I don’t understand why the following is correct: “If an asset is impaired the ROA decreases.”
When an asset is impaired, Net Income drops and also Assets drop. So how do I know what caused the bigger effect on the ROA ratio since both numerator and denominator go down at the same time?
Thanks
Pick a publicly traded company. Any company.
Look at their income statement and balance sheet. In the US, you can get that information from Edgarscan.
Compare the magnitudes of their net income and their total assets.
Then you can answer your own question.
I always use this method to answer this question.
ROA=NI/assets, if an impairment happen, it is obvious that the numerator and denominator will minus a same number(impairment), so we suppose that:
initial NI=y, assets=x, the impairment=a
the initial ROA=y/x
after the impairment, the ROA=(y-a)/(x-a)
than we use the ROA after the impairment minus initial ROA, then we get the following equation:
(y-a)/(x-a)-y/x=(xy-xa-xy+ay)/(x*(x-a))=
(a*(y-x))/(x*(x-a))
In most situations, y<x and a<x
So we can get that (a*(y-x))/(x*(x-a))<0
Thus the ROA after the impairment is smaller than the initial ROA.
So ROA decreases.