asset. The accounting for goods in transit involves making entries in the company's general ledger when the risks and rewards get transferred. Until these goods reach the company, they are a part of the “goods in transit” account.

The accounting process records the movement of the goods from the supplier to the customer. When the supplier sends the goods, the customer must record them as goods in transit transaction. However, the legal ownership of these goods must be passed to the customer to count as a transit item. Once these goods reach the customer, they can move the balance to the inventory account.

What is the journal entry for Goods in Transit?

The journal entry for goods in transit is straightforward. It requires ascertaining that the legal ownership of the items has passed to the customer. However, the goods must not be in their possession. The journal entry to record these goods in transit will be as below.

Dr	Goods in transit
Cr	Bank or Cash or Accounts payable

Once the customer receives the goods, they must transfer the amount to the inventory account. The journal entry to do so is as follows.

Dr	Inventory
Cr	Goods in transit

Example

A company, Red Co., purchases $10,000 worth of inventory from an overseas supplier on credit. The supplier transfers the legal ownership of the goods to Red Co. However, the goods take 10 days to reach the company. At the time, Red Co. records the transaction as follows.

Dr	Goods in transit	$10,000
Cr	Accounts payable	$10,000

After 10 days, Red Co. receives the goods. The company transfers the amount from goods in transit to inventory as follows.

Dr	Inventory	$10,000
Cr	Goods in transit	$10,000

Conclusion

Goods in transit refer to inventory a company receives the risks and rewards from but not the physical possession. Usually, it includes products a supplier has shipped but has not reached the customer. The accounting for goods in transit may be complex due to the underlying concept. However, the journal entries are straightforward.

Originally Published Here: Goods in Transit: Definition, Accounting Treatment, Journal Entry, Example

Customer acquisition and retaining customers are top priorities for any business. One of the best ways to keep customers coming back is to provide them with everyday low pricing on their favorite products or services.

Everyday Low Pricing or EDLP is a pricing strategy in which the same price is given to all customers for all products. This helps build trust and loyalty, as customers know they can rely on you for consistently low prices.

What is Everyday Low Pricing

EDLP is a pricing strategy that offers low, consistent prices all day long. This means that the same price will be given to all customers regardless of their purchase frequency or quantity.

This helps businesses create a predictable pricing environment for their customers and also encourages repeat purchases from existing buyers.

To successfully implement an EDLP strategy, it's important to consider factors such as customer demand, competitor pricing, and cost structure.

This will help you determine the right price point to offer that gives your customers great value while also providing a profit margin for your business.

A good example of EDLP would be Walmart, which has consistently offered low prices to its customers. This strategy has helped them become one of the world’s largest retailers and a leader in customer satisfaction.

How Everyday Low Pricing Works

The pricing model of EDLP is different from other pricing strategies because it offers a consistent price for all its customers. It doesn't matter whether it's a sales day or a promotional event, the same price will be given to each customer.

This way customers don't have to compare different products and prices since they know they can get a low price no matter what. This helps to create brand loyalty and trust, as customers know they can rely on you for consistently low prices.

Benefits of Everyday Low Pricing

Everyday Low Pricing offers several benefits for businesses, including

1. Fewer marketing costs

One of the biggest benefits of EDLP is that it eliminates the need for promotions or discounts. This means you can save money on marketing costs, as there's no need to create special campaigns to attract customers or offer discounts.

2. Improved customer loyalty and trust

Consistently low prices help build customer loyalty and trust because customers know they can rely on you for great deals. This also creates a predictable pricing environment which makes it easier for customers to plan their purchases.

3. Improved customer experience

With EDLP, customers don't have to compare different products or prices. This saves customers time and effort and creates a better shopping experience. In addition, customers may be more likely to make impulse purchases because the price is always low.

4. Regular business profits

By offering consistent prices, businesses can ensure regular profits since they don't have to worry about fluctuating demand due to changing prices. This helps create more consistent revenue streams and keeps your business profitable in the long run.

Conclusion

Everyday Low Pricing is a great way for businesses to keep their customers coming back. With EDLP, businesses can provide consistent prices to their customers while also increasing customer loyalty and trust. This strategy is easy to implement, requires minimal marketing costs, and helps ensure regular profits for businesses.

Article Source Here: Everyday Low Pricing: Definition, What It Is, Examples, Strategy, Advantages

Some companies take up construction projects for internal use. These may include building a fixed asset for future use. Sometimes, this work may not be complete when a company prepares its accounts. Therefore, the company must perform specific accounting treatments to present this work. The process is not complex but requires an understanding of the concept first.

What is Construction in Progress?

Construction in progress (or construction work in progress (CWIP))is an account in the balance sheet that includes costs incurred during the construction phase of long-term assets. It may consist of work on a fixed asset such as a building, factory, or power plant. Usually, construction work in progress consists of materials, labour, equipment rental, borrowing costs, and other indirect expenses.

Accounting standards require companies to show uncompleted work separately from other assets. In the balance sheet, it appears as construction work in progress. Primarily, companies use this treatment as the asset is not yet complete and is considered a work in progress. Therefore, it is not readily generating income for the company. Once the work gets completed, the company can transfer the amounts from this account to the relevant fixed asset account.

