Impairment testing: What happens when your company’s assets lose value?

Startups often need to invest heavily in assets. That might include buying specialized equipment, proprietary software, or intellectual property. Or it could even involve acquiring entire companies to accelerate growth.

Business conditions rarely stay the same. Technologies become obsolete, markets shift, and acquisitions sometimes underperform. When any of these things happen, the value recorded on the balance sheet may no longer reflect the asset’s true economic worth. This is where the impairment of assets comes into play. 

Accounting rules require companies to evaluate whether certain assets retain their original recorded value. If the value of an asset has declined significantly, the company must recognize an asset impairment and adjust its balance sheet accordingly. For founders, CFOs, and finance leaders who are preparing for audits, fundraising, or acquisition readiness, understanding how impairment works is critical. Applying this knowledge helps finance teams ensure that financial statements align with real business performance.

An asset impairment occurs when the carrying value of an asset exceeds the amount the company can recover from it. Think of it this way:

Carrying value > recoverable value = impairment

The carrying value represents the amount recorded on the balance sheet after depreciation or amortization. The recoverable value reflects what the asset is actually worth today. 

Companies typically estimate recoverable value in one of two ways:

1. Fair value less the costs to sell: This estimates what the asset could reasonably be sold for in the market. 
2. Value in use: This calculates the present value of future cash flows that the asset is expected to generate.

If the recoverable amount falls below the carrying value, the difference must be recorded as an impairment loss. This reduces the asset’s balance-sheet value and recognizes an expense on the income statement.

Many types of assets can lose value over time, particularly in industries where technology and market conditions change quickly. Impairment testing most often applies to fixed assets, intangible assets, and goodwill.

Fixed assets

Physical assets — such as equipment, buildings, hardware infrastructure, and leasehold improvements — fall into this category. Because these assets generate value over long periods, they can lose value if demand declines or technologies evolve. When the asset can no longer generate the cash flows originally expected, consider fixed asset impairment testing.. 

Intangible assets

Many startups hold significant intangible assets, including patents, trademarks, proprietary software, and capitalized development costs. Intangible asset impairment testing assesses whether these assets will continue to generate economic benefits as originally expected. If a technology platform becomes outdated or the company pivots away from a product line, the asset’s value may need to be reassessed.

Goodwill

Goodwill appears when a company buys another business for more than the value of its identifiable assets. That extra amount reflects expectations about future growth, customer relationships, or strategic advantages from the deal. Because those expectations may change over time, companies must periodically run a goodwill impairment test. If the acquired business performs worse than expected, part of the recorded goodwill may need to be written down.

Accounting rules differ slightly under the U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) , but the core idea is the same: Companies should adjust asset values when those assets are no longer worth what the balance sheet says they are.

Companies don't need to continuously test every asset for impairment. Instead, monitor for indicators that suggest an asset’s value may have declined.

Several conditions can signal that it’s time for an asset impairment test. A significant decline in market value is one of the most obvious signals. When market conditions change, the asset may no longer reflect its recorded value on the balance sheet. Operational underperformance can also be a trigger. If an asset generates less revenue or cash flow than expected, the assumptions used to justify its value may no longer hold. Technological change is another common factor, particularly for startups. New tools or platforms can quickly make an existing system less valuable. Other triggers include regulatory changes, macroeconomic downturns, or integration challenges following an acquisition.

Not every dip in performance requires an immediate write-down. However, when these indicators arise, finance teams typically perform an asset impairment test to determine whether the asset’s carrying value continues to reflect its recoverable amount.

When impairment indicators appear, companies generally follow a structured process to determine whether a write-down is required. These asset impairment testing steps provide a clear framework for evaluation.

1. Identify impairment indicators

Impairment indicators might include declining financial performance, shifts in market demand, or regulatory changes affecting the asset’s usefulness.

2. Determine the asset’s carrying amount

The asset’s carrying amount on the balance sheet should include any accumulated depreciation or amortization.

3. Estimate the recoverable amount

To estimate the recoverable amount, companies may rely on market comparisons, valuation analysis, or projections of future cash flows generated by the asset.

4. Compare the carrying value and the recoverable amount

Next, compare the recoverable amount and the carrying asset. If the carrying value exceeds the recoverable value, the asset is considered impaired.

5. Record impairment loss if applicable

Recording impairment loss (if applicable) reduces the asset’s balance sheet value and recognizes the loss on the income statement. 

According to GAAP, in many fixed asset impairment testing situations, companies should first check whether an asset is expected to generate enough future cash flow to justify its current value. If not, the next step is to calculate the impairment amount and record the write-down.

Goodwill represents the premium paid when acquiring a business for more than the fair value of its identifiable assets and liabilities. This premium reflects expectations about growth, customer relationships, brand value, or benefits from combining the two businesses. Over time, those expectations may change. If the acquired business performs below projections or market conditions shift, the goodwill balance may need to be reassessed.

So, the goodwill impairment test compares a reporting unit's fair value with its carrying value. If the carrying value exceeds the fair value, the company records a goodwill impairment. Although this adjustment can significantly reduce reported earnings, it doesn’t involve a cash outflow. 

The goodwill impairment test is particularly important for companies that grow through acquisitions. 

Asset impairment affects several financial statements, even though the adjustment itself is non-cash. These include:

• Balance sheet: On the balance sheet, the value of the impaired asset decreases, which reduces total assets. 
• Income statement: On the income statement, the impairment loss is recognized as an expense, which reduces net income for the reporting period.
• Cash flow statement: On the cash flow statement, the impairment is treated as a non-cash adjustment and added back to operating cash flow.

Even though impairment doesn’t immediately affect cash, it can influence investor perception, company valuation, and compliance with financial rules set by lenders. 

For startups, conducting impairment testing helps to increase transparency and ensure that financial statements keep pace with the realities of a rapidly evolving business. 

Companies that capitalize development costs, invest in infrastructure, or pursue acquisitions often carry large asset balances. When strategy changes or market conditions shift, those assets may need to be reevaluated. Impairments can sometimes signal overly optimistic projections. However, impairments are also common in industries where technologies evolve quickly. Addressing asset impairment early can help companies maintain credible financial reporting during audits, fundraising, or acquisition discussions.

What is an asset impairment?

An asset impairment occurs when the carrying value of an asset exceeds the amount the company can recover from using or selling it.

What triggers an impairment test?

Common triggers include:

• Declining market value
• Operational underperformance
• Technological disruption
• Regulatory changes
• Integration challenges following an acquisition

How does a goodwill impairment test work?

A goodwill impairment test compares the fair value of a reporting unit with its carrying value. If the carrying value exceeds the fair value, the company records a goodwill impairment.

What is fixed asset impairment testing?

Fixed asset impairment testing evaluates long-term, physical assets (such as equipment or buildings) to determine whether their carrying value exceeds their recoverable value.

How does impairment affect net income?

Impairment losses appear as expenses on the income statement, which reduces net income for the reporting period.

Is impairment a cash expense?

No, impairment isn't a cash expense. It's a non-cash accounting adjustment that reduces asset values but doesn’t involve an immediate cash payment.