Impairment

Under IFRS, an asset is impaired when its carrying amount exceeds its recoverable amount, defined as the higher of fair value less costs of disposal and value in use. Value in use is the present value of the future cash flows the entity expects to derive from continuing to use the asset and from its eventual disposal, discounted at a pre-tax rate reflecting the asset's specific risk. The write-down equals carrying amount minus recoverable amount, and it is booked immediately.

Because many assets do not generate independent cash inflows, testing is performed at the level of the cash-generating unit, the smallest identifiable group of assets producing largely independent cash flows. Testing is triggered by indicators such as a sharp fall in market value, adverse regulatory change, physical damage, or evidence of economic underperformance. Goodwill and indefinite-life intangibles must be tested at least annually regardless of indicators.

US GAAP applies a stricter gate for long-lived assets held for use. The entity first compares the carrying amount with the sum of undiscounted expected future cash flows. If undiscounted cash flows are at least equal to carrying amount, no loss is recorded even when a discounted valuation would suggest value has been lost. Only if the recoverability screen fails is the loss measured, and then as carrying amount minus fair value, a discounted concept. This two-stage design means US GAAP tends to recognise impairment later and, once triggered, in larger amounts.

Goodwill is handled separately. It is assigned to reporting units and tested by comparing the unit's fair value with its carrying amount including goodwill; any shortfall is charged against goodwill and cannot exceed the goodwill balance. Under IFRS the equivalent shortfall at the cash-generating unit is applied to goodwill first, then pro rata to other assets.

The charge reduces assets, retained earnings and net income in the period recognised, while leaving the cash balance untouched. Deferred tax effects usually follow, since many write-downs are not deductible until the asset is sold, so a deferred tax liability may be released or a deferred tax asset created.

The more important consequence for analysis is what happens afterwards. A lower carrying amount means lower future depreciation or amortisation, so subsequent reported earnings are higher. With a smaller asset base and a smaller equity base, return on assets, return on equity and asset turnover all improve mechanically, while debt-to-equity deteriorates. A firm that writes down aggressively therefore looks more profitable in later years without any operational change, and cross-company comparisons of returns become unreliable unless the analyst adjusts for the historical write-down.

Impairment is confirmation, not prediction. By the time goodwill is written down, the market has usually repriced the equity, because the underlying deterioration in demand, pricing power or discount rates was already visible. The informational content lies in what it reveals about management: a large goodwill charge is an admission that an acquisition price was not supported by the cash flows subsequently generated, and repeated charges suggest a systematic pattern of overpaying.

Timing is discretionary in practice, since valuation inputs are unobservable. Charges cluster around management changes and weak years, consistent with big-bath behaviour that clears future depreciation and resets the earnings base. Candidates should be able to identify triggering events, calculate the loss under each framework, restate assets and equity to remove the write-down for ratio comparison, and confirm the add-back in the operating section of the cash flow statement.