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.
Which Assets Incur Impairment Losses?
Impairment losses are not usually recognized for low-cost assets, since it is not worth the time of the accounting department to conduct impairment analyses for these items. Thus, impairment losses are usually confined to high-cost assets, and the amount of these losses can be correspondingly large. In particular, a business is mostly likely to incur an impairment loss on its goodwill asset. This is the excess price paid for an acquired business over the fair value of its assets and liabilities. A business is required to conduct a periodic impairment analysis of this asset, which will likely result in an impairment loss if the cash flows associated with the underlying assets have declined.
Related AccountingTools Courses
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.