What An Asset Impairment Really Means

When a company decides to impair an asset, it may not seem more than a simple accounting treatment. However, it does have an impact on shareholders.

- Simon Brown

Woolworths* is once again impairing the value of David Jones, this time by AU$437.4m. I want to dig into not only what this means, but why a company may decide to impair an asset it recently bought.

When an asset is purchased, it is automatically recorded on the asset side of the balance sheet, albeit in various pieces. For example, the value can be classified as cash, property, plant and equipment (PPE), inventories and the like. There is, of course, also goodwill. Determining this requires a complex calculation, but a good proxy for finding this value is calculating the difference between the purchase price and the net asset value (NAV) of the business being bought. NAV is calculated as all assets less all liabilities.

Goodwill always worries me. While it is real in that it was paid for, it provides no real benefit compared to the other assets of the business. That said, in a sense goodwill represents the potential the business has for making a profit in the future – and when we buy a business, we’re truly just buying future profits.