Permanent Diminution in Value

Permanet Diminution in Value: A Comprehensive Guide§

Definition§

Permanent diminution in value refers to a significant fall in the value of an asset that is not expected to recover. When this occurs, the fixed asset must be reported on the balance sheet at the reduced amount, which is essentially the estimated recoverable amount. Any decrease or provision for this must go through the profit and loss account. If it is later determined that the provision for diminution is no longer necessary, it should be reversed and written back into the profit and loss account.

Examples§

1. Impairment Loss of Equipment: If a company’s machinery becomes obsolete due to technological advancements, and its value drops significantly and irreversibly, this would be classified as a permanent diminution in value.

2. Write-Down of Real Estate: If a natural disaster damages a building owned by a business and the damage is so severe that the property’s value plummets and is unlikely to recover fully, this would also constitute a permanent diminution in value.

Frequently Asked Questions (FAQs)§

Q1: What necessitates a permanent diminution in value adjustment? A1: When an asset’s value suffers a permanent and significant drop that cannot be reasonably expected to recover, accounting standards require that this change be reflected in the financial statements.

Q2: How is a permanent diminution in value different from depreciation? A2: Although both account for a decline in asset value, permanent diminution in value reflects an unexpected and irreversible drop, while depreciation is a systematic allocation of an asset’s cost over its useful life.

Q3: Where is the reduced value of an asset shown after a permanent diminution in value? A3: The reduced value is shown on the balance sheet at the estimated recoverable amount.

Q4: How should the provision for diminished value be recorded? A4: The provision should be recorded through the profit and loss account as an expense.

Q5: Can a permanent diminution in value be reversed? A5: Yes, if it is subsequently found that the diminution in value is no longer required, the provision can be written back to the profit and loss account.

Related Terms§

• Fixed Asset: Long-term tangible pieces of property that a company owns and uses in its operations to generate income.
• Balance Sheet: A financial statement that summarizes a company’s assets, liabilities, and shareholders’ equity at a specific point in time.
• Recoverable Amount: The higher of an asset’s fair value less costs to sell and its value in use.
• Profit and Loss Account: A financial statement that summarizes the revenues, costs, and expenses incurred during a specific period.

Online Resources§

1. Investopedia - Impairment Definition
2. AccountingTools - Understanding Permanent Diminution in Value
3. International Financial Reporting Standards (IFRS) - IAS 36

Suggested Books for Further Studies§

1. “Financial Accounting” by Walter T. Harrison Jr. and Charles T. Horngren
2. “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
3. “Accounting for Non-Accountants” by Wayne A. Label

Accounting Basics: Permanent Diminution in Value Fundamentals Quiz§

Thank you for exploring the concept of permanent diminution in value and testing your newfound knowledge with our comprehensive quiz. Keep striving for excellence in your accounting and financial expertise!