Impairment

Loading the player...

What is 'Impairment'

Impairment is an accounting principle that describes a permanent reduction in the value of a company's asset, normally a fixed asset. When testing for impairment, the total profit, cash flow or other benefit that's expected to be generated by a specific asset is periodically compared with that same assets book value. If it's found that the book value of the asset exceeds the cash flow or benefit of the asset, the difference between the two is written off and the value of the asset declines on the company's balance sheet.

BREAKING DOWN 'Impairment'

Impairment is specifically used to describe a reduction in the recoverable amount of a fixed asset below its book value. Impairment normally occurs when there is a sudden and large decline in the fair value of an asset below its carrying amount, or the amount recorded on a company's balance sheet. An accountant tests assets for impairment periodically; if any impairment exists, the accountant writes off the difference in the fair value and the book value. Fair value is normally derived as the sum of an asset's undiscounted expected future cash flows plus the expected salvage value.

Accounting Procedures for the Impairment of an Asset

The impairment of an asset only occurs when the difference between fair value and the carrying amount is deemed to be unrecoverable. Under generally accepted accounting principles (GAAP), all assets are considered to be impaired when the fair value falls below the book value.

Any write-off due to an impairment loss can have adverse affects on a company's balance sheet and its resulting financial ratios. It's therefore very important for a company to test all fixed assets for impairment periodically. Standard GAAP practice is to test assets for impairment at the lowest asset 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.

Specific situations where an asset might become impaired and unrecoverable include such scenarios as assets with excessive costs to finance or construct, assets that are expected to be sold well before the end of their useful life, and when there is a significant change to an asset's intended use. Additionally, adverse changes to legal factors that affect an asset may be a signal of impairment. If any of these situations arise, it's important to test for impairment immediately.

Impaired Capital

Similar to an impaired asset, a company's capital can also become impaired. Impaired capital event occurs when a company's total capital becomes less than the par value of the company's capital stock. However, unlike the 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.

RELATED TERMS
  1. Impaired Asset

    A company's asset that is worth less on the market than the value ...
  2. Impaired Capital

    1. When a bank's actual assets are worth less than their stated ...
  3. Book Value Reduction

    Reducing the value at which an asset is carried on the books ...
  4. Impaired Insurer

    An insurance company that is potentially unable to fulfill its ...
  5. Impaired Credit

    A deterioration in the creditworthiness of an individual or entity. ...
  6. Goodwill Impairment

    Goodwill that has become or is considered to be of lower value ...
Related Articles
  1. Term

    How Is Impairment Loss Calculated?

    Impairment loss is the decrease in an asset’s net carrying value that exceeds the future undisclosed cash flow it should generate.
  2. Economics

    What is an Impaired Asset?

    An impaired asset is one where the fair market value of the asset is less than the historical cost (or book value) of the asset.
  3. Economics

    Understanding Impairment

    In finance and accounting, impairment refers to the loss of value of a company’s capital stock.
  4. Economics

    Impairment Charges: The Good, The Bad And The Ugly

    Impairment charge is the term for writing off worthless goodwill.
  5. Economics

    Explaining Goodwill Impairment

    Goodwill impairment results when the fair market value of a company’s goodwill asset is less than its historical cost.
  6. Professionals

    Goodwill Impairment Test: When You Overpay in M&A

    Overpaying for acquisitions can result in goodwill impairment charges and loss in stock value. How do companies test whether they have paid too much?
  7. Economics

    Understanding Historical Cost

    Historical cost equals the original purchase price of an asset recorded on a company’s balance sheet.
  8. Savings

    Assessing Bank Assets: Are Your Savings Safe?

    Learn how to determine if your assets are safe or if your bank has spread itself too thin.
  9. Investing

    The Difference Between Book and Market Value

    Book value is the price paid for an asset. It never changes as long as the asset is owned. Market value is the current price at which the asset can sell.
  10. Investing Basics

    How Does Goodwill Affect Stock Prices?

    “If a business does well, the stock eventually follows.” - Warren Buffett
RELATED FAQS
  1. How do businesses determine if an asset may be impaired?

    Find out how a business should determine if an asset may be impaired in accordance with the generally accepted accounting ... Read Answer >>
  2. How is impairment loss calculated?

    Learn how companies re-evaluate their assets and compare them against book values to recognize impairment and why this strategy ... Read Answer >>
  3. How do accountants record impaired assets?

    Learn why accountants need to identify and record impaired assets, how impairments are measured and how they impact financial ... Read Answer >>
  4. How do you write off impaired assets from the financial statement?

    Learn what an impaired asset is and how it effects a company's financial statements. Understand how an accountant writes ... Read Answer >>
  5. What are some ways a business owner can reduce unlimited liability?

    Understand how a fixed asset becomes impaired. Learn the accounting practices of impairing a fixed asset, and how it's recognized ... Read Answer >>
  6. How are impaired assets treated under U.S. accounting rules?

    Learn how to identify, test and measure impaired assets under the generally accepted accounting principles, Statement 144 ... Read Answer >>
Hot Definitions
  1. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  2. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
  3. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
  4. Sharing Economy

    An economic model in which individuals are able to borrow or rent assets owned by someone else.
  5. Unlevered Beta

    A type of metric that compares the risk of an unlevered company to the risk of the market. The unlevered beta is the beta ...
  6. Treasury Inflation Protected Securities - TIPS

    A treasury security that is indexed to inflation in order to protect investors from the negative effects of inflation. TIPS ...
Trading Center