Key Takeaways
- Permanent reduction in asset's book value.
- Loss recognized when recoverable amount drops.
- Affects long-term tangible and intangible assets.
- Impairment loss recorded on income statement.
What is Impairment?
Impairment is a permanent reduction in the carrying amount of an asset when its recoverable amount falls below its book value, requiring a loss recognition on the income statement. This adjustment ensures that financial statements accurately reflect the diminished economic benefits of the asset, distinct from regular depreciation or amortization.
Accounting standards like GAAP and IFRS provide frameworks for recognizing and measuring impairment losses.
Key Characteristics
Impairment has distinct features that affect asset valuation and financial reporting:
- Asset Types: Primarily affects long-term tangible and intangible assets, including goodwill and patents.
- Carrying vs. Recoverable Amount: Impairment occurs when the carrying amount exceeds the recoverable amount, which is the higher of fair value less costs to sell or value in use.
- Irreversibility: Under GAAP, impairment losses are generally not reversible, unlike some provisions under IFRS.
- Income Statement Impact: Impairment loss is recorded as an expense, reducing reported earnings.
- Testing Triggers: Physical damage, market declines, or economic changes can initiate impairment testing.
How It Works
When impairment indicators arise, companies assess whether the asset’s carrying value exceeds its recoverable amount. This involves estimating future cash flows discounted to present value to determine value in use, or considering fair market value less selling costs.
Once impairment is confirmed, the loss is recorded by debiting an impairment expense and crediting a contra-account, reducing the asset’s book value. This adjustment impacts depreciation going forward, based on the revised asset value. Accounting for impairment follows rules set forth by impaired asset guidelines under relevant standards.
Examples and Use Cases
Impairment is common across industries facing asset value fluctuations and economic shifts:
- Energy Sector: Companies like ExxonMobil and Chevron may record impairments when oil prices drop, affecting reserves and equipment values.
- Financial Services: JPMorgan Chase might recognize impairments on financial assets or goodwill after acquisitions under IFRS standards.
- Market Shifts: Firms in technology or manufacturing may impair assets due to obsolescence or demand decline, as highlighted in large-cap stock analyses.
Important Considerations
Accurate impairment testing requires timely recognition of triggers and careful estimation of recoverable amounts. Misstatements can distort financial health and mislead investors.
Understanding the differences between GAAP and IFRS impairment rules is critical, especially regarding reversals and goodwill allocation. Companies should also consider the impact on future depreciation and accelerated depreciation methods following impairment recognition.
Final Words
Impairment reflects a permanent decline in asset value that must be recognized to keep financial statements accurate. Review your assets regularly for indicators of impairment and consult accounting standards to determine when testing or adjustments are necessary.
Frequently Asked Questions
Impairment is a permanent reduction in the carrying amount of an asset when its recoverable amount or fair market value falls below its book value. It requires recognizing a loss on the income statement and adjusting the asset value on the balance sheet.
Companies test for impairment when there are indicators such as physical damage, market declines, economic changes, or internal factors like reduced usage. Under IFRS, impairment tests are done annually or when such indicators arise.
Primarily long-term tangible assets like buildings and machinery, as well as intangible assets such as goodwill and patents, can be impaired. Certain assets like inventories and deferred taxes are generally excluded under accounting standards.
An impairment loss is recorded as an expense on the income statement and reduces the asset’s carrying amount through a contra-account like Accumulated Impairment Losses. Future depreciation is then based on this reduced asset value.
Under U.S. GAAP, impairment losses are recognized when book value cannot be recovered and are not reversible. IFRS requires annual tests or tests on indicators, allows reversal of impairment losses for non-goodwill assets if values recover.
The recoverable amount is the higher of an asset’s fair value less costs to sell or its value in use, which is the present value of expected future cash flows from the asset.
Yes, accounts receivable can be impaired when it is expected that some amounts will not be collected, requiring a loss recognition to reflect the reduced recoverable amount.
Common causes include physical damage like fire or flood, technological obsolescence, market demand decline, adverse economic conditions, and internal factors such as decreased asset usage.
