What Is Impairment?
In accounting, impairment is a permanent reduction in the value of a company asset. It may be a fixed asset or an intangible asset.
When testing an asset for impairment, the total profit, cash flow, or other benefits that can be generated by the asset is periodically compared with its current book value. If the book value of the asset exceeds the future cash flow or other benefits of the asset, the difference between the two is written off, and the value of the asset declines on the company's balance sheet.
Key Takeaways
- Impairment can occur as the result of an unusual or one-time event, such as a change in legal or economic conditions, a change in consumer demand, or damage that impacts an asset.
- Assets should be tested for impairment regularly to prevent overstatement on the balance sheet.
- Impairment exists when an asset's fair value is less than its carrying value on the balance sheet.
- If impairment is confirmed as a result of testing, an impairment loss should be recorded.
- An impairment loss records an expense in the current period that appears on the income statement and simultaneously reduces the value of the impaired asset on the balance sheet.
Understanding Impairment
Impairment is most commonly used to describe a drastic reduction in the recoverable value of a fixed asset. The impairment may be caused by a change in the company's legal or economic circ*mstances or by a casualty loss from an unforeseeable disaster.
For example, a construction company may face extensive damage to its outdoor machinery and equipment due to a natural disaster. This will appear on its books as a sudden and large decline in the fair value of these assets to below their carrying value.
An asset's carrying value, also known as its book value, is the value of the asset net of accumulated depreciation that is recorded on a company's balance sheet.
Periodic Evaluation for Impairment
An accountant tests assets for potential impairment periodically. If any impairment exists, the accountant writes off the difference between the fair value and the carrying value. Fair value is normally derived as the sum of an asset's undiscounted expected future cash flows and its expected salvage value, which is what the company expects to receive from selling or disposing of the asset at the end of its life.
Other accounts that may be impaired, and thus need to be reviewed and written down, are the company's goodwill and its accounts receivable.
A company's capital can also become impaired. An impaired capital event occurs when a company's total capital becomes less than the par value of the company's capital stock.
Unlike impairment of an asset, impaired capital can naturally reverse when the company's total capital increases back above the par value of its capital stock.
Impairment vs. Depreciation
Impairment is unexpected damage. Depreciation is expected wear and tear.
The value of fixed assets such as machinery and equipment depreciates over time. The amount of depreciation taken in each accounting period is based on a predetermined schedule using either a straight line method or one of a number of accelerated depreciation methods.
Depreciation schedules allow for a set distribution of the reduction of an asset's value over its lifetime, unlike impairment, which accounts for an unusual and drastic drop in the fair value of an asset.
For instance:
- A tractor depreciates in value from year to year throughout its useful lifetime.
- A tractor that gets crushed by a falling tree has experienced an impairment that must be recorded on the books as such.
GAAP Requirements for Impairment
Under generally accepted accounting principles (GAAP), assets are considered to be impaired when their fair value falls below their book value.
Any write-off due to an impairment loss can have adverse effects on a company's balance sheet and its resulting financial ratios. It is, therefore, important for a company to test its assets for impairment periodically.
Certain assets, such as intangible goodwill, must be tested for impairment on an annual basis in order to ensure that the value of assets is not inflated on the balance sheet.
GAAP also recommends that companies take into consideration events and economic circ*mstances that occur between annual impairment tests in order to determine if it is "more likely than not" that the fair value of an asset has dropped below its carrying value.
Causes of Impairment
Specific situations in which an asset might become impaired and unrecoverable include when a significant change occurs to an asset's intended use when there is a decrease in consumer demand for the asset, damage to the asset, or adverse changes to legal factors that affect the asset.
If these types of situations arise mid-year, it's important to test for impairment immediately.
Standard GAAP practice is to test fixed assets for impairment at the lowest level where there are identifiable cash flows. For example, an auto manufacturer should test for impairment for each of the machines in a manufacturing plant rather than for the high-level manufacturing plant itself. If there are no identifiable cash flows at this low level, it's allowable to test for impairment at the asset group or entity level.
Example of Impairment
ABC Company, based in Florida, purchased a building many years ago at a historical cost of $250,000. It has taken a total of $100,000 in depreciation on the building and therefore has $100,000 in accumulated depreciation. The building's carrying value, or book value, is $150,000 on the company's balance sheet.
A category 5 hurricane damages the structure significantly. The company determines that the situation qualifies for impairment testing.
