Impaired Asset: Meaning, Causes, How to Test, and How to Record

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Impaired Asset: Meaning, Causes, How to Test, and How to Record

Definition

An impaired asset is a company asset (tangible or intangible) whose carrying value on the balance sheet exceeds its recoverable amount — in other words, it is no longer worth its recorded cost and must be written down.

Why it matters

Recognizing impairment ensures financial statements present a realistic view of a company’s resources. Overstated assets can mislead investors, prompt regulatory issues, and lead to poor business decisions. Recording impairment reduces net income in the period of recognition and lowers the asset’s carrying amount on the balance sheet.

Common causes of impairment

  • Market decline (e.g., sudden drop in property or commodity prices)
  • Technological obsolescence (assets replaced by newer technology)
  • Physical damage (fire, flood, other disasters)
  • Regulatory changes (laws that reduce an asset’s usefulness or permitted use)
  • Underperformance (assets failing to produce expected cash flows)

How impairment works (concept)

  • Carrying value: the asset amount recorded on the balance sheet (cost less accumulated depreciation/amortization).
  • Recoverable amount: the higher of an asset’s fair value (less costs to sell) or its value in use (present value of expected future cash flows).
  • An asset is impaired if carrying value > recoverable amount. The impairment loss equals the excess and must be recorded immediately.

How to test for impairment (steps)

  1. Identify indicators of impairment (e.g., market declines, obsolescence, damage, adverse legal changes).
  2. Estimate the recoverable amount:
  3. Fair value less costs to sell, or
  4. Value in use (discounted future cash flows).
  5. Compare recoverable amount to carrying value.
  6. If carrying value > recoverable amount, compute impairment loss = carrying value − recoverable amount.
  7. Record the impairment in the accounting records and reflect the new carrying amount on the balance sheet. The impairment loss is reported on the income statement, reducing net income for the period.

Example

Truck Drivers Inc. has a fleet with a carrying value of $500,000. Due to competitive, technology-driven losses, the fleet’s recoverable amount is estimated at $200,000.
– Impairment loss = $500,000 − $200,000 = $300,000.
Typical journal entry:
– Debit: Impairment Loss (expense) $300,000
– Credit: Asset (or Accumulated Impairment) $300,000
After the entry, the trucks’ carrying amount on the balance sheet is $200,000, and net income is reduced by $300,000.

Accounting rules: GAAP vs. IFRS (summary)

  • IFRS (IAS 36): Compare carrying value to the recoverable amount (the higher of fair value less costs to sell and value in use). If carrying value is higher, recognize an impairment loss for the difference.
  • U.S. GAAP: Uses a two-step approach for long-lived assets held for use:
  • Recoverability test — compare carrying amount to the sum of undiscounted future cash flows.
  • If not recoverable, measure impairment as carrying amount minus fair value.
    Note: Specific guidance varies by asset type (e.g., goodwill, indefinite-lived intangibles have distinct rules).

Impairment vs. Depreciation

  • Depreciation/amortization: a systematic, planned allocation of an asset’s cost over its useful life; anticipated and recorded periodically.
  • Impairment: an unplanned, often sudden write-down triggered by events or changes in circumstances that reduce an asset’s recoverable amount below its carrying value.

Recording and reporting considerations

  • Record the impairment loss in the period it is identified.
  • Reduce the asset’s carrying amount on the balance sheet to its recoverable amount.
  • Disclose material impairments in the financial statement notes, with explanation of causes, measurement methods, and amounts recognized.

Key takeaways

  • Impairment adjustments keep financial statements accurate and transparent.
  • Test assets regularly for indicators of impairment, especially when external or internal events suggest a value decline.
  • Treatment differs under GAAP and IFRS; follow applicable standards and disclose material items in notes.

Sources: IAS 36 (Impairment of Assets); guidance from major accounting standards comparisons and professional firm materials.