Asset Impairment Test: A Simple US GAAP Guide
The asset impairment test under U.S. generally accepted accounting principles (GAAP), found in ASC 360, checks whether a long-lived asset held for use can still recover its carrying amount. Step 1: compare carrying amount with undiscounted future net cash flows from use and disposal. Step 2: if carrying amount is higher, record an impairment loss equal to carrying amount minus fair value.
This distinction matters: the cash-flow shortfall identifies a problem, but it does not measure the write-down. This guide covers property, plant, and equipment (PP&E) in Intermediate Accounting section 10.2. All numerical examples and practice questions are hypothetical.
Video lesson with Professor Farhat
Watch Professor Farhat explain impairment of property, plant, and equipment. Then use the original examples below to separate the decision to recognize a loss from the amount of that loss.
Watch Impairment of Assets (Property, Plant and Equipment) on YouTube.
What does the asset impairment test compare?
Carrying amount, or book value, is the asset’s recorded amount after accumulated depreciation and any earlier write-downs. Fair value is the price that would be received to sell the asset in an orderly transaction between market participants at the measurement date. For how companies measure and report it, see fair value measurement and disclosures. These amounts serve different purposes.
| Amount | Meaning | Role |
|---|---|---|
| Carrying amount | Recorded cost less accumulated depreciation and prior impairment | Starting amount on the books |
| Undiscounted net cash flows | Expected future net receipts, including eventual disposal, without present-value adjustment | Recoverability screening |
| Fair value | Market-based current value | Measures the loss after the screen fails |
“Undiscounted” means no adjustment for the time value of money. For example, three expected net receipts of $20,000 total $60,000 for this screen. Their present value would be a different calculation.
When should equipment be tested?
Test when events suggest that the recorded amount may not be recoverable. Examples include a major market-price decline, damaged equipment, an adverse change in how the asset is used, new legal restrictions or a worse business climate, unexpectedly high construction costs, continuing operating losses, or a current expectation that the asset will more likely than not (a likelihood of more than 50 percent) be sold or disposed of well before the end of its estimated useful life.
A warning sign starts the evaluation; it is not automatically a loss. Suppose a new competitor reduces demand for a manufacturer’s product. Management must examine expected cash flows rather than choose an arbitrary write-down percentage.
The Financial Accounting Standards Board (FASB) describes the trigger and two-stage approach in Statement 144, paragraphs 7–8, the historical source of the model now codified in Accounting Standards Codification (ASC) 360. Current authoritative requirements are in the FASB Codification.
Apply the asset impairment test in order
| Stage | Action | Result |
|---|---|---|
| 1. Update the records | Bring depreciation up to the testing date and identify the appropriate asset or asset group. | Use the current carrying amount. |
| 2. Test recoverability | Compare carrying amount with total undiscounted net cash flows. | If cash flows equal or exceed carrying amount, record no impairment loss. |
| 3. Measure a failed test | Subtract fair value from carrying amount. | Recognize the excess as impairment loss. |
Cash flows are tested at the lowest level with largely independent identifiable cash flows. Classroom questions often simplify this to one machine; the examples here assume that is appropriate. Do not invent independent cash flows for a machine that works only as part of a production line.
Fair value may use observable market evidence or a suitable valuation technique. A present-value estimate used to measure fair value must reflect market-participant assumptions; it is not simply the undiscounted total from the screening step.
Worked example: passing and failing the test
Hypothetical example. Northline Packaging owns equipment costing $150,000. Accumulated depreciation at the testing date is $54,000, so carrying amount is $96,000. A decline in demand is the testing trigger.
| Fact or result | Scenario A | Scenario B |
|---|---|---|
| Carrying amount | $96,000 | $96,000 |
| Undiscounted cash flows | $103,000 | $88,000 |
| Fair value | $72,000 | $72,000 |
| Recoverability result | Passes | Fails |
| Impairment loss | $0 | $24,000 |
In Scenario A, expected cash flows cover $96,000. The lower fair value alone does not produce a held-for-use impairment loss. In Scenario B, $88,000 is below $96,000, so the equipment fails the recoverability test. Now fair value measures the loss: $96,000 − $72,000 = $24,000. The loss is not the $8,000 cash-flow shortfall.
