Impairment loss definition
/What is an Impairment Loss?
An impairment loss is a recognized reduction in the carrying amount of an asset that is triggered by a decline in its fair value. When the fair value of an asset declines below its carrying amount, the difference is written off. Carrying amount is the acquisition cost of an asset, less any subsequent depreciation and impairment charges. It is less likely for an impairment loss to be recognized for older assets, since their carrying amounts have already been substantially reduced by ongoing depreciation charges.
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Example of an Impairment Loss
A company owns a manufacturing plant that was originally purchased for $5 million. Over time, due to economic downturns and advancements in technology, the plant becomes obsolete and less productive. A recent appraisal estimates its fair value at only $2.5 million, while its carrying amount in the company’s books remains $4 million.
Since the carrying amount ($4 million) exceeds the recoverable amount ($2.5 million), the company must recognize an impairment loss of $1.5 million ($4 million - $2.5 million) in its financial statements.
This impairment loss would be recorded as an expense in the income statement, reducing the company’s reported profits for that period.
Impairment Loss FAQs
How do impairment losses affect future depreciation or amortization?
After an impairment loss is recognized, the asset’s carrying amount is reduced to its impaired value. This reduced amount becomes the new basis for future depreciation or amortization. As a result, periodic expense is generally lower over the asset’s remaining useful life.
Which assets incur impairment losses?
Impairment losses are generally recognized for higher-cost assets because analyzing low-cost items is usually not economical. Goodwill is especially susceptible to impairment. If the expected cash flows or fair value associated with an acquired business decline, an impairment analysis can result in a significant loss being recognized in earnings.