An asset impairment arises when there is a sudden drop in the fair value of an asset below its recorded cost. The accounting for asset impairment is to write off the difference between the fair value and the recorded cost. Some impairments can be so large that they cause a significant decline in the reported asset base and profitability of a business.
Impairment only occurs when the amount is not recoverable. This happens when the carrying amount exceeds the sum of the undiscounted cash flows expected to result from the use of the asset over its remaining useful life and the final disposition of the asset. The bulk of these cash flows are usually derived from subsequent use of the asset, since the disposition price may be low.
The amount of an impairment loss is the difference between an asset’s carrying amount and its fair value. Once you recognize an impairment loss, this reduces the carrying amount of the asset, so you may need to alter the amount of periodic depreciation being charged against the asset to adjust for this lower carrying amount.
It is necessary to test assets for impairment at the lowest level at which there are identifiable cash flows that are largely independent of the cash flows of other assets. In cases where there are no identifiable cash flows at all (as is common with corporate-level assets), place these assets in an asset group that encompasses the entire entity, and test for impairment at the entity level.
Also, test for the recoverability of an asset whenever the circumstances indicate that its carrying amount may not be recoverable. Examples of such situations are:
- Cash flow. There are historical and projected operating or cash flow losses associated with the asset.
- Costs. There are excessive costs incurred to acquire or construct the asset.
- Disposal. The asset is more than 50% likely to be sold or otherwise disposed of significantly before the end of its previously estimated useful life.
- Legal. There is a significant adverse change in legal factors or the business climate that could affect the asset’s value.
- Market price. There is a significant decrease in the asset’s market price.
- Usage. There is a significant adverse change in the asset’s manner of use, or in its physical condition.
If there is an impairment at the level of an asset group, allocate the impairment among the assets in the group on a pro rata basis, based on the carrying amounts of the assets in the group. However, the impairment loss cannot reduce the carrying amount of an asset below its fair value.
Under no circumstances is it allowable to reverse an impairment loss under GAAP.