Impairment Accounting

Impairment accounting is the set of procedures by which an organisation tests whether the amounts at which assets are carried in its books can still be recovered, and records a loss where they cannot. It covers the identification of assets at risk, the measurement of any shortfall, the journal entries that reduce the asset or build a loss allowance, later reversals and write-offs, and the related disclosures. The underlying concept is described under impairment; this entry concerns how the work is carried out.

Two families of rules apply. Non-financial assets, such as plant, software and goodwill, are tested under IAS 36 or its US counterparts. Financial assets, such as loans, receivables and debt securities, are covered by the expected credit loss model of IFRS 9, or the US current expected credit loss standard. The two differ in method, frequency and who performs the work, but both end in entries posted during the period-end close.

The finance function leads the process, with input from business units and valuation specialists.

• Trigger review. At each reporting date, finance collects evidence of possible impairment: falling margins, lost customers, damaged or idle assets, restructuring plans, or a share price below book value.
• Defining the unit tested. Assets are grouped into cash-generating units, and goodwill and corporate assets are allocated to them.
• Measurement. Forecasts approved by management are used to estimate value in use, or a market-based value is obtained. Discount rates and growth assumptions are documented and challenged.
• Recording. If the recoverable amount is below the carrying amount, an impairment charge is recognised in profit or loss, with the credit reducing the asset directly or through an accumulated impairment account. Future depreciation is recalculated.
• Review and approval. Results go to the chief financial officer and the board audit committee, and are examined by the external auditor.

Annual testing of goodwill and indefinite-life intangibles is usually scheduled at the same date each year, often ahead of year end so that the work is complete before the close.

For a bank or lender, impairment is a continuous, model-driven process run jointly by credit risk and finance. Each month or quarter, exposures are assigned to a stage, as described under staging under IFRS 9, based on arrears, rating changes and other indicators. Models then estimate probability of default, loss given default and exposure at default under several economic scenarios, and the weighted result is the required allowance.

The difference between the required allowance and the balance already held is posted as an impairment expense or release. The allowance is a contra asset account deducted from the gross loan balance; for loan commitments and guarantees it is a liability. Where models do not capture a known risk, management adds an adjustment, often called an overlay, which must be documented and approved. When a loan is judged uncollectable, it is written off against the allowance in line with the write-off policy, and any later recovery is credited to profit or loss. Companies with ordinary trade receivables use a simpler provision matrix based on the age of balances, recorded in an allowance for doubtful accounts.

Because impairment figures rest on forecasts, they are among the most judgemental numbers in the accounts and a common area of audit focus. Typical controls include formal approval of forecasts and scenarios by a committee, independent validation of credit models, reconciliation of the data feeding the models to the ledger, review of staging decisions and overlays, and comparison of earlier estimates with actual outcomes. Entries are prepared and approved by different people. Banks report impairment results to a provisions or impairment committee before they reach the board, and the timetable is built into the quarter-end close.

Auditors commonly report impairment of goodwill and loan loss allowances as key audit matters. Regulators review them as well: securities regulators challenge optimistic cash flow forecasts and thin disclosure, and bank supervisors compare coverage levels across institutions.

If conditions improve, an impairment loss on a non-financial asset other than goodwill is reversed, up to the amount at which the asset would have been carried had no loss been recorded. Loan allowances move up and down each period as a matter of course. Notes to the accounts explain the events behind significant charges, the key assumptions and their sensitivity, and, for financial assets, a reconciliation of the allowance by stage.

Timing is the central problem. Managers may be reluctant to recognise losses, and forecasts used in testing tend to be more hopeful than outcomes, so write-downs often arrive after the market has already marked down the company. For lenders, allowances depend heavily on the economic scenarios chosen, and can swing sharply when forecasts change, as they did in 2020. Differences between accounting impairment and the loan loss provision rules used for tax or prudential purposes add reconciling items. Data quality, particularly the history needed to estimate lifetime losses, remains a constraint for smaller institutions, and goodwill impairment testing is criticised for the shelter that healthy parts of a unit give to weak ones.

• IFRS Foundation
• Financial Accounting Standards Board