After measuring the loss, follow the impairment loss journal entry and revised depreciation example. If the equipment qualifies as held for sale, use the separate held-for-use versus held-for-sale comparison.
What Happens After You Record An Impairment Loss?
Once you know the loss, three things follow. Here is how they play out for Northline’s Scenario B.
1. Record the journal entry.
| Account | Debit | Credit |
|---|---|---|
| Impairment loss | $24,000 | |
| Accumulated depreciation, equipment | $24,000 |
Some companies credit the equipment account directly instead. Either way, the new carrying amount is $96,000 − $24,000 = $72,000.
2. Treat the new carrying amount as the cost basis. The $72,000 becomes the equipment’s new cost basis. You depreciate it over the remaining useful life. If Northline expects 4 more years of use and no residual value, new annual depreciation is $72,000 ÷ 4 = $18,000.
3. Never reverse the loss. Under U.S. GAAP, an impairment loss on an asset held for use can’t be restored later, even if fair value recovers next year.
On the income statement, report the loss in income from continuing operations before income taxes. If the company shows an operating income subtotal, the loss belongs inside it.
Common mistakes and the IFRS distinction
Starting with fair value: this skips the recoverability screen for assets held for use. Discounting the screening cash flows: this mixes the two stages. Using original cost: this ignores depreciation already recorded.
CPA exam tip: FAR questions often give you several numbers at once: carrying amount, undiscounted cash flows, present value of cash flows, and sometimes a quoted market price. Use the undiscounted total only for the pass or fail decision. Use fair value for the loss. When a quoted market price is unavailable, a discounted cash flow valuation may estimate fair value if both the cash flows and discount rate reflect market-participant assumptions.
Do not import these rules into loan impairment or goodwill questions. They use different models. Likewise, International Financial Reporting Standards (IFRS) do not use this U.S. GAAP undiscounted screen. IAS 36 compares carrying amount with recoverable amount, the higher of value in use and fair value less costs of disposal. Under IFRS, an impairment loss on an asset other than goodwill must be reversed when a change in the estimates used to determine recoverable amount supports a reversal. The revised carrying amount is limited to the amount that would have been determined, after depreciation or amortization, had the earlier impairment loss never been recognized. U.S. GAAP does not allow that for assets held for use.
How Other Assets Are Tested
| Asset | When to test | First check | Loss amount |
|---|---|---|---|
| PP&E and finite-lived intangibles held for use (U.S. GAAP) | When warning signs appear | Carrying amount vs. undiscounted cash flows | Carrying amount minus fair value |
| Indefinite-lived intangibles (U.S. GAAP) | At least once a year, plus when warning signs appear | Optional qualitative check, then carrying amount vs. fair value | Carrying amount minus fair value |
| Goodwill (U.S. GAAP) | At least once a year for each reporting unit, plus when warning signs appear | Optional qualitative check, then reporting unit carrying amount vs. fair value | The excess, capped at the goodwill in that reporting unit |
| Assets held for sale (U.S. GAAP) | Upon classification as held for sale and in each subsequent reporting period | Carrying amount vs. fair value less costs to sell | Write-down to fair value less costs to sell |
| Long-lived assets under IFRS (IAS 36) | Warning signs at each reporting date, plus yearly for goodwill and indefinite-life intangibles | Carrying amount vs. recoverable amount | Carrying amount minus recoverable amount, with qualifying reversals required for assets other than goodwill, subject to the reversal limit explained above |
A reporting unit is an operating segment or one level below it. Only the first row uses the undiscounted cash flow test covered in this guide.
Interactive PP&E Impairment Practice
Practice the U.S. GAAP recoverability test for property, plant, and equipment held for use. The asset passes when undiscounted net cash flows from use and eventual disposition equal or exceed its carrying amount. If the carrying amount is higher, use fair value in the next step to measure any impairment loss.
Practice questions with explained answers
1. Book value is $70,000, undiscounted cash flows are $75,000, and fair value is $52,000. What loss is recorded?
Answer: Zero. The held-for-use asset passes recoverability because $75,000 exceeds $70,000. Do not record the $18,000 fair-value difference.
