Key Takeaways
- Impaired asset value below its book value.
- Caused by damage, market changes, or obsolescence.
- Test impairment via recoverable vs. carrying amount.
- Record impairment loss to reflect true asset value.
What is Impaired Asset: Meaning, Causes, How to Test, and How to Record?
An impaired asset is one whose current market value or recoverable amount falls below its carrying value on the balance sheet, requiring a write-down to reflect its true worth. This adjustment ensures financial statements present a realistic view of the asset’s value in line with fair value principles.
Impairment differs from regular depreciation or amortization as it represents an unexpected loss in value due to specific causes such as physical damage, market changes, or technological obsolescence.
Key Characteristics
Impaired assets share distinct traits that help identify and account for their reduced value:
- Permanent reduction: Unlike depreciation, impairment reflects a sudden and lasting decline in asset value.
- Carrying value vs recoverable amount: Impairment occurs when the asset’s book value exceeds its recoverable amount, which is often based on projected cash flows or market price.
- Accounting standards: Testing and recording impairment follow specific rules under GAAP or IFRS, depending on the jurisdiction.
- Impact on financials: An impairment loss reduces net income and asset values on the balance sheet, affecting company valuation.
- Triggers for testing: Impairment tests are required annually for certain assets or when indicators suggest a drop in value.
How It Works
Testing for impairment involves comparing the asset’s carrying value with its expected future benefits. Under GAAP, this starts with a recoverability test that compares book value to undiscounted cash flows; if cash flows are insufficient, impairment is recognized.
Conversely, IFRS uses a one-step approach assessing whether the carrying amount exceeds the recoverable amount, defined as the higher of fair value less costs to sell or value in use. When impairment is confirmed, the loss is recorded by adjusting the asset’s book value and recognizing an impairment expense on the income statement.
Examples and Use Cases
Impairment applies across industries, especially where assets face rapid market or technological changes:
- Airlines: Companies like Delta have to assess aircraft and equipment values regularly due to fluctuating demand and regulatory changes affecting asset utility.
- Manufacturing: Equipment that becomes outdated or physically damaged often requires impairment to reflect reduced operational value.
- Inventory: Firms may impair inventory when market prices drop below book value, ensuring accurate reporting of assets.
- Technology firms: Rapid obsolescence can trigger impairment of intangible assets or fixed equipment.
Important Considerations
When dealing with impaired assets, you should carefully follow accounting guidelines to ensure proper recognition and disclosure. Differences between GAAP and IFRS can affect timing and measurement of impairment losses.
Additionally, accelerated depreciation methods like accelerated depreciation may influence carrying values, impacting impairment assessments. Understanding these nuances helps maintain accurate financial reporting and supports better decision-making in managing your investments.
Final Words
Impairment reflects a real and often sudden drop in an asset’s value that must be recognized to present accurate financials. Regularly test your assets against projected cash flows and market conditions to identify impairment early and adjust your records accordingly.
Frequently Asked Questions
An impaired asset is one whose current market value or recoverable amount has fallen below its carrying value on the balance sheet, indicating a permanent loss in value that must be recorded as an impairment loss.
Assets can become impaired due to physical damage, changes in consumer demand, legal or regulatory issues, market downturns, technological obsolescence, or reduced projected future cash flows.
Under GAAP, companies use a two-step recoverability test where they compare the asset's carrying value to the undiscounted future cash flows it is expected to produce; if the carrying value is higher, the asset is impaired.
IFRS uses a one-step approach where an impairment loss is recognized if the asset's carrying amount exceeds its recoverable amount, defined as the higher of fair value less costs to sell or value in use.
Certain assets like intangible assets with indefinite lives, assets not yet in use, and goodwill must be tested annually, while other assets are tested only when there is an indication of impairment.
When impairment is identified, the asset’s carrying value is written down to its recoverable amount, and an impairment loss is recognized on the income statement to reflect the decrease in value.
Depreciation is a planned, systematic reduction in an asset’s value over time, while impairment is an unexpected, permanent decline in value that requires immediate recognition.
For example, if a company bought equipment for $100,000 and has depreciated it to $90,000, but the market value drops to $80,000, the asset is impaired and must be written down to the lower market value.
