# What Does Impairment Mean in Accounting? With Examples

> **Definition**
>
> In accounting, impairment is an unexpected deterioration in an asset's ability to generate future economic benefits. It requires a write-down to prevent financial overstatement.

When a company's asset loses a significant amount of value below that recorded on its books, accountants must address it through asset impairment. Unlike routine [depreciation](https://www.investopedia.com/terms/d/depreciation.asp), which accounts for predictable wear and tear, impairment recognizes sudden, substantial drops in value that weren't anticipated in regular depreciation schedules.

Asset impairment can dramatically affect a company's financial statements, reducing both asset values on the balance sheet and profits on the income statement. By analyzing when and how companies record impairments, readers of financial statements can better assess management decisions, identify potential red flags, and make better investment choices.

### Key Takeaways

*   Asset impairment occurs when an asset's recoverable value falls significantly below its book value, often through technological changes, market downturns, or physical damage.
*   Companies must conduct regular impairment tests on certain types of assets, comparing carrying value with fair value and immediately recognizing any shortfall as a loss.
*   Impairment losses affect both the income statement (reducing current-period profits) and the balance sheet (permanently lowering the asset's recorded value), thus affecting financial ratios and investment analysis.
*   Unlike routine depreciation, which distributes an asset's cost over time, impairment reflects an unexpected loss of value.

![Impairment](https://www.investopedia.com/thmb/GFts32a2RdZIKsdpzV6jkomFAFs=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Impairment-Final-971b3c0742074160985263dd9eb329c2.jpg)

*— Investopedia / Xiaojie Liu*

## What Is Impairment?

Impairment is a substantial, unexpected decline in an [asset's recoverable value](https://www.investopedia.com/terms/e/estimated-recovery-value-erv.asp) that requires immediate recognition in financial statements. This applies when an asset's ability to generate future economic benefits has diminished significantly beyond the normal pace of depreciation.

Many companies struggle with impairment assessments because they require both accounting expertise and industry-specific knowledge to determine when technological or market changes have truly undermined an asset's value. For instance, a manufacturing company might discover that a specialized piece of equipment has become technologically obsolete because of industry changes, dramatically reducing its value below the [depreciated cost](https://www.investopedia.com/terms/d/depreciatedcost.asp) on the balance sheet. Likewise, an unexpected regulatory change might make certain production facilities noncompliant, requiring expensive changes that diminish an asset's overall value.

When assessing impairment, accountants compare an asset's [carrying value](https://www.investopedia.com/terms/c/carryingvalue.asp) (original cost minus accumulated depreciation) against its [fair value](https://www.investopedia.com/terms/f/fairvalue.asp), which typically is the present value of expected future cash flows plus any potential salvage value. This evaluation often involves complex estimates, particularly for specialized assets without active markets.

By preventing the overstatement of assets, impairment enables companies to provide stakeholders with a more accurate picture of their financial position and earning potential.

> **Fast Fact**
>
> The transparency involved in impairment, while sometimes revealing uncomfortable truths about past decisions—by definition, management didn't see the impairment coming—ultimately supports better-informed business strategies and investor decisions.

### Periodic Evaluations for Impairment

Companies should systematically assess their assets for potential impairment rather than wait for obvious signs of problems. This approach ensures financial statements reflect economic reality and prevents the sudden recognition of massive losses that could have been identified earlier.

The impairment process involves several steps. First, accountants identify triggering events that might indicate impairment, such as significant drops in market value, regulatory changes, or physical damage. Next, they determine the asset's recoverable amount by calculating its fair value, often using [discounted cash flow](https://www.investopedia.com/terms/d/dcf.asp) models that project future economic benefits. Finally, they compare this recoverable amount to the asset's current carrying value on the balance sheet.

When this reveals that an asset's carrying value is more than its recoverable amount, accountants write down the asset to its fair value and recognize an [impairment loss](https://www.investopedia.com/ask/answers/101314/how-impairment-loss-calculated.asp). This write-down establishes a new [cost basis](https://www.investopedia.com/articles/investing/060313/what-determines-your-cost-basis.asp) for the asset, which becomes the starting point for future depreciation calculations. Under U.S. accounting standards, impairment losses cannot be reversed even if the asset's value later increases.

Companies must also regularly assess intangible assets like goodwill, patents, and trademarks for potential impairment. [Goodwill](https://www.investopedia.com/articles/professionals/080415/goodwill-impairment-test-understand-basics.asp), which is the premium paid in acquisitions above the fair value of identifiable assets, requires mandatory annual impairment testing regardless of whether triggering events have occurred. This requirement acknowledges the subjective nature of goodwill valuation and its susceptibility to overstatement.

## Impairment Example

Let's go through a scenario that illustrates how asset impairment works in practice. Suppose ABC Manufacturing bought a specialized production facility for $10 million five years ago. The company has recorded $3 million in accumulated depreciation since then, resulting in a current carrying value of $7 million on its balance sheet.

A significant technological advance recently changed the industry, making ABC's production methods significantly less efficient than newer alternatives. Management estimates that retrofitting the facility would cost $2.5 million and still leave them at a competitive disadvantage. Based on projected cash flows using the existing facility, management determines its fair value is now only $4.2 million.

Since the $4.2 million fair value falls below the $7 million carrying value, ABC has to recognize an impairment loss of $2.8 million. The accounting entry would include the following:

1.  A debit to "Impairment Loss" for $2.8 million (which appears on the income statement, reducing profit)
2.  A credit to "Production Facility" (or a [contra-asset account](https://www.investopedia.com/terms/c/contraaccount.asp)) for $2.8 million, reducing the asset's value on the balance sheet

After recording this impairment, the production facility's new carrying value becomes $4.2 million. Future depreciation will be calculated based on this reduced amount spread over the facility's remaining useful life. Even if economic conditions improve unexpectedly and the facility's value increases, U.S. accounting standards prohibit ABC from reversing the impairment loss.