After assessing the damages, ABC Company determines the building is now only worth $100,000. The building is therefore impaired and the asset value must be written down to prevent overstatement on the balance sheet.
A debit entry is made to "Loss from Impairment," which will appear on the income statement as a reduction of net income, in the amount of $50,000 ($150,000 book value – $100,000 calculated fair value).
As part of the same entry, a $50,000 credit is also made to the building's asset account, to reduce the asset's balance, or to another balance sheet account called the "Provision for Impairment Losses."
How Is Impairment Determined?
The generally accepted accounting principles (GAAP) define an asset as impaired when its fair value is lower than its book value. To check an asset for impairment, the total profit, cash flow, or other benefit expected to be generated by the asset is compared with its current book value. If it is determined that the book value of the asset is greater than the future cash flow or benefit of the asset, an impairment is recorded.
Where Are Impairment Losses Shown?
Impairment losses are shown both on the income statement and the balance sheet. An impairment loss is simultaneously recorded as an expense on the income statement and reduces the value of the impaired asset on the balance sheet.
How Is Impairment Accounted for?
An accountant will write off the difference between the fair value and the carrying value if an impairment is present, and the value of the asset decreases on the company's balance sheet.
Fair value is typically the sum of an asset's undiscounted expected future cash flows and its expected salvage value, which is what the company would expect to receive from selling or disposing of the asset at the end of its useful life.
What Is the Purpose of Asset Impairment?
The overall goal of asset impairment is to periodically evaluate a company's assets to make sure the total value of the assets is not being overstated. An impaired asset is one that has a market value less than what is listed on the company's balance sheet. There are various factors that can affect an asset's value so periodically checking its value is prudent business management.
Is an Impaired Asset Considered a Loss?
Under GAAP, an impaired asset must be recorded as a loss on the income statement. It is important to compare the value of the asset to the fair market value to help determine the loss.
The Bottom Line
Impairment refers to the reduction in the value of a company asset, either a fixed asset or an intangible asset. The entire value of the asset is not typically recorded as a loss, but most often the difference between the predicted cash flow of the asset and the book value (if the book value is higher) is the amount recorded as a loss.
Periodically evaluating the value of assets helps a company accurately record its asset value rather than overstating its asset value, which could lead to financial problems later on.
FAQs
In accounting, impairment is a permanent reduction in the value of a company asset. It may be a fixed asset or an intangible asset. When testing an asset for impairment, the total profit, cash flow, or other benefits that can be generated by the asset is periodically compared with its current book value.
What are the examples of impaired assets? ›
Assets that are most likely to become impaired include accounts receivable, as well as long-term assets such as intangibles and fixed assets. When an impaired asset's value is written down on the balance sheet, there is also a loss recorded on the income statement.
What does impairment mean in accounting terms? ›
Impairment describes a reduction in the value of a company asset, either fixed or intangible, so as to reflect a decline in the quality, quantity, or market value of the asset.
What are examples of impairment costs? ›
Some examples include: Damaging assets physically or through non-use. Presenting no benefits for merging the organization with another company. Holding assets for disposal or restructuring.
How do you know if something is impaired in accounting? ›
Assets are considered impaired when the book value, or net carrying value, exceeds expected future cash flows. If the impairment is permanent, is must be reflected in the financial statements.
What are three examples of impairment? ›
Examples of impairments include blindness, deafness, loss of sight in an eye, paralysis of a limb, amputation of a limb; mental retardation, partial sight, loss of speech, mutism.
What are five types of impairment? ›
Types of impairments
- Vision impairments: A person who is blind has a permanent vision impairment. ...
- Hearing impairments: A person who is deaf has a permanent hearing impairment. ...
- Mobility impairments: A person who is paralyzed has a permanent mobility impairment. ...
- Cognitive impairments: ...
- Speech impairments:
An impairment loss is recognised immediately in profit or loss (or in comprehensive income if it is a revaluation decrease under IAS 16 or IAS 38). The carrying amount of the asset (or cash-generating unit) is reduced. In a cash-generating unit, goodwill is reduced first; then other assets are reduced pro rata.
What is the difference between asset write down and impairment? ›
An impairment in accounting is a permanent reduction in the value of an asset to less than its carrying value. Written-down value is the value of an asset after accounting for depreciation or amortization. It is also called book value or net book value.
Why is impairment an expense? ›
An impairment charge is a process used by businesses to write off worthless goodwill. These are assets whose value drops or is lost completely, rendering them completely worthless. Investors, creditors, and others can find these charges on corporate income statements under the operating expense section.
