Asset impairment is a situation where the usefulness of an asset suddenly declines, making it so expensive to maintain that it can no longer expect to pay for itself through future cash flows. A company can choose to maintain the asset on its books but write down the value to more accurately reflect is value, or it can list the asset for sale and dispose of it. Once an asset is impaired, it cannot be recovered, and thus companies are careful to test assets before placing them in this category.
There are several circumstances under which an asset can become impaired. One is through regulatory obsolesce, where an asset was usable, but a change in regulations meant the company could no longer use it; for example, if a machine no longer has adequate pollution control mechanisms. Damage can also be a cause of asset impairment, as can an abrupt change in technology and market conditions. A company may buy a piece of new equipment, only to find that the standards for a process change so rapidly that the equipment can no longer be used in manufacturing.
Companies must subject theoretically impaired assets to testing to determine whether they qualify for asset impairment. An accountant determines the current value of the asset, the carrying value associated with maintenance and repair, and the projected future cash flows created through the asset. If these are lower than the carrying value, the asset is impaired, and can be downgraded in the company books.
Asset impairment can have advantages and disadvantages. Companies often look for ways to report a loss on tax forms to limit liability, but too many losses can attract negative attention from shareholders and other interested parties. An impaired asset also becomes a liability for a company, as it needs to find something to do with it. If it retains ownership, it may not be able to sell it in the future, as the impairment would be an impediment to a future buyer. No one may want, for instance, a machine used in an obsolete process.
Some accounting firms specialize in asset impairment testing and may offer this service to companies as they decide what to do with assets that appear obsolete. A company can take an asset out of service or sell it without necessarily downgrading if the asset isn't impaired, but it no longer has a use for it. Surplus assets may fall under this category.