What is the effect of recognizing an impairment loss on the fundamental accounting equation?

• A. Assets decrease; equity decreases
• B. Liabilities decrease; equity increases
• C. Liabilities increase; assets increase
• D. Assets increase; equity increases

Answer: (A)

Verified step by step guidance

1. Understand the fundamental accounting equation: Assets = Liabilities + Equity. This equation must always remain balanced.
2. Recognize that an impairment loss occurs when the carrying amount of an asset exceeds its recoverable amount, leading to a decrease in the value of the asset.
3. Determine the impact of the impairment loss on the accounting equation. Since the asset's value decreases, this reduction directly affects the 'Assets' side of the equation.
4. Consider how the impairment loss is recorded. It is typically recognized as an expense in the income statement, which reduces net income. A reduction in net income decreases retained earnings, a component of equity.
5. Conclude that recognizing an impairment loss results in a decrease in assets and a decrease in equity, while liabilities remain unchanged.