Impairment of assets

What Is Impairment of Assets?

Impairment of assets is an accounting principle indicating that the carrying amount of an asset on a company's balance sheet is greater than its recoverable amount. This concept falls under financial accounting, specifically dealing with the valuation and reporting of long-lived assets. When an asset is impaired, its value on the financial statements must be reduced, and a corresponding [impairment of assets] loss is recognized. This ensures that a company's financial position is accurately represented, reflecting the true economic value of its resources. Impairment of assets can apply to various types of non-current assets, including property, plant, and equipment (PP&E), intangible assets, and goodwill.

History and Origin

The concept of impairment of assets evolved within global accounting standards to ensure financial statements provide a faithful representation of an entity's economic resources. Before formal standards, companies had more discretion in how they valued assets, potentially leading to overstatements of value. The need for standardized rules became evident as economies became more interconnected and transparency in financial reporting grew in importance.

Internationally, the International Accounting Standards Board (IASB) addressed asset impairment through IAS 36, "Impairment of Assets." This standard, initially issued by the International Accounting Standards Committee in June 1998, was adopted by the IASB in April 2001 and has undergone several revisions since, including significant amendments in 2004, 2008, and 2013 as part of broader projects on business combinations and fair value measurement. IAS 36 consolidates requirements for assessing asset recoverability, previously scattered across other standards such as IAS 16 (Property, Plant and Equipment) and IAS 38 (Intangible Assets).³²,³¹

In the United States, the Financial Accounting Standards Board (FASB) provides guidance under Accounting Standards Codification (ASC) Topic 360, "Property, Plant, and Equipment," specifically its "Impairment or Disposal of Long-Lived Asset" subsections.³⁰ This guidance requires a multi-step approach to impairment testing, primarily for long-lived assets held and used. Prior to the FASB Accounting Standards Codification's launch in July 2009, this guidance was primarily found in SFAS 144.²⁹

Key Takeaways

• Impairment of assets occurs when an asset's carrying amount exceeds its recoverable amount.
• It results in a non-cash expense on the income statement, reducing asset values on the balance sheet.
• Both U.S. GAAP (ASC 360) and IFRS (IAS 36) provide specific guidelines for identifying, measuring, and reporting asset impairment.
• Triggering events, such as significant market price declines or adverse changes in usage, often necessitate an impairment test.
• Once an asset is written down due to impairment under U.S. GAAP, the impairment loss cannot be reversed in future periods, even if market conditions improve.

Formula and Calculation

The calculation for [impairment of assets] under U.S. Generally Accepted Accounting Principles (GAAP), specifically ASC 360, involves a two-step process for long-lived assets to be held and used:

1. Recoverability Test: Determine if the asset's carrying amount is recoverable. An asset is considered not recoverable if its carrying amount exceeds the sum of the undiscounted future cash flow expected to result from its use and eventual disposition.²⁸,²⁷

   If ( \text{Carrying Amount} > \text{Sum of Undiscounted Future Cash Flows} ), then impairment may exist, and the second step is performed. If the carrying amount is less than or equal to the undiscounted cash flows, no impairment is recognized.²⁶

2. Impairment Loss Measurement: If the asset fails the recoverability test, an impairment loss is recognized. The impairment loss is the amount by which the carrying amount of the asset exceeds its fair value.²⁵,²⁴

   $$\text{Impairment Loss} = \text{Carrying Amount} - \text{Fair Value}$$

Under International Financial Reporting Standards (IFRS), specifically IAS 36, the process is slightly different:

1. Determine Recoverable Amount: The recoverable amount of an asset is the higher of its fair value less costs of disposal and its value in use. Value in use is the present value of the future cash flows expected to be derived from the asset.²³,²²

   $$\text{Recoverable Amount} = \text{Max(Fair Value - Costs of Disposal, Value in Use)}$$

2. Recognize Impairment Loss: An impairment loss is recognized if the carrying amount of the asset exceeds its recoverable amount.²¹

   $$\text{Impairment Loss} = \text{Carrying Amount} - \text{Recoverable Amount}$$

The impairment loss is typically recognized as an expense on the income statement.²⁰

Interpreting the Impairment of Assets

Interpreting an [impairment of assets] charge requires understanding its implications for a company's financial statements and future prospects. A recorded impairment loss suggests that an asset is no longer expected to generate the economic benefits originally anticipated when it was acquired or developed. This reduction in value directly lowers the asset's carrying amount on the balance sheet, which, in turn, reduces total assets and potentially shareholder equity.