2. Book value is $70,000, cash flows are $62,000, and fair value is $48,000. What is the loss?
Answer: $22,000. The screen fails, then $70,000 − $48,000 measures the loss. The $8,000 screening shortfall is not the entry amount.
3. Cash flows exactly equal the $70,000 carrying amount. Does the screen fail?
Answer: No. Carrying amount must exceed undiscounted cash flows. Equality passes the recoverability screen.
4. Book Value Is $90,000 And Cash Flows Are $84,000. No Market Price Exists, But A Discounted Cash Flow Valuation Using Market-Participant Assumptions Estimates Fair Value At $66,000. What Is The Loss?
Answer: $24,000. The screen fails because $84,000 is below $90,000. The $66,000 fair value estimate uses both expected cash flows and a discount rate based on market-participant assumptions. The loss is $90,000 − $66,000 = $24,000. The $6,000 screening shortfall is not the entry amount.
Frequently asked questions
Is impairment the same as depreciation?
Answer: No. Depreciation allocates depreciable cost over useful life. Impairment recognizes a write-down when the relevant recoverability and measurement requirements are met.
Does impairment mean the equipment must be sold?
Answer: No. A company may keep using impaired equipment. It simply depreciates the new, lower carrying amount over the remaining useful life. If it later decides to sell, held-for-sale rules apply. If it scraps the equipment, follow the steps for retirement of fixed assets.
Is this a mandatory annual fair-value revaluation?
Answer: No. For the held-for-use PP&E covered here, events or changes in circumstances trigger recoverability testing. This is not a recurring revaluation to market price.
Can An Impairment Loss Be Reversed Under U.S. GAAP?
Answer: No. For property, plant, and equipment held for use, a recognized impairment loss can’t be reversed, even if fair value recovers. The written-down amount becomes the new cost basis. Under IFRS (IAS 36), a reversal is required for an asset other than goodwill when a change in the estimates used to determine recoverable amount supports a reversal. The revised carrying amount cannot exceed the amount that would have been determined, after depreciation or amortization, without the earlier impairment loss.
Where Does An Impairment Loss Appear On The Income Statement?
Answer: In income from continuing operations before income taxes. If the company shows an operating income subtotal, the loss is included in it.
What Is An Asset Group?
Answer: An asset group is the lowest level at which a company can identify cash flows that are largely independent of other assets. For example, a whole production line can be an asset group when one machine on the line doesn’t produce cash flows of its own.
Is The Asset Impairment Test On The CPA Exam?
Answer: Yes. Property, plant, and equipment, including impairment, is part of Area II of the FAR section. Expect questions that ask you to decide whether an asset passes the recoverability test and then compute the loss.
Key Takeaways
- The U.S. GAAP asset impairment test has two steps: recoverability, then measurement.
- Step 1 compares carrying amount with undiscounted net cash flows from use and disposal. If cash flows are equal or higher, there is no loss.
- Step 2 measures the loss as carrying amount minus fair value, not the cash-flow shortfall.
- Test only when warning signs appear. Held-for-use PP&E has no required annual test.
- The written-down amount becomes the new cost basis, and the loss can’t be reversed.
- IFRS uses a one-step test against recoverable amount. Qualifying reversals are required for assets other than goodwill, up to the carrying amount that would exist after depreciation or amortization without the earlier impairment loss.
Sources and lesson context
This original guide supports Wiley Intermediate Accounting, section 10.2: Impairments. Its examples and practice questions were created for this article. Current U.S. GAAP is in the FASB Accounting Standards Codification, particularly Topic 360. Linked Statement 144 material is historical background, not a substitute for current Codification text.
Ready to practice more? Work through PP&E impairment questions in the FAR Test Bank, take the full Intermediate Accounting course, or start with the Farhat Lectures free sample course.
About The Author
Mansour Farhat, CPA, CIA, DBA, teaches accounting and creates the video lessons and practice questions on Farhat Lectures for CPA, CMA, and EA candidates and accounting students.
Responses