What Is an Impairment?
An impairment occurs when the value of an asset on a company's books can no longer be justified by the cash flows or sale price it is expected to generate. When that happens, accounting rules require the company to write the asset down to its recoverable value and record the difference as an impairment loss.
Impairments most often hit goodwill and intangible assets from past acquisitions, but they can also apply to property, equipment, and other long-lived assets when business conditions deteriorate.
How It Works
Companies test goodwill and indefinite-lived intangibles for impairment at least annually, and test other long-lived assets whenever events suggest their value is in doubt, such as losing a major customer or a sustained drop in market conditions. If the carrying amount exceeds fair value, the excess is charged against earnings.
The charge is non-cash: no money leaves the company when an impairment is booked, because the cash was actually spent earlier when the asset was acquired. On the cash flow statement, the loss is added back to net income in the operating section. Under US GAAP, impairments generally cannot be reversed later, even if the asset recovers.
Example
Suppose a company carries $2 billion of goodwill from an acquisition made three years ago, but the acquired unit's performance has badly lagged the deal model. An annual test concludes the unit's fair value supports only $1.2 billion, so the company records an $800 million impairment charge, slashing reported net income even though no cash left the business.
Why It Matters
Impairments are effectively a public admission that past capital allocation, usually an acquisition, destroyed value, so large charges draw intense scrutiny from investors and boards. They can also breach debt covenants tied to net worth and shake confidence in management's judgment.
For analysts, impairment is a favorite interview topic: explaining how a non-cash write-down flows through the income statement, balance sheet, and cash flow statement is a classic three-statement question.