On the income statement, an impairment charge is typically reported as a non-cash operating expense, reducing net income for the period.¹⁹ While it doesn't directly affect immediate cash flow, it signals underlying issues. For instance, a large impairment related to a manufacturing plant might indicate decreased demand for its products or technological obsolescence. If the impairment relates to [goodwill], it suggests that the acquired business is not performing as well as expected, and the synergies or future profitability anticipated at the time of acquisition have not materialized.¹⁸ Analysts often view significant or recurring impairment charges as a red flag, potentially indicating poor capital allocation decisions, declining market conditions, or flawed business strategies.

Hypothetical Example

Consider "Tech Innovations Inc.," a company that developed specialized machinery (PP&E) for producing a unique microchip. The machinery was acquired three years ago for $10 million and has accumulated depreciation of $3 million, giving it a carrying amount of $7 million.

Due to a sudden technological breakthrough by a competitor, the demand for Tech Innovations' microchip drops significantly. This new development serves as a "triggering event" for an impairment test.

Step 1: Recoverability Test (U.S. GAAP)

Tech Innovations' management estimates the undiscounted future cash flow expected from the machinery's continued use and eventual disposal to be $6 million.

Since the carrying amount ($7 million) is greater than the undiscounted future cash flows ($6 million), the asset fails the recoverability test, indicating potential impairment.

Step 2: Impairment Loss Measurement (U.S. GAAP)

Management then determines the fair value of the machinery. Due to the rapid technological obsolescence, the fair value is estimated to be only $4.5 million.

The impairment loss is calculated as:
Impairment Loss = Carrying Amount - Fair Value
Impairment Loss = $7,000,000 - $4,500,000 = $2,500,000

Tech Innovations Inc. would record a $2.5 million [impairment of assets] loss on its income statement, reducing its net income. The carrying amount of the machinery on its balance sheet would be reduced from $7 million to $4.5 million. This non-cash charge reflects the decreased economic value of the machinery.

Practical Applications

[Impairment of assets] is a critical aspect of financial reporting and analysis across various sectors, ensuring that assets are not overstated on a company's balance sheet.

• Financial Reporting and Compliance: Companies are mandated by accounting standards, such as U.S. GAAP (ASC 360) and IFRS (IAS 36), to periodically assess their assets for impairment. This ensures that the financial statements accurately reflect the assets' recoverable amounts. The U.S. Securities and Exchange Commission (SEC) closely scrutinizes these disclosures, particularly for material impairment charges, and expects companies to provide early warnings and detailed explanations of the circumstances leading to such charges.¹⁷ For instance, the SEC announced settled charges against United Parcel Service Inc. for failing to take an appropriate goodwill impairment charge for a poorly performing business unit, resulting in alleged material misrepresentations of earnings.¹⁶

• Mergers & Acquisitions (M&A): Post-acquisition, the goodwill recorded from a business combination is frequently subject to impairment testing. If the acquired entity or its associated reporting units do not perform as expected, a goodwill impairment charge may be necessary. For example, Kraft Heinz took a $9.3 billion non-cash impairment charge in Q2 2025, primarily due to a sustained decline in its stock price which reduced the carrying value of its intangible assets and goodwill.¹⁵

• Industry-Specific Challenges: Certain industries are more prone to asset impairment due to rapid technological change, volatile commodity prices, or shifts in consumer behavior. The oil and gas sector, for example, frequently experiences impairment charges on its property, plant, and equipment when commodity prices decline, affecting the profitability of reserves and infrastructure. Australian oil and gas producer Beach Energy recently faced a significant impairment charge due to a "lower commodity price outlook" impacting its Cooper Basin and Perth Basin operations.¹⁴ Similarly, technology companies might impair research and development assets or specialized equipment if a product fails or technology becomes obsolete.

• Capital Allocation and Investment Decisions: Impairment signals that past capital expenditure or investment decisions may not have yielded the expected returns. This information is crucial for management in reassessing their investment strategies and for investors in evaluating the long-term viability and efficiency of a company's operations.