What is the accounting for Construction in Progress?

The accounting for construction in progress occurs through several accounting periods. Firstly, when a company starts construction work on an asset, it records it in a separate account. As mentioned above, these costs include material, labour, borrowing, equipment costs, etc. Over time, the amount in this account builds up until the construction work is complete.

Once the company stops working on an asset and that asset is available for use, it must remove the amount from the account. Usually, all the amount from the construction-in-progress account gets transferred to the relevant fixed asset account. From this point onwards, the accounting for the amounts falls under the applicable accounting standards.

What is the journal entry for Construction in Progress?

As mentioned above, the accounting for construction in progress includes various stages. It starts when a company begins construction work on an asset. At this point, the company must capitalize all relevant expenses pertinent to the construction to a separate account. In most cases, this account is known as the construction work-in-progress account.

The journal entry to record expenses incurred for construction work at this stage is as follows.

Dr	Construction work in progress
Cr	Cash or bank or accounts payable

Once the work on the asset under construction is complete, the company can transfer the amount to the assets account. At this stage, the journal entry is as follows.

Dr	Fixed asset
Cr	Construction work in progress

Example

A company, Blue Co., begins constructing a building for future office space. The company spends $100,000 in materials for the construction work. Similarly, the labour charges are $150,000. Other expenses related to the building amount to $50,000. Overall, the company records these amounts in the construction work-in-progress account. Blue Co. pays all these expenses through its bank account.

The collective journal entry for these is as below.

Dr	Construction work in progress	$300,000
Cr	Bank	$300,000

After the work on the building is complete, Blue Co. transfers these costs to the relevant account. The journal entry for this transfer is as below.

Dr	Building	$300,000
Cr	Construction work in progress	$300,000

Conclusion

Construction in progress refers to costs that a company incurs for construction work on incomplete assets. Once the construction gets completed, the company transfers these costs to the relevant fixed asset account. Accounting for construction in progress occurs in two stages, as stated above.

Post Source Here: Construction Work in Progress: Definition, Accounting Treatment, Journal Entry, Example

In option pricing theory, the risk-neutral measure is a measure that allows for the valuation of financial instruments such as options. The risk-neutral measure is obtained by assuming that investors are indifferent to the risk and that the expected rate of return on all assets is equal to the risk-free rate of return.

Under the risk-neutral measure, the price of an option is its expected future payoff discounted to the present using the risk-free rate. The risk-neutral measure is widely used in financial mathematics and allows for the valuation of a wide range of financial derivatives, including options, futures, and other complex financial instruments. It is important to note, however, that the risk-neutral measure is a theoretical concept and does not necessarily reflect the actual risk preferences of market participants.

Reference [1] developed a market factor-based option pricing model using the business-cycle CAPM. It allows for the evaluation of options traversing between the risky and risk-neutral probability measures. The authors pointed out,

The business-cycle CAPM transforms the measure of the risky output variable to the risk-neutral predicted values. Therefore, it accomplishes option pricing through rational expectations and martingale. Martingale suggests the possibility of an arbitrage-free hedging strategy. The option pricing process demonstrates the stochastic discount factor pricing model straddling between factor and stochastic expectation pricing models. The business-cycle CAPM assumes liquidity and credit risks due to asymmetric information. The volatility of the risk-neutral predicted values shows jumps. Therefore, we are dealing with options data of market incompleteness. Consistent with the risk-neutral probability of the predicted values, we develop the underlying stock distribution around the market stock price using its market information of volatility and kurtosis. For LinearReg, the risk-neutral regression finds the hedging parameters of the delta-hedge stock-money portfolio with the regression mean equal to the market option price.

This is another interesting article that attempts to go beyond risk-neutral pricing.

Let us know what you think in the comments below or in the discussion forum.

References

[1]  Tse, Wai Man, Factor-Based Option Pricing with Perfect Dynamic Delta Hedge (2023). https://ssrn.com/abstract=4149481

Article Source Here: An Option Pricing Model Based on Market Factors

Running a business in a comparative market can be difficult. Businesses need to maintain their competitive edge to stay in business. They need to find ways to increase their market power while minimizing losses.

One way businesses can achieve these goals is through horizontal integration. It is a simple yet effective strategy in which business entities operating within the same industry join forces to increase their production of goods and services.

What is Horizontal Integration?

Horizontal integration is a strategy employed by businesses to acquire or merge with companies that are operating at the same level of the value chain in the same industry.

This strategy can create economies of scale and reduce costs, as well as increase market power and customer base. Horizontal integration can also provide access to new technologies and resources that would otherwise be unavailable to the business.

In simple words, a business entity expands its operations by taking over competing firms in the same industry. The purpose of horizontal integration is to increase market power, gain access to new sources of revenue, reduce costs, and improve operational efficiency.

How Horizontal Integration Works

Horizontal integration is the process of purchasing, merging, or acquiring companies that are at the same stage in the production chain and within the same industry. The idea behind horizontal integration is to increase control over a specific market or area of production.

