Impairment in Accounting

What is impairment?

Impairment is a significant, unexpected decline in an asset’s ability to generate future economic benefits. When an asset’s recoverable amount falls below its carrying value (original cost minus accumulated depreciation), companies must write the asset down to its fair value and recognize an impairment loss. This prevents overstating assets and earnings on the financial statements.

Key takeaways

• Impairment is an immediate write-down for unexpected, material losses in asset value; depreciation is a systematic allocation of expected cost over an asset’s useful life.
• Impairment losses reduce current-period profit (income statement) and permanently lower the asset’s carrying amount (balance sheet), affecting financial ratios and analysis.
• Companies must test certain assets regularly (notably goodwill and indefinite-lived intangibles) and evaluate other long-lived assets when indicators of impairment exist.
• Under U.S. GAAP, recognized impairment losses generally cannot be reversed; IFRS permits reversal in some circumstances.

When and how assets are evaluated

1. Identify triggering events: significant market declines, regulatory changes, technological obsolescence, physical damage, or other events suggesting reduced future benefits.
2. Determine the recoverable amount: estimate fair value—often via discounted cash flow models reflecting expected future cash flows and salvage value—especially for assets without active markets.
3. Compare recoverable amount to carrying value: if recoverable amount < carrying value, recognize an impairment loss equal to the shortfall.
4. Record the write-down: the loss is charged to the income statement and the asset’s carrying amount is reduced to the recoverable amount; future depreciation is based on the new basis.

Special considerations

• Goodwill and indefinite-lived intangibles: require annual impairment testing (or earlier if indicators exist) because their valuation is highly subjective.
• Long-lived assets: GAAP uses a two-step process—first test recoverability by comparing undiscounted expected future cash flows to carrying amount; if not recoverable, measure impairment by comparing carrying amount to fair value.
• Disclosure requirements: companies should disclose events that triggered the impairment, the valuation methods and key assumptions used, and the quantitative impact on financial statements. This documentation supports audit review and investor transparency.

Example

ABC Manufacturing purchased a specialized facility for $10 million. After $3 million accumulated depreciation, carrying value = $7 million. A technology shift reduces the facility’s fair value to $4.2 million. ABC recognizes an impairment loss of $2.8 million:
* Debit Impairment Loss $2.8 million (income statement)
* Credit Production Facility or contra-asset $2.8 million (balance sheet)
New carrying value = $4.2 million; future depreciation is based on this amount. Under U.S. GAAP, ABC cannot reverse this loss if value later recovers.

Impairment vs. depreciation

• Depreciation: expected, systematic allocation of cost over useful life; recurring expense.
• Impairment: sudden, unexpected, and material decline in value; recorded immediately as a loss and treated as a nonrecurring item.
  After impairment, depreciation continues using the reduced carrying amount.

Effects on analysis and decision-making

Impairment charges can signal industry disruption, poor prior investment decisions, regulatory impacts, or rapid technological change. They reduce earnings and asset totals, which can materially affect leverage, return-on-assets, and other financial metrics. Regular and transparent impairment testing helps investors and management make better-informed decisions.

Regulatory framework

• U.S. GAAP: impairment guidance is primarily in ASC 360 (long-lived assets) and ASC 350 (intangibles and goodwill). GAAP generally prohibits reversing impairment losses.
• IFRS: IAS 36 governs impairment and allows reversals of impairment in certain circumstances.
  Companies must follow the applicable standards for testing, measurement, and disclosure.

Conclusion

Impairment accounting ensures assets are not carried at amounts that exceed their recoverable value. Timely recognition and clear disclosure of impairment improve the accuracy of financial reporting and help stakeholders understand changes in a company’s asset base and future earnings potential.

Sources

Selected reference standards and guidance:
* FASB ASC 360 (Property, Plant, and Equipment) and ASC 350 (Intangibles—Goodwill and Other)
IAS 36 (Impairment of Assets)
Journal of Accountancy and practitioner accounting guides