Impairment accounting explained: How and when to record losses

Published Friday 7 November 2025

Table of contents

• What is impairment?
• What is the purpose of asset impairment?
• How impairment is calculated
• Where is impairment recorded?
• Key differences between depreciation and amortization
• Examples of asset impairment in small businesses
• Managing asset impairments with accounting software
• FAQs on impairment accounting

Key takeaways

• Conduct annual impairment testing for all assets and perform additional tests whenever triggering events occur, such as physical damage, market downturns, or technological obsolescence that could reduce asset values below their book value.

• Apply the recoverability test by comparing an asset's book value to its expected undiscounted future cash flows, and if the book value exceeds recoverable amounts, record an impairment loss equal to the difference between book value and fair market value.

• Record impairment losses by debiting an impairment loss expense account and crediting the asset account to reduce its carrying value, ensuring both your income statement and balance sheet accurately reflect the asset's diminished worth.

• Recognize that impairment losses cannot be reversed under GAAP once recorded, making the reduced value the new permanent book value for future accounting periods even if the asset's market value later recovers.

What is impairment?

Impairment is the permanent reduction in the value of a fixed asset or intangible asset when its market value drops below the recorded book value. Under Generally Accepted Accounting Principles (GAAP), impairments are entered as a loss on the income statement.

Unlike depreciation or amortization, impairment is unexpected. Depreciation and amortization are planned value reductions. Impairment happens when assets suddenly lose value due to market changes or obsolescence.

You must assess your assets for impairment every year to stay compliant with Generally Accepted Accounting Principles (GAAP). An auditor will verify this. SEC guidance says there should be no more than 12 months between tests, even if you change the date of your annual test. This helps you recognize impairment charges on time.

What is the purpose of asset impairment?

Asset impairment ensures your financial statements accurately reflect asset values when market conditions change unexpectedly.

Why impairment matters:

• Prevents overvaluation: Stops assets from appearing more valuable than they actually are
• Maintains accuracy: Ensures financial statements reflect current market reality
• Protects investors: Provides transparent asset valuations for decision-making

Common impairment scenarios:

• Long-lived assets: Equipment, buildings, and patents are most vulnerable due to extended useful lives
• Technology changes: Patents become worthless when competitors develop better alternatives
• Market shifts: Assets lose value when demand disappears or industry conditions change

When impairment happens, record the loss and adjust your asset’s book value to match its current market value.

How impairment is calculated

Impairment testing compares an asset’s book value to its recoverable amount to see if you need to reduce its value on your books.

The testing process:

The testing process involves these steps:

• comparing the book value to the net income generated or fair market value
• checking if the book value is higher than the expected undiscounted cash flows
• calculating the loss as the difference between book value and discounted future cash flows

Fair market value represents either the current sale price or the future cash flows the asset can generate in ongoing operations.

Recoverability test

The GAAP rules call for annual recoverability tests for businesses. These tests consider the effects of economic downturns and events like pandemics or natural disasters on asset values.

To calculate impairment, compare the asset’s book value to the net income it generates or its fair market value. If a triggering event happens, you can assess qualitative factors to decide if the asset’s fair value is likely less than its carrying amount.

You also check if the book value exceeds the undiscounted cash flows the asset is expected to generate. If the book value is higher than what you can recover, you need to record an impairment loss. If it costs more to keep the asset than its fair market value, you should recognize the loss. The impairment loss is the difference between the asset’s book value and the discounted future cash flows.

Where is impairment recorded?

You need to record impairment on both your income statement and balance sheet to show the asset’s reduced value.

Journal entry process:

1. Debit: Impairment Loss (expense account)
2. Credit: Asset account (reduces asset value)

Real-world example:Lakestar Machinery has equipment with a book value of $30,000 but a market value of only $25,000 after hurricane damage.

Impairment calculation: $30,000 - $25,000 = $5,000 loss

• Debit: Impairment Loss $5,000 (income statement expense)
• Credit: Equipment $5,000 (reduces balance sheet asset value)

Result: The asset now shows its true $25,000 value on the balance sheet, and the $5,000 loss reduces net income.

Key differences between depreciation and amortization

Depreciation and amortization are predictable, while impairment happens when something unexpected reduces an asset’s value below its book value. Impairment is different from depreciation and amortization in when and how it happens.

Depreciation

• Asset type:Fixed assets (vehicles, equipment, computers)
• Timing: Planned and regular (monthly, quarterly, annually)
• Nature: Expected value reduction over useful life

Amortization

• Asset type:Intangible assets (patents, goodwill, trademarks)
• Timing: Planned and systematic over asset's life
• Nature: Expected value reduction based on predetermined schedule

Impairment

• Asset type: Any fixed or intangible asset
• Timing: Unexpected, triggered by specific events
• Nature: Sudden value loss due to market changes or damage

Examples of asset impairment in small businesses

Impairment can affect any business, but the circumstances often look different for a small business. Here are a few practical examples of how asset impairment might happen.

A local restaurant owns a specialized pizza oven with a book value of $10,000. New health regulations make the oven non-compliant, and its market value drops to just $1,500 for its parts. The restaurant must record an impairment loss of $8,500.

A construction company's excavator is damaged in a flood. Its carrying value is $50,000, but due to the damage, its fair market value is now only $20,000. The company recognizes a $30,000 impairment loss to reflect the sudden drop in value.

Managing asset impairments with accounting software

Tracking asset values, calculating impairments, and recording losses can be complex. Accounting software makes it easier to keep your financial records accurate and compliant.

Xero accounting software gives you a clear view of your fixed assets, so you can spot potential impairments and manage your books with confidence. You can track the book value of your assets in one place and run reports to help you and your accountant assess them for impairment. With clear financial data, you can focus on running your business.

FAQs on impairment accounting

Here are some common questions and answers small business owners might have about impairment accounting.

When is impairment testing required for small businesses?

Test an asset for impairment whenever something happens that could reduce its value. If you run a small business, review your assets for impairment at the end of each reporting period.

Can impairment losses be reversed under GAAP?

If you plan to keep using an asset, you cannot reverse an impairment loss under Generally Accepted Accounting Principles (GAAP). Once you reduce the asset’s value, that lower amount becomes its new value for future accounting, even if its fair value goes up later.

What happens if you don't record impairment properly?

Recording impairment losses keeps your assets and net income accurate. If you do not record impairment, your financial statements may not reflect your business’s true financial health, which can affect decisions by lenders and investors.

How often should assets be tested for impairment?

Test your assets for impairment at least once a year. Also test them whenever something significant happens, like physical damage, a major market downturn, or new technology that makes your equipment obsolete.