What is Impairment?
The term impairment refers to assets that are no longer of the same value as in a prior period. An impairment charge is used and the asset is revalued downward and a 'charge' is made to net assets.
How Does Impairment Work?
Impairment normally happens when the value of a company's goodwill declines in market value. Since the advent of FAS (Financial Accounting Standards) 141 and 142, the amortization of goodwill is no longer required, however periodic and annual impairment tests are now necessary. This can work both ways. The goodwill (asset) will stay on the books of the company indefinitely which helps EPS but if there is a market downturn on these assets, a write-down of the value of the asset (impairment charge) will be required which has immediate impact on the income of the company.
Goodwill Asset Value (year 0) $4,000,000
Impairment Test Results Value (Year 1) $3,000,000
Income Statement Impact/ Impairment Charge $1,000,000
Why Does Impairment Matter?
Under US GAAP (Generally Accepted Accounting Principles), tests of impairment are required annually. Thus, an internal control procedure must be established within companies that potentially have such exposure to ensure they are abiding by US GAAP. Failure to do so risks a qualified or adverse opinion from the companies’ auditors.