# Basic question about shareholders equity

Hi all, going through the questions of Long Lived assets I realized I am missing a basic understanding of shareholders equity. Below an example to explain it:

-Let’s say I have an asset with a carrying amount of “Ca”. An impairment happens for the value of “i”, so the new book value of the asset is “Ca-i”. Applying the accounting equation (Assets-Liabilities=Equity), my Equity just went down by an amount of “i”.

Now let’s take another route. This impairment causes a loss in the Income Statement of “i”. If there is a tax rate of “tr”, the Net Income will be lowered by i*(1-tr). In consequence, the Retained Earnings will get reduced by i*(1-tr) and the Equity will also get reduced by i*(1-tr).

Here is my basic question: in the second way to do it, where is the remaining amount of the impairment (i*tr)? Obviously the reduction in Retained Earnings is smaller than the reduction in the value of the asset calculated in the beffining, so the Equity calculated through the second method wil be higher than the equity calculated by the first.

What am I doing wrong?

Thanks!!

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If the impairment is tax deductible, then the value of the asset decreases by i, cash increases by i × tr (because the deduction reduces the taxes you have to pay on your other income), and equity decreases by i × (1 − tr).

For the most part, however, such impairments aren’t tax deductible; you have to wait until the asset is sold (so the impairment is realized) and determine the capital gain/loss at that point.  So assets and equity both decrease by i when the impairment is recognized (but not yet realized).

Simplify the complicated side; don't complify the simplicated side.

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Thanks, very clear and quite simple! I need more practice because I keep missing the tax implications of different changes in the books

My pleasure.

Simplify the complicated side; don't complify the simplicated side.

Financial Exam Help 123: The place to get help for the CFA® exams
http://financialexamhelp123.com/