How Do Businesses Determine if an Asset May Be Impaired?

What Is an Impaired Asset?

In the United States, an asset is considered impaired when its fair market value unexpectedly drops to less than the book value, or net carrying value, recorded on the balance sheet.

If the loss is permanent, it must be reflected on the balance sheet and recorded on the income statement.

Impairment can occur for a variety of reasons including changes in market conditions, regulations, technology, environmental conditions, and more.

If any such change damages an asset, makes it obsolete, or otherwise causes a reduction in its value below book value that can’t be recovered, the asset is impaired.

Key Takeaways:

• An asset is considered impaired when its fair market value drops below book value permanently.
• The impairment must be reflected in the financial statements if the loss can’t be recovered.
• Impairment recognition and measurement are jointly regulated by the Internal Revenue Service (IRS), the Financial Accounting Standards Board (FASB), and the Governmental Accounting Standards Board (GASB).
• Tangible asset impairment might result from regulatory or technology changes or shifts in the market or usage rates.

Determining if an Asset Is Impaired

To determine, or test, whether an asset is impaired, a company:

1. Calculates an accurate fair market value for the asset
2. Compares that value to the asset’s book value recorded on the balance sheet

A value below the book value indicates an impairment while a value equal to or above the book value does not.

Importantly, the general threshold for impairment, as described under generally accepted accounting principles (GAAP), is the inability to recover the book value amount.

If the asset is determined to be impaired, it can be written down unless otherwise excluded by the Internal Revenue Service or GAAP.

Assets must be properly valued (fair market value) in accordance with GAAP. Groups of similar assets should be tested together, with the testing set at the lowest level of identifiable cash flows considered independent of other assets. 

FASB Statement No. 144

Long-term, tangible asset impairments are addressed in FASB Statement No. 144: Accounting for the Impairment or Disposal of Long-Lived Assets.

FASB 144 discusses the application of goodwill allocation to long-term assets, suggests a preferred method for estimating cash flow (probability-weighted), and recommends when assets should be held for sale.

Important

Impairment recognition and measurement are regulated by the Internal Revenue Service (IRS), the Financial Accounting Standards Board (FASB), and the Governmental Accounting Standards Board (GASB).

Identifying Assets to Value

As pointed to above, tangible asset impairment might result from regulatory changes, technology changes, significant shifts in consumer preferences or community outlook, a change in the asset’s usage rate, or other forecasts of long-term non-profitability. 

Intangible asset impairment is less clear. Many types of intangible assets are covered in FASB 144 and FASB 147.

It is often impractical to simply value every single asset for profitability in every accounting period.

Instead, businesses should take such action if an event or circumstantial change, such as those mentioned, signals a possibility of impairment and the prospect that a particular net carrying amount might not be recoverable.

Note

Long-term tangible assets are the assets most likely to become impaired. But it can occur to accounts receivable and intangible assets, as well.

Additional Signs of Impairment

Other more direct signs can point to potential impairment.

For instance, a business should test for impairment when accumulated costs are higher than amounts needed to construct or acquire an asset. In other words, when it is more expensive than once thought to obtain a business asset.

Other signs are correlative; an asset might be associated with a history of current period losses or operating cash flow losses. Perhaps the asset shows a pattern of declining market value.

In addition, adverse changes in legal factors and general economic conditions are both grounds for measuring an asset’s value (despite a broad range of possible interpretations of adversity).

What Kinds of Assets Become Impaired?

Many kinds. For example, machinery, equipment, trucks and other vehicles, land, facilities, systems hardware and software can all become impaired.

Does an Impairment Loss Always Get Recorded?

No, it’s only recorded on a company’s financial statements if the amount of the loss cannot be recovered.

What Can Alert a Company to Potential Impairment?

If a company experiences events that it suspects could damage the market value of an asset, such as seriously bad weather or natural disasters, changes in market conditions, a loss of asset functionality, new regulations, or innovative new technology, then it should be prepared to determine impairment.

The Bottom Line

Companies determine asset impairment by accurately measuring the fair market value of an asset and comparing it to the book value on the balance sheet. If the fair market value is less than the book value, then the asset is impaired.