Assets most likely to become impaired include accounts receivable and long-term assets. A loss due to an asset impairment is recorded on both the balance sheet and the income statement. Asset impairment occurs when the net carrying amount, or book value, cannot be recovered by the owner.
How do you record impairment expenses? ›
An impairment loss is an asset's book value minus its market value. You must record the new amount in your books by writing off the difference. Write the asset's new value on your future financial statements. And, you may also need to record a new amount for the asset's depreciation.
What are the three causes of impairment and examples? ›
Three causes of impairment are attenuation, distortion, and noise. Attenuation means a loss of energy. When a signal, simple or composite, travels through a medium, it loses some of its energy in overcoming the resistance of the medium. That is why a wire carrying electric signals gets warm, if not hot, after a while.
Where does impairment go on the balance sheet? ›
Where Are Impairment Losses Shown? Impairment losses are shown both on the income statement and the balance sheet. An impairment loss is simultaneously recorded as an expense on the income statement and reduces the value of the impaired asset on the balance sheet.
What triggers impairment in accounting? ›
Indications of impairment [IAS 36.12]
- market value declines.
- negative changes in technology, markets, economy, or laws.
- increases in market interest rates.
- net assets of the company higher than market capitalisation.
The amount of the impairment loss reduces the carrying amount of the asset on the balance sheet and reduces net income on the income statement. The impairment loss is a non-cash item and doesn't affect cash from operations.
What are the three most common forms of impairment? ›
Unfortunately, some drivers on the road disregard the safety of others by driving while impaired. There are three main forms of impairment - alcohol, drugs, and distracted driving.
How do you use impairment in easy sentences? ›
He has a visual impairment in the right eye. Banks were partly responsible for the impairment of their asset portfolios because of their imprudent lending and investment policies.
What is impairment also known as? ›
The words “impairment,” “disability,” and “handicap,” are often used interchangeably.
What are functional impairment examples? ›
Functional impairments (FI) manifest themselves as difficulties in taking care of yourself or performing everyday actions. For example, these could be vision, hearing or movement limitations or growth, behavioural, language development or physical or spiritual development disorders.
On a scale of 0 to 100, 0 to 4 percent is interpreted as no problem, 5 to 24 percent is a mild problem, 25 to 49 percent is a moderate problem, 50 to 95 percent is severe, and 95 to 100 is total or complete problem.
What are the characteristics of an impairment? ›
Characteristic for an impairment is the loss or 'abnor- mality' of an anatomical structure, a physiological or a psychological function, which can be temporary or permanent, regressive or progressive, and reversible or irreversible.
Does impairment affect cash? ›
The impairment charge is a non-cash expense and added back into cash from operations. The only change to cash flow would be if there were a tax impact, but that would not normally be the case, as impairments are generally not tax-deductible.
Is goodwill an impairment? ›
Goodwill impairment occurs when a company decides to pay more than book value for the acquisition of an asset, and then the value of that asset declines. The difference between the amount that the company paid for the asset and the book value of the asset is known as goodwill.
What is the journal entry for impairment loss? ›
An impairment loss is recognized through a journal entry that debits Loss on Impairment, debits the asset's Accumulated Depreciation and credits the Asset to reflect its new lower value.
When must a company recognize an impairment loss? ›
An impairment loss must be recognised for a CGU when the recoverable amount of the unit is less than its carrying amount. IAS 36 prescribes the impairment loss to be allocated: first, to reduce the carrying amount of any goodwill allocated to the CGU.
Is bad debts the same as impairment? ›
Yes, bad debt expense equals an impairment loss in accounting. This is because every stock in the company has the standard value in which it should be sold at and in case it doesn't meet the value due to value deducted from it inform of total loss makes a loss to the company.
How does impairment affect the financial statements? ›
Reporting Asset Impairments on Financial Statements
An impairment loss ultimately reduces the profit your business reports for the period, but it has no immediate impact on the company's cash balance. You also write down the asset's carrying value that is reported on the balance sheet to the fair value you calculated.
What is the formula for impairment? ›
Impairment loss = carrying cost – recoverable amount. This is what you note as your impairment.
Is impairment loss a cash expense? ›
Impairments charges or losses are non-cash expenses; companies add them back into cash from operations. Therefore, such an expense could only change a business's cash flow in the case of a tax impact.
An inventory write-down, also referred to as “inventory impairment,” is an accounting term that recognizes when your inventory's market value falls below the book value, but it still considered sellable.