Limitations and Criticisms

While [impairment of assets] aims to provide a more accurate depiction of a company's financial health, the application and interpretation of impairment rules carry several limitations and criticisms.

One primary criticism lies in the inherent subjectivity involved in estimating future cash flow and fair value. Both U.S. GAAP (ASC 360) and IFRS (IAS 36) require management to make significant judgments and assumptions about future economic conditions, market demand, and technological advancements.¹³,¹² These estimates can be difficult to project accurately, particularly for specialized assets or in rapidly changing industries. A slight change in assumptions can lead to a materially different impairment charge. Regulators, such as the SEC, often scrutinize these estimates and the timing of impairment tests.¹¹

Another limitation under U.S. GAAP is the "no reversal" rule for impaired long-lived assets held and used. Once an asset's carrying amount is reduced due to an impairment, that value cannot be written back up, even if conditions improve and the asset's fair value subsequently increases.¹⁰ This can lead to a disconnect where an asset's book value remains depressed despite a clear recovery in its economic value. In contrast, IFRS allows for the reversal of an impairment loss if there has been a change in the estimates used to determine the recoverable amount, though an impairment loss for goodwill cannot be reversed.⁹

Furthermore, the "triggering event" approach, where impairment tests are only initiated when specific indicators arise (e.g., significant decrease in market price, adverse change in physical condition), can lead to delays in recognizing a decline in asset value.⁸ This reactive approach may mean that assets are carried at inflated values for some time before an impairment is formally recognized, potentially misleading investors.

The non-cash nature of an impairment charge also means it does not directly affect a company's cash flow, which can sometimes lead to it being overlooked by less sophisticated investors focusing solely on cash generation. However, it significantly impacts reported earnings and the balance sheet, reflecting a real erosion of asset value and future earning potential.

Impairment of Assets vs. Asset Write-Down

While the terms "impairment of assets" and "asset write-down" are often used interchangeably, impairment of assets is a specific type of asset write-down. A write-down is a general accounting adjustment that reduces the book value of an asset. This reduction can occur for various reasons, such as correcting an overvaluation, adjusting for obsolescence, or lowering the value of inventory. Impairment, however, specifically refers to the situation where an asset's carrying amount exceeds its recoverable amount. Therefore, all impairments are asset write-downs, but not all asset write-downs are impairments. For instance, reducing the value of inventory due to spoilage would be an asset write-down, but it is typically not categorized as an "impairment of assets" under the same accounting standards that govern long-lived assets or goodwill. The impairment of assets process involves a specific test of recoverability and fair value measurement, as defined by accounting standards.

FAQs

What types of assets can be impaired?

Impairment of assets primarily applies to long-lived assets, including property, plant, and equipment (PP&E), intangible assets (such as patents, trademarks, and customer lists), and goodwill. Some assets, like inventory or financial instruments, are subject to other specific valuation rules (e.g., lower of cost or market for inventory, or fair value accounting for financial assets) rather than the impairment rules for long-lived assets.⁷,⁶

How does an impairment of assets affect a company's financial statements?

An [impairment of assets] loss is recognized as a non-cash expense on the income statement, which reduces net income and, consequently, earnings per share. On the balance sheet, the carrying amount of the impaired asset is reduced, leading to a decrease in total assets and shareholders' equity. While it's a non-cash charge, it can signal a deterioration in the asset's future economic benefits.⁵

What causes an asset to become impaired?

Various "triggering events" can indicate that an asset may be impaired. These include a significant decrease in an asset's market price, a significant adverse change in its physical condition, a change in how the asset is being used, a decline in expected future cash flow generated by the asset, or adverse changes in the business or legal environment.⁴,³

Is an impairment loss reversible?

Under U.S. GAAP (ASC 360) for long-lived assets held and used, an impairment loss is generally not reversible. Once an asset is written down, its new carrying amount becomes its cost basis for future depreciation or amortization. Under IFRS (IAS 36), an impairment loss can be reversed if there has been a change in the estimates used to determine the asset's recoverable amount, but this reversal cannot exceed the asset's carrying amount had no impairment been recognized. However, impairment losses on goodwill are not reversible under either GAAP or IFRS.²,¹