Impairment accounting: how to test and record losses

Published Wednesday 27 May 2026

Key takeaways

• Impairment is a permanent reduction in an asset's value that you record when its market value drops below its carrying amount on your books, unlike the gradual, planned reductions from depreciation or amortization.
• You should test goodwill and indefinite-lived intangible assets for impairment at least annually, and test other long-lived assets whenever a triggering event occurs, such as physical damage, a market downturn, or technological obsolescence.
• To record an impairment loss, debit an impairment loss expense account and credit the asset account for the difference between the carrying value and the fair market value, which updates both your income statement and balance sheet.
• Under Generally Accepted Accounting Principles (GAAP), impairment losses on long-lived assets can't be reversed once recorded, so the reduced value becomes the new permanent book value for all future periods.

What is impairment?

Impairment is the permanent reduction in the value of an asset when its market value falls below the amount recorded on your books. If you own fixed assets like equipment or vehicles, or intangible assets like patents or trademarks, impairment may apply when those assets lose value unexpectedly.

Unlike depreciation or amortization, which spread value reductions over a planned schedule, impairment happens suddenly. A flood damages your equipment, a competitor's new product makes your patent less valuable, or a market shift reduces demand for what your asset produces. In each case, the asset is worth less than what your books show.

Under GAAP, you're required to recognize impairment as a loss on your income statement. This keeps your financial records accurate and ensures you're not overstating what your business owns.

What is the purpose of asset impairment?

Asset impairment exists to make sure your financial statements reflect reality when something unexpected reduces the value of what you own. Without impairment accounting, your books could show assets at values that no longer match the market.

Recording impairment matters for several reasons:

• It prevents your balance sheet from overstating asset values that have dropped due to damage, obsolescence, or market changes.
• It gives lenders, investors, and potential buyers a transparent picture of your business's financial health.
• It keeps your business compliant with GAAP, which requires accurate asset valuations on every reporting period.
• It helps you make better decisions about whether to repair, replace, or dispose of underperforming assets.

When you record impairment on time, your financial statements stay reliable. That accuracy supports everything from securing a loan to planning your next capital investment.

Types of assets that can be impaired

Not every asset on your books is subject to impairment testing in the same way. The type of asset determines which accounting standards apply and how you assess its value.

Fixed assets

Fixed assets are physical, long-lived items your business uses to operate. These include equipment, vehicles, buildings, and machinery.

Because fixed assets have extended useful lives, they're especially vulnerable to impairment from physical damage, technological changes, or shifts in how your business operates. For example, if you own a delivery truck that's been in a serious accident, its fair market value may drop well below its carrying amount. You'd test it for impairment and record any loss. Over time, fixed assets also lose value through accumulated depreciation, but impairment captures sudden, unplanned drops that depreciation schedules don't account for.

Intangible assets

Intangible assets are non-physical items that still hold value for your business. Patents, trademarks, copyrights, and customer lists all fall into this category.

These assets can become impaired when market conditions shift or competitors develop better alternatives. A patent on outdated technology, for instance, may lose most of its value if a new industry standard emerges. Intangible assets with a finite useful life are amortized over that period, but you still need to test them for impairment whenever indicators suggest their value has dropped.

Goodwill

Goodwill is the premium you pay when acquiring another business above the fair value of its identifiable assets. It represents things like brand reputation, customer relationships, and expected future earnings.

Unlike other intangible assets, goodwill isn't amortized under GAAP. The Financial Accounting Standards Board (FASB) requires you to test it for impairment at least once a year. If the reporting unit's fair value falls below its carrying amount, you record a goodwill impairment loss. This often happens after an acquisition when the purchased business doesn't perform as expected.

Common impairment triggers

Certain events and changes signal that an asset's value may have dropped below its carrying amount. Recognizing these triggers early helps you stay on top of impairment testing and keep your financials accurate.

