Impairment test

Definition

An impairment test is an accounting procedure used to determine whether the carrying amount of an asset exceeds its recoverable amount, indicating that the asset may be impaired. This test is especially important for intangible assets, as it helps ensure that their reported values on the balance sheet reflect their actual economic benefits. The impairment test involves comparing the asset’s carrying value to the estimated future cash flows or fair value, ensuring that losses are recognized in a timely manner.

5 Must Know Facts For Your Next Test

1. Impairment tests for intangible assets must be conducted annually or whenever there are indicators of impairment, such as significant changes in market conditions.
2. The two-step process for impairment testing first involves assessing if the carrying amount exceeds the recoverable amount, followed by measuring the amount of impairment loss if applicable.
3. For indefinite-life intangible assets, the impairment test is usually performed at the reporting unit level rather than the individual asset level.
4. If an intangible asset is determined to be impaired, it must be written down to its recoverable amount on the balance sheet, impacting earnings in that reporting period.
5. Intangible assets with finite useful lives are amortized and tested for impairment whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable.

Review Questions

• How does the impairment test specifically apply to intangible assets compared to tangible assets?
  • The impairment test for intangible assets is unique because it often requires a qualitative assessment of events or circumstances that could indicate impairment. Unlike tangible assets that might have more straightforward depreciation methods, intangible assets like goodwill or trademarks can have indefinite lives and require a different approach. Additionally, for intangible assets with finite lives, both amortization and impairment considerations come into play, making the process slightly more complex.
• Discuss the implications of failing to perform an impairment test when required for intangible assets.
  • Failing to perform an impairment test can lead to overstated asset values on the balance sheet, which misrepresents a company's financial health. This oversight can affect investment decisions by stakeholders and might lead to significant financial restatements in future periods if impairments are discovered later. Moreover, it can also result in legal repercussions if stakeholders believe they were misled about the company's true value.
• Evaluate how changes in market conditions can impact the impairment test results for intangible assets and what management should do in response.
  • Changes in market conditions can significantly affect the recoverable amounts of intangible assets. For instance, a decline in industry demand may lower future cash flow expectations from these assets. Management should closely monitor these conditions and conduct impairment tests as required. If an impairment is identified, management needs to adjust financial statements accordingly and possibly reevaluate their strategic plans regarding the utilization or development of these intangible assets.

Related terms

Intangible assets: Non-physical assets that provide long-term value to a company, such as patents, trademarks, copyrights, and goodwill.

Carrying amount: The value at which an asset is recognized on the balance sheet, often based on its acquisition cost less accumulated depreciation or amortization.

Recoverable amount: The higher of an asset's fair value less costs to sell and its value in use, used to determine if an asset is impaired.