Impairment

Definition

Impairment refers to a permanent reduction in the value of an asset, indicating that its carrying amount exceeds its recoverable amount. This concept is crucial for recognizing losses on assets, ensuring that financial statements present an accurate view of a company's financial health. Impairment can affect various asset types, including notes receivable, acquisition costs, intangible assets, and available-for-sale securities, impacting both balance sheets and income statements.

5 Must Know Facts For Your Next Test

1. Impairment losses must be recognized in the period they occur and cannot be reversed in future periods, maintaining the integrity of financial reporting.
2. For notes receivable, impairment indicates that a borrower may default on payments, prompting lenders to assess the collectability of these receivables.
3. Acquisition costs may become impaired if there are significant changes in market conditions or operational performance affecting future cash flows.
4. Intangible assets, like goodwill, are tested for impairment annually or when triggering events occur, impacting their valuation and potential write-downs.
5. Available-for-sale securities are assessed for impairment when there is a decline in fair value below cost, requiring a determination if this decline is other-than-temporary.

Review Questions

• How does impairment impact notes receivable and what steps should a company take to assess impairment?
  • Impairment in notes receivable occurs when it becomes probable that the borrower will not pay back the full amount due. Companies need to assess the creditworthiness of borrowers and evaluate historical collection patterns. If there is evidence of default risk, they must recognize impairment losses by adjusting the carrying value of the notes receivable to reflect their recoverable amounts.
• Discuss how impairment can affect the accounting treatment of intangible assets and what indicators may signal an impairment test is necessary.
  • Impairment affects intangible assets by requiring companies to test these assets for recoverability whenever there are indicators such as significant changes in market conditions or adverse changes in expected cash flows. When impairment is identified, companies must write down the asset to its recoverable amount, impacting both their financial position and profitability. This process helps ensure that intangible assets are accurately reflected on financial statements.
• Evaluate the implications of recognizing impairment on available-for-sale securities and how it differs from other asset classes.
  • Recognizing impairment on available-for-sale securities has unique implications as it reflects a decline in market value that may be other-than-temporary. Unlike other asset classes where impairment affects operational assets directly linked to income generation, impairments on securities primarily influence investment income and equity sections of the balance sheet. When an impairment loss is recognized, it adjusts the security's carrying value and impacts reported comprehensive income, demonstrating the volatility of investments in changing market conditions.

Related terms

Recoverable Amount: The higher of an asset's fair value less costs to sell and its value in use, which is used to determine if an asset is impaired.

Fair Value:

The price that would be received to sell an asset in an orderly transaction between market participants at the measurement date.

Write-down: An accounting adjustment that reduces the carrying amount of an asset on the balance sheet due to impairment.