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.

Explaining ‘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.

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.

Further Reading