Impairment is a financial accounting term. It means a) lowering of value of a company’s working capital or b) the entire capital is lesser than the original value of a firm’s current capital stock. Impairment is a negative term and if it has occurred it is not profitable for the firm.
Impairment is often linked to the devaluing of an asset (that is known to have a longer life) because that particular asset does not provide the same benefits that it used to provide at the time of purchase/induction. This devaluing has to be verified through a standardized series of assessment that are best suited to the firm. Impairment will only be considered if and when the decrease in asset’s worth is considerable.
For example a cosmetics’ firm bought a lab to perform animal testing. Due to a revision in that state’s laws the company can no longer experiment on the animals. This means the lab is redundant. It will result in a significant drop in the firm’s value owing to revised corporate conditions.
There are multiple reasons that could result in a different market value of the asset; it could be owing to a change in government regulations, a change in corporate environment as well. In order to analyze the impairment value of a given asset, comparison of the value of the asset with its estimated recoverable amount must be conducted. Recoverable amount is denoted by its maximum financial worth that can be achieved from selling that asset.
Methods to assess impairment:
– Indexation where indices are implemented in the cost value of assets to go at the current cost of the assets
– Current Market Price or CMP of asset = CMP of other new similar asset x remainder functional life of asset / original functional life of asset.
– Appraisal Method where experts are called in to examine and assess the asset. It is especially pertinent when insurance is to be claimed.
Impairment, if exists at the stage of asset group, can be allotted between the assets on the basis of pro rata. In spite of this impairment loss cannot minimize the carrying amount of the asset lower than its value. According to US GAAP (Generally Accepted Accounting Principles) evaluation tests are to be conducted each year as a mandatory practice.