Recognizing the impairment alerts those reading the financial statements about several important realities: the technological disruption affecting the industry, the reduced cash-generating capacity of ABC's assets, and the impact on the company's overall financial position.

## Impairment vs. Depreciation

The distinction between depreciation and impairment reveals management's assumptions about market conditions. Depreciation reflects expected obsolescence, while impairment indicates an unexpected development, including a market shift that caught management off guard.

Depreciation follows a systematic, predetermined schedule to allocate an asset's cost over its useful life, reflecting expected wear and tear from normal use. For example, when a delivery company purchases a new truck for $50,000 with an expected five-year life, it might recognize $10,000 in depreciation annually regardless of the truck's actual market value. This happens predictably whether business conditions are favorable or challenging.

Impairment, by contrast, is for sudden, significant value declines triggered by unexpected events. If that same delivery truck suffers major damage in an accident or becomes obsolete because of regulatory changes prohibiting its use in urban areas, the company must check for impairment. After determining the truck's fair value has fallen below its depreciated carrying amount, the company would recognize an immediate impairment loss rather than waiting for the depreciation schedule to catch up.

The accounting treatment also differs significantly. Depreciation appears on [income statements](https://www.investopedia.com/terms/i/incomestatement.asp) as a recurring operating expense spread predictably across reporting periods. Impairment losses, however, appear as distinct nonrecurring items that signal extraordinary circumstances for financial statement readers. In addition, depreciation calculations continue after impairment but are based on the newly established lower asset value.

## GAAP Requirements for Impairment

The generally accepted accounting principles ([GAAP](https://www.investopedia.com/terms/g/gaap.asp)) have specific guidelines for asset impairment to ensure consistent financial reporting across companies. These requirements are primarily outlined in [accounting standards codification (ASC)](https://www.investopedia.com/terms/a/accounting-standards-committee/asc.asp) 360 for long-lived assets and ASC 350 for goodwill and other intangible assets.

Under GAAP, companies must evaluate assets for potential impairment whenever changes in circumstances suggest an asset's carrying value may not be recoverable. This assessment follows a two-step process for [long-lived assets](https://www.investopedia.com/terms/l/longtermassets.asp): first determining recoverability by comparing undiscounted expected future cash flows to the asset's carrying amount, then measuring impairment by comparing the carrying amount to fair value if the asset is deemed unrecoverable.

For goodwill and indefinite-lived intangible assets, GAAP mandates annual impairment testing regardless of whether impairment indicators exist. This more stringent requirement reflects these assets' subjective valuation and their susceptibility to overstatement. Companies may first perform a qualitative assessment to determine whether quantitative testing is necessary, potentially streamlining the process when impairment is unlikely.

GAAP also requires extensive disclosures about impairment decisions, including the events triggering impairment, valuation methodologies used, and financial statement impacts. These help investors understand the circumstances surrounding value deterioration and management's response. Companies must also document their impairment testing assumptions and methodologies, making them available for auditor review to prevent arbitrary or biased assessments.

Once an impairment loss is recognized under GAAP, it establishes a new cost basis for the asset that cannot be reversed in future periods, even if the asset's value subsequently increases. This contrasts with [international financial reporting standards (IFRS)](https://www.investopedia.com/terms/i/ifrs.asp), which permit impairment reversal under certain circumstances.

## The Bottom Line

Asset impairment helps keep financial statements accurate once assets unexpectedly lose significant value. By requiring companies to recognize these value declines promptly, impairment accounting ensures investors receive transparent information about a company's true financial condition and future earnings potential.

Impairment charges can signal industry disruption, technological obsolescence, management investment missteps, or changing market conditions.

> **Article Sources**
>
> 1.  Journal of Accountancy. "[Asset Impairment and Disposal](https://www.journalofaccountancy.com/issues/2002/mar/assetimpairmentanddisposal.html)."
>     
> 2.  International Accounting Standards Board. "[IAS 36 Impairment of Assets](https://www.ifrs.org/issued-standards/list-of-standards/ias-36-impairment-of-assets/)."
>     
> 3.  Financial Accounting Standards Board. "[Intangibles—Goodwill and Other (Topic 350), Business Combinations (Topic 805), and Not-for-Profit Entities (Topic 958)](https://www.fasb.org/Page/ShowPdf?path=Proposed_ASU-Intangibles-Goodwill_and_Other_%28Topic_350%29.pdf&title=PROPOSED+ACCOUNTING+STANDARDS+UPDATE%E2%80%94INTANGIBLES%E2%80%94GOODWILL+AND+OTHER+%28TOPIC+350%29%2C+BUSINESS+COMBINATIONS+%28TOPIC+805%29%2C+AND+NOT-FOR-PROFIT+ENTITIES+%28TOPIC+958%29%3A+EXTENDING+THE+PRIVATE+COMPANY+ACCOUNTING+ALTERNATIVES+ON+GOODWILL+AND+CERTAIN+IDENTIFIABLE+INTANGIBLE+ASSETS+TO+NOT-FOR-PROFIT+ENTITIES&acceptedDisclaimer=true&Submit=)."
>     
> 4.  Accounting Tools. "[Impairment Definition](https://www.accountingtools.com/articles/impairment)."
>     
> 5.  Joanne M. Flood. "[Practitioner's Guide to GAAP 2023: Interpretation and Application of Generally Accepted Accounting Principles: Chapter 25](https://onlinelibrary.wiley.com/doi/10.1002/9781394152698.ch25)." Wiley, 2023.