For example, if a company manufactures chocolate products, it might merge with another chocolate-manufacturing company to increase production and market share. As a result, it would have more control over raw materials and production costs, as well as access to new markets.

Horizontal integration also allows businesses to gain access to new resources, technologies, and customers. By merging with or acquiring another firm in the same industry, a company can expand its operations and reduce the cost of production.

Benefits of Horizontal Integration

Horizontal integration brings several benefits to businesses, here are some of the main ones

1. Larger market share

One of the main benefits of horizontal integration is that it allows businesses to increase their market share.

By merging or acquiring competitors, businesses can increase their customer base and access new markets. This can lead to an increased bottom line for the business.

2. Access to a larger customer base

Since merging or acquiring other businesses in the same industry will increase a business’s customer base, it can also lead to increased revenue. This is because the business can now access more customers and generate greater sales.

3. Access to necessary resources at a lower cost

By merging with or acquiring other businesses in the same industry, a business can gain access to resources such as raw materials and production methods at a lower cost.

This gives the business an edge over its competitors as it will be able to produce goods and services more efficiently, leading to increased profits.

4. Increased revenue

More customers mean more revenue - and horizontal integration can help businesses achieve this goal. This makes sense as a larger customer base means more potential customers and more sales opportunities.

By merging with other businesses, a business can also increase its bargaining power, allowing it to negotiate better deals and better pricing for its products and services.

5. Increased efficiency in production

It only makes sense that a business that is operating in the same industry as another will be able to produce goods and services more efficiently. By pooling resources, businesses can also reduce duplication of efforts and waste of resources.

This improved efficiency in production leads to cost savings and increased profits for the business.

Drawbacks of Horizontal Integration

Despite its many potential benefits, there are also some drawbacks to horizontal integration.

• Increased competition
• Reduced flexibility
• Difficult to manage
• High costs

Conclusion

Despite the drawbacks, horizontal integration is still a viable business strategy for those looking to expand their operations and gain a competitive edge in the marketplace. By carefully considering all the pros and cons of such a move, businesses can profit from the increased market share and efficiency that horizontal integration can provide.

Originally Published Here: Horizontal Integration: Definition, Examples, Who Used, Meaning, vs Vertical

Assets are the essence of a company’s operations. Every company has fixed assets that help them generate revenues. Unlike other resources, companies cannot charge the cost of these assets to one fiscal period. Instead, accounting standards require them to spread over several periods. This process occurs through depreciation. This expense represents the fall in the asset's value over time.

Sometimes, assets may also lose value for other reasons. Accounting standards require companies to record those costs separately as impairment.

What is the Impairment of Assets?

In accounting, impairment of assets refers to a decrease in an asset's value for several reasons. This situation occurs when a company's balance sheet does not reflect that asset’s actual value. Usually, the impairment of assets occurs due to external factors. However, internal ones also decrease the asset's value beyond its book value on the balance sheet.

Impairment of assets is crucial in presenting assets for their actual value. Accounting standards require companies to record an impairment when an asset’s recoverable amount is lower than its book value. However, companies must consider two amounts when calculating the former. These include the asset's fair value minus the cost to sell and its value in use.

What is the accounting for the Impairment of Assets?

Impairment of assets relates to the conservatism principle in accounting. It requires companies to record losses as soon as they occur. Therefore, when an asset’s recoverable amount drops below its book amount, it falls under a loss. The company must treat the difference between the two amounts as an impairment on that asset.

The recoverable amount of an asset is the higher of two values, its fair value minus costs to sell and its value and use. Usually, this amount is the same as the book value or higher than it. If it is higher, there is no negative impairment charged. If the recoverable amount is lower, the company must create an impairment expense.

What is the journal entry for Impairment of Assets?

The journal entry for the impairment of assets involves two accounts. The first is an expense account, which decreases profits in the income statement. The other side relates to the asset for which the company charges the impairment. In this case, the amount also decreases the book value of that asset in the balance sheet.

Overall, the journal entry for impairment of assets is as follows.

Dr	Impairment on asset
Cr	Asset

The credit side goes to the specific asset account which has suffered an impairment loss.

Example

A company, Red Co., owns a vehicle that has a book value of $10,000 in its books. The asset's fair value is $11,000, with a selling cost of $2,000. On the other hand, its value in use is $8,000. Based on these figures, the recoverable amount is the higher of these two values, which is $9,000 ($11,000 fair value - $2,000 selling cost).

Based on the above figures, the recoverable amount for the vehicle is $1,000 lower than its book value of $10,000. Therefore, Red Co. must charge impairment on the asset. The company uses the following journal entry to do so.

Dr	Impairment expense	$1,000
Cr	Vehicle	$1,000

Conclusion

Assets may suffer impairment for external or internal reasons. Companies must create an expense in their books to reflect this decrease in the asset's value, known as impairment. In accounting, if the recoverable amount of a resource is lower than its book value, it is considered impaired. Companies must create an impairment charge on assets to comply with the conservatism principle.

Post Source Here: Impairment of Assets: Definition, What It Is, Journal Entry, Examples, Meaning, Accounting Treatment