Impairment Loss
1. Definition
Impairment Loss is a recognized reduction in the carrying amount of an asset that is triggered by a decline in its fair value. It occurs when the book value of an asset exceeds its recoverable amount, indicating that the asset is no longer worth what is stated on the balance sheet.
2. Recognition Criteria
Impairment is recognized when there is objective evidence that the asset's value has diminished significantly and possibly permanently.
- Comparison: Carrying Amount vs. Recoverable Amount
- Recoverable Amount: The higher of:
- Fair Value less costs of disposal: The price at which the asset could be sold.
- Value in Use: The present value of future cash flows expected to be derived from the asset.
- Result: If
Carrying Amount > Recoverable Amount, the difference is recorded as an Impairment Loss (Expense).
3. vs. Depreciation
| Criteria | Depreciation | Impairment |
|---|---|---|
| Nature | Systematic allocation of cost | Adjustment for loss of value |
| Timing | Recurring over useful life | Irregular, triggered by events |
| Predictability | Predictable (Planned) | Unpredictable (Sudden) |
| Cause | Wear and tear, usage | Market crash, damage, obsolescence |
4. Key Examples & Impact
4.1. Goodwill Impairment
Often occurs after an acquisition if the acquired company underperforms. The acquiring company must write down the value of the Goodwill, which can lead to a significant drop in reported earnings.
4.2. Tangible Asset Impairment
Occurs when physical assets like machinery or factories are damaged (e.g., fire, flood) or become technologically obsolete, rendering them less productive.
4.3. Big Bath
A strategy where a company (often under new management) recognizes large impairment losses in a single year to "clean up" the balance sheet, making future earnings look better by comparison.