Impairment

What Is an Impairment?

An impairment is a reduction in the recorded value of an asset, recognized because the asset is worth less than the amount at which it is carried on the books. In accounting, the carrying value of an asset is its original cost less accumulated depreciation or amortization. When events or changes in circumstances suggest that carrying value may not be recoverable, a company must test whether an impairment exists and, if so, record a loss.

Impairment is different from normal depreciation. Depreciation spreads a predictable cost over an asset's useful life, while an impairment is an unexpected decline in value that requires a one-time adjustment.

How Impairment Works

For long-lived assets such as factories, equipment, and finite-lived intangible assets, companies first look for warning signs, such as a sustained drop in demand, a major change in how an asset is used, or continuing operating losses. If a warning sign exists, the company compares the asset's carrying value with the cash flows it is expected to generate. If the carrying value is higher than what the asset can recover, the asset is write-down|written down to its fair value or a related measure, and the difference is recorded as an impairment loss in the income statement.

goodwill|Goodwill, the premium paid in an acquisition above the fair value of identifiable net assets, is handled differently. Under both U.S. GAAP and IFRS, goodwill must be tested for impairment at least once a year, and also whenever a triggering event occurs. Impairment of financial assets, such as loans and receivables, follows separate rules based on expected credit loss estimates.

Why Impairment Matters to Investors

An impairment charge reduces reported net income and shareholders' equity, often sharply in the period it is recorded. Because it is a non-cash charge, it does not directly reduce cash flow. However, it can signal that past investments did not produce the returns management expected. Investors often read large impairments as a sign that an acquisition or expansion may have been overvalued.

Impairment accounting also involves judgment. Management must estimate future cash flows and discount rates, and different assumptions can lead to very different conclusions. For this reason, it is useful to read the notes to the financial statements, where companies usually explain what was tested and which assumptions were used.