Impaired Asset: Meaning, Causes, How To Test, and How To Record

An impaired asset is a long-term asset that has lost its value. This can happen for a number of reasons, such as changes in the market value of the asset, physical damage to the asset, or obsolescence. When an asset is impaired, it is necessary to record the impairment loss in the financial statements.

There are two main types of impairment losses:

• Recoverable impairment loss: This is the amount by which the asset's carrying value exceeds its fair value. The fair value of an asset is the amount that would be received in a sale between a willing buyer and a willing seller, both of whom are knowledgeable about the asset and are acting in their own best interests.
• Unrecoverable impairment loss: This is the amount by which the asset's carrying value exceeds its net realizable value. The net realizable value of an asset is the amount that would be received if the asset were sold, less the costs of disposal.

The impairment loss is recorded as a charge to the income statement. The carrying value of the asset is reduced to its fair value or net realizable value, whichever is lower.

There are two ways to test for impairment:

• The recoverability test: This test is used to determine whether an asset is impaired. The asset is considered to be impaired if its carrying value exceeds its fair value less costs of disposal.
• The goodwill impairment test: This test is used to determine whether goodwill is impaired. Goodwill is considered to be impaired if its carrying value exceeds its implied value. The implied value of goodwill is the present value of the future cash flows that are expected to be generated by the asset.

Once an asset has been determined to be impaired, the impairment loss is recorded in the financial statements. The carrying value of the asset is reduced to its fair value or net realizable value, whichever is lower.

Impaired assets can have a significant impact on a company's financial statements. The impairment loss can reduce the company's net income and equity, and it can also increase the company's debt-to-equity ratio. As a result, impaired assets can make it more difficult for a company to obtain financing.