What are the effects of impairment? ›
Impairment effects consider the everyday impact of people's impairments on their lives in conjunction with the disabling impacts encountered through their relations with society, and society's relations with them.
What impairments are there? ›
Different types of disabilities
- vision Impairment.
- deaf or hard of hearing.
- mental health conditions.
- intellectual disability.
- acquired brain injury.
- autism spectrum disorder.
- physical disability.
The asset impairment practice ensures that assets are reported on the balance sheet at their fair market value. The practice better reflects the financial picture of a company's assets for users of the financial statements. Asset impairment can also smoothen the loss of sales when the asset is disposed of.
What are the benefits of impairment in accounting? ›
Asset impairment helps a company to evaluate its assets periodically and ensures it doesn't overstate the total value of its assets. It's essential to check asset values periodically because many factors can affect an asset's value, resulting in a lower market value than the book value.
What are the disadvantages of impairment? ›
Disadvantages of Impairment
It is generally difficult to know the measurement value that must be used to ascertain the impairment amount. A few of the popular ways of measuring impairment include finding out the current market value, current cost, NRV, or the sum of future net cash flows from the income-producing unit.
Is impairment taxable? ›
Impairment losses are not deductible for tax purposes.
Which assets are tested for impairment annually? ›
The recoverable amount of the following assets in the scope of IAS 36 must be assessed each year: intangible assets with indefinite useful lives; intangible assets not yet available for use; and goodwill acquired in a business combination.
What are the conditions that may indicate impairment to assets? ›
Indications of impairment [IAS 36.12]
- market value declines.
- negative changes in technology, markets, economy, or laws.
- increases in market interest rates.
- net assets of the company higher than market capitalisation.
Impairment in a person's body structure or function, or mental functioning; examples of impairments include loss of a limb, loss of vision or memory loss. Activity limitation, such as difficulty seeing, hearing, walking, or problem solving.
Financial assets subject to impairment
lease receivables. contract assets. irrevocable loan commitments, and. financial guarantee contracts that are not accounted for at fair value through profit or loss under IFRS 9.
What would cause an asset to be tested for impairment? ›
Impairment testing is required when events occur that indicate an asset (asset group) may not be recoverable. Such events are commonly referred to as triggering events.
How does GAAP treat impairment losses? ›
Under the U.S. generally accepted accounting principles (GAAP) assets considered impaired must be recognized as a loss on an income statement. The technical definition of impairment loss is a decrease in net carrying value of an asset greater than the future undisclosed cash flow of the same asset.
Why is asset impairment bad? ›
It reduces the value of goodwill to the fair market value (FMV) and represents a mark-to-market (MTM) charge. Individuals need to be aware of these risks and factor them into their investment decision-making process.
What are the advantages of asset impairment? ›
Asset impairment helps a company to evaluate its assets periodically and ensures it doesn't overstate the total value of its assets. It's essential to check asset values periodically because many factors can affect an asset's value, resulting in a lower market value than the book value.
How do you audit impairment of assets? ›
When there is evidence of an asset impairment, use the following procedure to record a reduction in its carrying amount in the accounting records:
- Step 1: Select Assets to Test. ...
- Step 2: Determine Impairment Level. ...
- Step 3: Update Accounting Records. ...
- Step 4: Revise Depreciation Calculations.
Three causes of impairment are attenuation, distortion, and noise. Attenuation means a loss of energy. When a signal, simple or composite, travels through a medium, it loses some of its energy in overcoming the resistance of the medium.
What are the three main causes of impairment? ›
For children with disabilities, most impairments were present at birth. For adults, disease and illness was the main cause of impairment, followed by accident and injury. An impairment is the term for the actual condition that someone has.
What is the entry for impairment in accounting? ›
Impairment is the accounting term for a long-term decline in a corporate asset's value. It could be an intangible asset or a fixed asset. The overall profit, cash flow, or other benefits that the asset can produce are periodically compared to its existing book value when an asset is tested for impairment.
What is impairment of financial assets under US GAAP? ›
An impairment loss is recognized when the carrying amount is greater than the recoverable amount. The recoverable amount is the greater of: (a) the fair value less costs to sell and (b) the value in use (i.e., the present value of future cash flows expected to be derived from the asset[s]).
If there is an impairment of intangible assets, you must recognize an impairment loss. This will be a debit to an impairment loss account and a credit to the intangible assets account. The new carrying amount of the intangible asset is its former carrying amount, less the impairment loss.
