In accounting, organisations consult official reporting standards to determine when the carrying amount of an asset on their balance sheet exceeds its recoverable amount. Recognizing an impairment loss ensures that organisations do not present inflated asset values to lenders, investors, and auditors.
Finance teams encounter asset impairment when reviewing non-current assets such as machinery, commercial property, patents, or acquired goodwill. Reviewing balance sheet items for potential write-downs helps maintain accurate financial statements.
What is impairment in accounting?
Impairment represents a reduction in an asset's recoverable economic value relative to its recorded balance sheet amount. Finance teams record write-downs when balance sheet valuations exceed recoverable levels, ensuring financial statements present a realistic view of an organisation's resources.
In the UK, entities determine specific compliance criteria, definitions, and testing requirements by consulting official accounting standards, such as those issued by the Financial Reporting Council (FRC).
Indicators that an asset is impaired
Finance teams evaluate whether internal or external circumstances suggest that an asset may require a valuation review. Preparers should consult relevant accounting standards for the full list of statutory impairment indicators.
For specialised items such as goodwill or intangible assets, preparers should refer directly to the relevant standard text to determine review requirements.
External sources of information
Official frameworks direct preparers to consult relevant standards for external indicators that can prompt a valuation review, which may include:
- Decline in market value: Market evidence suggesting unexpected price drops, as defined under applicable standards.
- Broader market conditions: Adverse changes across industry conditions, legal environments, or economic dynamics outlined in standard manuals.
- Increased interest rates: Shifts in benchmark interest rates affecting valuation calculations, according to official standard criteria.
- Entity valuation discrepancies: Enterprise market valuation metrics diverging from balance sheet totals in accordance with standard guidance.
Internal sources of information
Relevant accounting standards direct preparers to internal operating indicators that may warrant review:
- Asset condition: Potential physical wear, obsolescence, or operational changes as evaluated under applicable accounting guidance.
- Operational changes: Strategic restructuring or altered asset usage identified in accordance with standard rules.
- Operating performance: Internal reporting indicating performance variations against expectations, as assessed under governing standards.
How to calculate an impairment loss
When an indicator appears, finance teams evaluate the asset's recoverable amount against its balance sheet carrying value. Finance teams consult official accounting standards to establish whether carrying value exceeds recoverable value.
If valuation testing determines that an asset's carrying value exceeds its recoverable amount, an impairment loss is calculated to reflect the difference.
Recoverable amount, fair value, and value in use
Under official accounting frameworks, determining an asset's recoverable amount involves evaluating operational utility alongside potential market disposal proceeds. Standards direct preparers to consult official guidance when assessing two key concepts:
- Fair value less costs of disposal: Preparers consult relevant accounting frameworks for official measurement criteria regarding potential asset disposal proceeds and associated costs.
- Value in use: Finance teams refer to applicable standard guidance for requirements on modelling projected operational cash flows and selecting discount rates.
When assets operate as part of a broader cash-generating group rather than producing distinct revenue independently, official standards outline specific rules for assessing the group and allocating potential write-downs. Preparers should consult the relevant reporting standard for rules governing collective asset assessments and goodwill treatment.
Applicable accounting frameworks also outline specific conditions regarding whether past impairment losses may be reversed. Finance teams must refer directly to the governing reporting standard to verify restrictions regarding reversals for goodwill and other non-current assets.
Difference between depreciation and impairment
Depreciation and impairment address different aspects of asset accounting.
Finance teams consult relevant accounting standards regarding depreciation of tangible assets over their expected useful life. Under IAS 38, amortisation applies to intangible assets with a finite useful life, while intangible assets with an indefinite useful life are not amortised.
Rather than routine periodic schedules, impairment addresses specific valuation declines identified under governing standards. When an asset experiences an impairment event, finance teams refer to relevant accounting standards to determine the appropriate ongoing treatment and adjustments for subsequent reporting periods.
Accounting treatment and journal entry for impairment
The accounting treatment for an impairment write-down depends on whether the asset is held under the historical cost model or a revaluation framework.
Historical cost model
For assets held under historical cost, finance teams record impairment adjustments through standard ledger entries that reflect the expense in profit or loss on the income statement. Preparers consult accounting standards and their internal chart of accounts to ensure the corresponding journal entry correctly adjusts the asset's balance sheet position.
Revaluation model
Where an asset is carried at revalued amounts, standard practice requires finance teams to consult the specific provisions of relevant accounting standards. Preparers should review applicable reporting standards to determine the appropriate allocation of write-downs between equity reserves and profit or loss.
UK Corporation Tax considerations
For UK Corporation Tax, finance teams must review HMRC guidance and tax legislation to determine the allowable status of accounting write-downs and capital asset provisions.
For corporate intangible assets, UK tax treatment generally aligns with accounting write-downs, subject to specific rules for acquired goodwill. Companies can also elect for a statutory fixed-rate tax deduction of 4% per year on qualifying intangibles instead of following accounts-based debits (HMRC). For qualifying goodwill acquired on or after 1 April 2019 alongside intellectual property, tax relief is provided at a statutory rate of 6.5% per annum (HMRC).