Impairment in accounting means a permanent reduction of asset value recorded in the balance sheet. The test for impairment compares expected economic benefits with the current net book value.

So, if the expected economic benefit is lower than the net book value, the difference is posted as an impairment in the accounting record via the following journal entry.

Description	Debit	Credit
Impairment (profit and loss)	XXX
Asset Net book value		XXX

The debit impact of this transaction is recording expenses in the profit and loss statement. This expense reduces profit for the current accounting period. On the other hand, the credit impact reduces the net book value of the asset, which is the prime purpose of recording impairment in the financial statement.

What’s the concept behind recording impairment in the accounting record?

The prudence principle of accounting drives the concept of impairment. As per this concept, the business needs to record possible losses.

So, recording impairment is a proactive approach in line with the prudence concept designed to enhance stakeholders’ confidence in the business financial statement.

What causes impairment in the assets?

The following situations may indicate impairment in the business assets.

1. Significant decline in consumer demand for the assets.
2. Legal aspects are negatively impacting the assets.
3. Damages observed in the asset functions.

If any of the above indications are found, it is mandatory to test assets for impairment.

How do we test assets for impairment?

The standard approach is to test each separately identifiable asset. For instance, multiple machines are used in manufacturing helicopters and airplanes. So, the business is required to individually test each asset in terms of impairment. However, if assets are not separately identifiable or it’s not possible to forecast cash flow separately, impairment testing can be applied to a group of assets.

What’s the purpose of recording impairment in the asset?

Recording impairment is intended to show the least favorable financial performance possible, in compliance with the prudence/conservatism concept of accounting. However, it’s important to reasonably estimate cash inflow for the asset under consideration.

When to test assets for impairment?

Some adverse event triggers impairment testing. The adverse event may be due to an economic downturn, financial adversity, operational hindrance, or multiple other sources. However, due to sensitive nature, goodwill and receivables are tested for impairment at the end of each accounting period.

Is impairment the same as depreciation?

No, impairment is different from depreciation. Impairment is a sudden decline in the asset’s recoverable amount, which may be driven by sudden changes in legal/economic factors, business operational factors, and more. On the other hand, depreciation is a planned reduction to account for economic benefits obtained using the asset.

For instance, depreciation expense is recorded each year on the business vehicle, which is a planned expense. On the other hand, any vehicle accident reduces its fair value. Hence, impairment is to be recorded in the books to reflect this accident.

Conclusion

Impairment means a permanent reduction in the asset’s net book value. The reduction is predicted or measured by comparing the asset’s recoverable amount with the current book value. So, if the book value is higher than the expected value, impairment is recorded and vice versa.

The impairment testing may be triggered by adverse economic/financial/operational events. However, periodic assessments must be made for the goodwill and accounts receivable.

It’s important to note that impairment is different from depreciation. Impairment refers to a sudden decrease in an asset’s value, while depreciation is planned expenses related to capital assets.

The concept of impairment is in line with the prudence principle of accounting. In line with this principle, the business must show the least positive financial image of the business.