Impairment
Candlefocus EditorImpairment exists when an asset’s fair value has declined to less than its carrying value (the value on the balance sheet). Generally accepted accounting principles (GAAP) require that when impairment has been confirmed through testing, an impairment loss should be recorded. An impairment loss records an expense in the current period that is reported on the income statement as a decrease in total profit, as well as reduces the value of the impaired asset on the balance sheet.
The process used to test assets for impairment helps identify and measure impairments. If a company recognizes an impairment, they should determine how much of the carrying value of the asset must be included as an income statement expense. Depending on the asset, different methods of testing may be used, including the discounted cash flow model, the option-pricing method, and the relief-from-royalty method. In most cases, the entity uses the current market value of the asset to determine impairment.
Companies should regularly update the values of their assets on the balance sheet and test for impairment. Doing so will properly account for any current or foreseeable diminishment in value and ensure that the statements issued by the entity are accurate.
In summary, impairment occurs when an asset suffers a decrease in its fair value or future cash flows that is deemed material, and is subject to a regular test for confirmation. If an impairment loss is verified, the associated expense should be entered in the current period of the income statement, and the asset’s value should be adjusted to reflect the new carrying value on the balance sheet. Proper adherence to this process will help avoid any misleading or false financial statements being distributed by the entity.