External factors that may trigger an impairment test include:

• a significant decline in the market price of the asset
• major changes in technology that make your asset less useful or obsolete
• new laws, regulations, or industry standards that limit how the asset can be used
• a downturn in the broader economy or in your specific industry
• a sustained drop in your company's stock price below its book value

Internal factors that may also indicate impairment include:

• physical damage to the asset from accidents, natural disasters, or wear beyond normal use
• a decision to dispose of or restructure the asset significantly sooner than planned
• evidence that the asset's performance or productivity has declined sharply
• operating losses or negative cash flows connected to the asset
• a plan to discontinue or significantly change the operations that use the asset

If any of these apply to an asset you own, it's time to run an impairment test rather than waiting for your next scheduled review.

How to test for asset impairment

Impairment testing follows a structured process that compares what your asset is worth on paper to what it's actually worth in the market. Under GAAP, you need to test goodwill and indefinite-lived intangible assets at least annually. For other long-lived assets, you test whenever triggering events suggest the asset's value may have dropped.

Step 1. Identify impairment indicators

Start by reviewing your assets for any signs that their value may have dropped. Look for the external and internal triggers covered in the previous section, such as physical damage, market declines, or regulatory changes.

If no indicators exist, you don't need to proceed with a full impairment test for that asset at this time. However, goodwill and indefinite-lived intangible assets still require annual testing regardless of whether indicators are present.

Step 2. Determine the asset's carrying amount

The carrying amount is the asset's original cost minus any accumulated depreciation or amortization recorded so far. This is the value currently shown on your balance sheet.

Pull this figure from your accounting records. If you use straight-line depreciation, your carrying amount decreases by the same amount each period. Other methods may result in different carrying values at the time of testing.

Step 3. Estimate the recoverable amount

The recoverable amount is the higher of two figures: the asset's fair value minus costs to sell, or its value in use. Fair value is what a willing buyer would pay in the current market. Value in use is the present value of the future cash flows the asset is expected to generate.

For small businesses, estimating fair value often means getting an appraisal, checking comparable sales, or using a qualified professional's assessment. Value in use requires projecting the cash flows the asset will produce over its remaining useful life and discounting them back to today's value.

Step 4. Compare carrying value to recoverable amount

Compare the carrying amount from Step 2 to the recoverable amount from Step 3. If the carrying amount is higher, the asset is impaired. The impairment loss equals the difference between the two figures.

If the recoverable amount is equal to or greater than the carrying amount, no impairment exists and no adjustment is needed.

Step 5. Record the impairment loss

If your test confirms impairment, record the loss in your books immediately. Debit an impairment loss expense account for the amount of the loss, and credit the asset account to reduce its carrying value on your balance sheet.

After recording, the reduced amount becomes the asset's new carrying value. Under GAAP, this lower value is permanent for long-lived assets and can't be reversed, even if the asset's market value recovers later. After recording, any depreciation or amortization is calculated based on the new, lower carrying amount.

Where is impairment recorded?

You record impairment on both your income statement and your balance sheet. The journal entry reduces the asset's value on the balance sheet while recognizing the loss as an expense on the income statement.

To record impairment, debit the impairment loss expense account to increase your expenses on the income statement, then credit the asset account to reduce the asset's carrying value on the balance sheet.

Here's how this works in practice. Lakestar Machinery owns equipment with a book value of $30,000. After hurricane damage, its fair market value drops to $25,000. The impairment loss is $30,000 minus $25,000, which equals $5,000.

The journal entry records a $5,000 debit to the impairment loss account and a $5,000 credit to the equipment account. After this entry, the equipment shows its true value of $25,000 on the balance sheet, and the $5,000 loss reduces net income on the income statement for that period.

How impairment affects your financial statements

Recording an impairment loss has a ripple effect across your main financial statements. Understanding these impacts helps you see the full picture of how an impairment changes your business's reported financial position.

On your balance sheet, the asset's carrying value decreases by the amount of the impairment loss. This reduces your total assets and, because net income drops, your retained earnings decline as well. The result is a lower total equity figure.

On your income statement, the impairment loss shows up as an expense in the period you record it. This directly reduces your net income for that period. For small businesses, a large impairment loss can significantly affect reported profitability, which lenders and investors may notice.

