Impairment allowance

What it means

An impairment allowance reduces an asset’s carrying amount to what the company realistically expects: an uncollectable receivable, unsellable inventory, impaired equipment. The asset stays on the books, it is simply carried more prudently.

The reduction is temporary: when the debtor pays or the goods sell, the allowance is released. A permanent reduction is handled by writing the asset off the books.

An impairment allowance is not a provision. The allowance reduces the value of an asset the company has; a provision is a liability the company will probably incur, for instance from a lawsuit or a warranty. The first is shown against assets as a reduction, the second among liabilities, and mixing them up distorts both sides of the balance sheet.

How it works in practice

The trigger is usually the stocktake: overdue receivables, stock with no movement, equipment no longer in use. Creating one is supported by analysis rather than a guess - a percentage by age must rest on an internal rule.

The accounting and tax views differ: the Income Tax Act recognises an allowance against a receivable only where its own conditions are met, typically by age or on the debtor’s bankruptcy.

With inventory we look at goods whose selling price after discounts has fallen below cost and at goods nearing their expiry date. An inventory allowance reduces accounting profit but is not tax-deductible, so in the return we reverse it with an add-back and keep track of when it will be released.

What to watch out for

Creating no allowances overstates both assets and profit, and the accounts stop reflecting reality. The opposite extreme is blanket allowances with no support - those are non-deductible and do not survive an inspection.

When the debtor pays or the receivable is written off, the allowance has to be released. If it was non-deductible when created, its release is taken out in the return as a deduction item; forget that and the same income is taxed twice, once when the allowance is created and again when it is released.