Impairment

Definition

Impairment is a financial term that refers to the reduction in the value of an asset, either tangible or intangible, due to a decrease in its expected future economic benefits. It occurs when the asset’s carrying amount exceeds its recoverable amount. Impairment losses must be recognized in financial statements to accurately reflect the company’s financial health and true value of its assets.

Phonetic

The phonetic spelling of the keyword “Impairment” is:/ɪmˈpɛr.mənt/

Key Takeaways

1. What does financial impairment mean? In the world of finance, impairment refers to a decline in an asset’s value below its carrying value. This may occur for a variety of reasons, including a change in the asset’s fair value, a modification of the anticipated future cash flows from the asset, or an occurrence of a legal or regulatory circumstance that lessens the asset’s worth.
2. What makes impairment crucial to finance? Because it can significantly affect a company’s financial statements, impairment is crucial in finance. When an asset is impaired, the business must reduce its balance sheet’s asset value, which can lower net income and equity. This may make the business appear less financially successful and prosperous.

Importance

Impairment is an important term in business and finance because it reflects the reduction in the value of an asset over time due to various factors such as wear and tear, obsolescence, or changes in market demand. It impacts the financial health and reporting of a company, as accurate assessment and recognition of impairment losses help maintain the transparency and reliability of financial statements. By identifying and accounting for impairments, businesses can make informed decisions on asset management, resource allocation, and future investments. Furthermore, understanding the concept of impairment is crucial for investors and stakeholders to evaluate a company’s true financial position and assess the potential risks and returns associated with their investment.

Explanation

Impairment is a crucial concept in the finance and business world as it serves to maintain a fair representation of a company’s financial health. The primary purpose behind recognizing and accounting for impairments is to prevent the overstatement of assets and to provide a more accurate assessment of a company’s financial position. When assets such as property, plant, equipment, or intangible assets lose value or their ability to generate future cash flows diminishes, impairments occur. By writing down or adjusting the value of these assets on financial statements, a company is better able to communicate its real financial standing to investors, creditors, and other stakeholders. This transparency is essential, as it not only assists in investment decisions but also aids in certain operational and strategic decisions by the company’s management. Impairment tests are performed to identify and measure any substantial decline in the value of an asset, which may impact a company’s financial position. Regular and timely assessments of assets’ carrying values ensure that a company’s financial statements reflect the economic reality. When an organization identifies an impairment, management must determine the new fair value of the asset, which may require consultation with specialists or through market-based pricing methods. The impairment loss, i.e., the difference between the original carrying amount and the new fair value, is then recognized in the company’s income statement, resulting in a decrease in the company’s total assets and net income. By recognizing these impairments in a timely manner, a company can manage its balance sheet more effectively and make informed decisions about asset utilization, budgeting, and forecasting, ultimately contributing to its long-term success.

Examples

1. General Electric (GE) Power Unit: In 2018, General Electric declared an impairment loss of $22 billion due to its coal and natural gas power plant portfolio in the power unit. This was mainly because the company overestimated the revenue and profit projections when it acquired the energy units of Alstom in 2015. The shift towards renewable energy sources, decreased demand for coal and gas-fired plants, and a downturn in the global power market also contributed to the significant impairment in the value of GE’s power assets. 2. Telefonica’s O2 UK operations: In 2016, Telefonica, a Spanish multinational telecommunications company, recognized an impairment loss of around €2.2 billion (about $2.4 billion) for its UK operation, O2. The impairment was due to the devaluation of the British pound following the Brexit referendum, which led to a decrease in the value of O2’s assets, as well as market uncertainty and increased competition. 3. BP Gulf of Mexico Oil Spill: In 2010, an explosion on BP’s Deepwater Horizon drilling rig in the Gulf of Mexico resulted in one of the largest oil spills in history. This disaster not only caused 11 deaths but also had significant environmental and economic impacts. BP had to recognize an impairment loss of over $17 billion for its cleanup efforts and legal liabilities resulting from the accident. The impairment charges reflected the decrease in value of its assets due to the incident and the subsequent financial ramifications.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Asset Depreciation
• Goodwill Impairment
• Recoverable Amount
• Impairment Loss
• Impairment Testing

Sources for More Information

• Investopedia
• Indeed
• AccountingTools
• WallStreetMojo