An impairment loss is the amount by which an asset’s carrying amount exceeds the amount that asset can still recover, and under US GAAP it is recognized in earnings in the period the write-down is booked. Impairment losses are measured asset by asset, by asset group, or by reporting unit. Which figure counts as recoverable depends on the asset and the framework. For long-lived assets held and used, and for goodwill, US GAAP runs a separate test for each, while IFRS Accounting Standards run a single recoverable-amount test across both.
The Two-Step Test for Long-Lived Assets Held and Used
A long-lived asset is not written down just because its fair value has fallen. An impairment loss is recognized only if the carrying amount of the asset or asset group is not recoverable and exceeds its fair value, and that carrying amount is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset or asset group (FASB Statement No. 144, paragraph 7). The second comparison runs only when the first one fails, and the loss is then measured as carrying amount less fair value. Fair value here is the price that would be received to sell the asset in an orderly transaction between market participants at the measurement date (FASB Statement No. 157, paragraph 5), the same exit-price definition used in unrealized gain and loss.
The test runs on events, not a calendar. A long-lived asset or asset group is tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable (FASB Statement No. 144, paragraph 8). A significant drop in the asset’s market price is one such event. So is a significant adverse change in the extent or manner in which the asset is used, or in its physical condition. A current-period operating or cash flow loss combined with a history of those losses is another.
How an Impairment Loss Is Calculated
Take an asset group on three stated inputs.
Carrying amount of the asset group 500,000
Undiscounted cash flows from use and disposal 460,000
Step 1: 460,000 is below 500,000, so the carrying amount is not recoverable
Fair value of the asset group 380,000
Step 2: impairment loss, 500,000 less 380,000 120,000Change one input and the answer flips. Had the undiscounted cash flows exceeded the carrying amount, there would be no loss at all, even with fair value below carrying amount, because the carrying amount would still be recoverable.
The loss belongs in income from continuing operations before income taxes, and any income from operations subtotal has to include it (FASB Statement No. 144, paragraph 25).
The Write-Down Becomes a New Cost Basis
The reduced figure is not a temporary mark. The adjusted carrying amount is the asset’s new cost basis, a depreciable asset is depreciated over its remaining useful life on that basis, and restoration of a previously recognized impairment loss is prohibited (FASB Statement No. 144, paragraph 15). A booked impairment therefore moves a carrying-amount ratio permanently, the point made in asset to liabilities ratio.
Goodwill Is Tested at the Reporting Unit
Goodwill is tested at the reporting unit rather than asset by asset, and how that unit’s fair value gets estimated is worked through in multiples. The timing is not event-driven the way the long-lived asset test is. Goodwill is tested at least annually, and between annual tests when an event or change in circumstances would more likely than not reduce a reporting unit’s fair value below its carrying amount (FASB Accounting Standards Update 2017-04, paragraphs 350-20-35-28 and 35-30). The test is a single comparison: the fair value of the reporting unit against its carrying amount, with an impairment charge recognized for the amount by which carrying amount exceeds that fair value, capped at the total goodwill allocated to the unit (FASB Accounting Standards Update 2017-04).
Sequence matters when both tests are live. When goodwill and another asset or asset group of the reporting unit are tested at the same time, the other asset is tested first and any loss on it is recognized before goodwill is tested, and that ordering applies to every asset tested for impairment, not only those under Subtopic 360-10 (FASB Accounting Standards Update 2017-04, paragraphs 350-20-35-31 and 35-32).
Depreciation Versus Impairment
Depreciation is planned. It is the systematic allocation of an asset’s cost, less any salvage value, across the periods the asset serves the business, and the schedule is set when the asset goes into service. How that allocation is computed sits in depreciated and straight line depreciation. Nothing has to go wrong for depreciation to run.
Impairment is unplanned. Nothing is recognized until an event or a change in circumstances says the carrying amount may not be recoverable, and the amount recognized sits on no schedule at all.
They also do not replace each other. After an impairment loss is booked the asset keeps depreciating, over the remaining useful life on the new basis. Depreciation reduces carrying amount because time passed. Impairment reduces it because the expectation changed.
What IFRS Does Differently
IAS 36 collapses the two US steps into one. An asset is impaired when its carrying amount exceeds its recoverable amount (IAS 36, paragraph 8), and recoverable amount is the higher of fair value less costs of disposal and value in use, the present value of the future cash flows expected to be derived from the asset (IAS 36, paragraph 6). No undiscounted screen stands in front of that comparison, so facts that produce no loss under the US test can produce one here.
The reversal rule is the sharper split. An impairment loss recognized in prior periods for an asset other than goodwill is reversed if, and only if, the estimates used to determine recoverable amount have changed (IAS 36, paragraph 114), and the increased carrying amount cannot exceed what it would have been, net of depreciation, had no impairment loss ever been recognized (IAS 36, paragraph 117). Goodwill is carved out, and a goodwill impairment is never reversed (IAS 36, paragraph 124). US GAAP permits no reversal of an impairment loss on a long-lived asset held and used, and no subsequent reversal of a previously recognized goodwill impairment loss (FASB Accounting Standards Update 2017-04, paragraph 350-20-35-13). A narrower version of the same split runs through inventory write-downs, in GAAP vs IFRS.
A firm that would rather not carry impairment testing through a full busy season can run a block of its own work through Accountably’s offshore team and review chain first.
