Impairment Charge

An impairment charge is an expense a company records when an asset is worth less than the amount at which it is carried in the accounts and that shortfall is not expected to reverse soon. The charge reduces the asset's value on the balance sheet and appears as a loss on the income statement. Companies, banks and auditors use it so that reported assets are not overstated.

Impairment applies to many kinds of asset: factories, machinery, software, brands, licences, investments in other companies and acquired goodwill. Under IFRS the main rule for non-financial assets is IAS 36 Impairment of Assets; US GAAP splits the topic between ASC 360 (long-lived assets) and ASC 350 (goodwill and other intangibles). Loans and other financial assets follow separate credit-loss rules, IFRS 9 and ASC 326 (CECL).

Imagine you bought a food truck to sell ice cream at a beach, and you record it in your notebook at the price you paid less a bit of wear each year. Then the town closes the beach for good. The truck still runs, but it will never earn what you expected, and nobody would pay the old price for it. Keeping the old figure in your notebook would be fooling yourself.

An impairment charge is the moment you cross out the old figure and write in a lower, honest one. The difference is counted as a loss for the year. Nothing has been paid out in cash, but the business is admitting that part of what it spent will not come back.

Ordinary wear on an asset is spread over its life through depreciation or amortization. Impairment is different: it is a one-off adjustment triggered by an event or change in conditions. Typical warning signs include falling demand, physical damage, new regulation, a sharp rise in interest rates, a plan to close a site, or a company's market value dropping below its book value.

Under IAS 36, when there is an indicator, the company compares the asset's carrying amount with its recoverable amount, which is the higher of two figures: fair value less costs of disposal (what it could be sold for, net of selling costs) and value in use (the present value of the cash it is expected to generate). Assets that do not produce cash on their own are grouped into a cash-generating unit. US GAAP uses a different first step for long-lived assets: the company checks whether the asset's undiscounted future cash flows cover its carrying amount, and only if they do not does it write the asset down to fair value.

Some assets must be tested every year whether or not there is a warning sign. These include goodwill and intangible assets with indefinite lives; see goodwill impairment for how those tests run.

Under IFRS the loss is measured as:

with

• $\text{Carrying amount}$ is the asset's cost less accumulated depreciation and any earlier impairment.
• $\text{FVLCD}$ is fair value less costs of disposal, measured using the fair value hierarchy.
• $\text{VIU}$ is value in use: expected cash flows discounted at a pre-tax discount rate, in the same way as a net present value calculation.

Worked example: a production line has a carrying amount of 10.0 million. A buyer would pay 6.5 million, with 0.3 million of selling costs, so FVLCD is 6.2 million. Discounting the expected cash flows gives a value in use of 7.4 million. The recoverable amount is the higher figure, 7.4 million, so the impairment loss is 10.0 − 7.4 = 2.6 million. The line is then carried at 7.4 million and depreciated from that new base.

An impairment charge lowers operating profit and net income in the period it is booked. Because it is a non-cash item, it is added back in the operating section of the statement of cash flows, and analysts usually strip it out of EBITDA and "adjusted" earnings. Tax authorities often do not allow a deduction until the asset is sold or scrapped, so the gap between book and tax values can create a deferred tax asset.

The rules on reversal differ. IFRS allows an impairment of most assets other than goodwill to be reversed if conditions improve, up to the carrying amount the asset would have had without the write-down. US GAAP does not allow reversal for assets held and used.

For banks, the word impairment mostly means credit losses on loans. IFRS 9 and CECL replaced older "incurred loss" rules with forward-looking expected credit loss models, under which a bank books a loan loss provision before a borrower actually defaults. The logic is the same as for a factory, an asset written down to what is likely to be collected, but the measurement relies on default probabilities and recovery rates rather than on sale prices or value in use.

Value in use depends on management's own forecasts and choice of discount rate, so impairment testing involves a lot of judgement. Critics say charges often come late, after the market has already marked down the share price, and that large write-downs are sometimes timed for a new chief executive's first year ("big bath" accounting). Regulators and the independent auditor therefore focus on the assumptions behind the test, and standards require disclosure of key inputs and how sensitive the result is to them.

• IFRS Foundation
• Financial Accounting Standards Board