On your cash flow statement, impairment has no direct impact because it's a non-cash expense. No money actually leaves your business when you record an impairment loss. However, the reduced net income flows into the operating activities section, where the impairment loss is added back as a non-cash adjustment.

Key differences: impairment, depreciation, and amortization

Impairment, depreciation, and amortization all reduce the value of assets on your books, but they work differently and apply in different situations. Understanding the distinctions helps you account for each one correctly.

Depreciation is the planned, gradual reduction in the value of fixed assets like equipment, vehicles, and buildings. You spread the cost over the asset's useful life on a set schedule, whether monthly, quarterly, or annually. Depreciation is expected and predictable.

Amortization works the same way but applies to intangible assets with finite useful lives, such as patents, copyrights, and software licenses. You reduce the asset's value over a predetermined period using a systematic method.

Impairment, by contrast, is unplanned and triggered by specific events. It can apply to any type of asset, whether fixed, intangible, or goodwill. When an asset's market value drops below its carrying amount due to damage, obsolescence, or market shifts, you record the loss immediately rather than spreading it over time.

One important difference between GAAP and International Financial Reporting Standards (IFRS) relates to reversals. Under GAAP, once you record an impairment loss on a long-lived asset, it's permanent. You can't reverse it even if the asset's value later recovers. Under IFRS, impairment losses on assets other than goodwill can be reversed if conditions improve.

If your business operates internationally or reports under IFRS, this distinction matters for how you manage asset values over time.

Examples of asset impairment in small businesses

Impairment can affect any business, but the circumstances often look different for smaller operations. These examples show how impairment plays out in practical, everyday scenarios.

A local restaurant owns a specialized pizza oven with a book value of $10,000. New health regulations make the oven non-compliant, and modifying it isn't cost-effective. Its market value drops to $1,500 based on what the parts are worth. The restaurant records an impairment loss of $8,500 to reflect the oven's reduced value on its books.

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. Future depreciation on the excavator will be based on the new $20,000 carrying value rather than the original amount.

A small marketing agency acquired a local competitor for $200,000, with $60,000 allocated to goodwill. Two years later, the acquired client base has shrunk significantly and the reporting unit's fair value has dropped below its carrying amount. After testing, the agency determines goodwill is impaired by $35,000 and records that loss on its income statement.

Manage asset impairments with Xero

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FAQs on impairment accounting

Here are some frequently asked questions about impairment accounting.

When is impairment testing required for small businesses?

You should test assets for impairment whenever a triggering event occurs, such as physical damage, a market downturn, or a change in how you use the asset. Goodwill and indefinite-lived intangible assets require testing at least once a year, even without a specific trigger.

Can impairment losses be reversed under GAAP?

No. Under GAAP, once you record an impairment loss on a long-lived asset, the reduced value becomes permanent. Even if the asset's fair value recovers later, you can't reverse the write-down. Under IFRS, reversals are allowed for assets other than goodwill.

What happens if you don't record impairment properly?

Failing to record impairment overstates your assets and net income on your financial statements. This can mislead lenders, investors, and potential buyers about your business's true financial position. It may also put you out of compliance with GAAP reporting requirements.

How often should assets be tested for impairment?

Test your assets for impairment at least once a year. You should also test whenever a significant event occurs, such as physical damage, major market shifts, or new regulations that affect how the asset can be used. For goodwill and indefinite-lived intangibles, GAAP requires annual testing regardless of whether triggers exist.

What is goodwill impairment?

Goodwill impairment happens when the fair value of a reporting unit falls below its carrying amount, including goodwill from a past acquisition. You test goodwill annually and record a loss if the carrying amount exceeds fair value. Unlike other asset impairments, goodwill impairment under GAAP can't be reversed.

Is impairment a cash expense?

No, impairment is a non-cash expense. Recording an impairment loss doesn't involve any money leaving your business. It's an accounting adjustment that reduces the asset's value on your balance sheet and lowers net income on your income statement for the period.