Impairment write down

CFA Level I FRA
#1

Hi All,

question in regards the below:

Defining total asset turnover as revenue divided by average total assets, all else equal, impairment write-downs of long-lived assets owned by a company will most likely result in an increase for that company in:

A the debt-to-equity ratio but not the total asset turnover.

B the total asset turnover but not the debt-to-equity ratio.

C both the debt-to-equity ratio and the total asset turnover.

C is correct. Impairment write-downs reduce equity in the denominator of the debt-to-equity ratio but do not affect debt, so the debt-to-equity ratio is expected to increase. Impairment write-downs reduce total assets but do not affect revenue. Thus, total asset turnover is expected to increase.

The correct answer is C like mentioned. However, I would guess that once assets decrease, depreciation expense should also decrease, therefore net income should also increase resulting in higher equity. Or is the impact of depreciation minor compared to the impact of of the impairment write down on equity?

Many thanks for the help!

#2

Impairement losses are recognized on income statement. so the effect is less Net income which leads to less retained earnings in equity and hence a higher debt to equity ratio. While depreciation has an effect but it is definitely minor to just impairing the whole asset. so looking at the bigger picture, Net Income will decrease as a result.

1 Like