What Is a Reversal of an Impairment Loss?

When a company invests in long-term assets like buildings or machinery, it records them at their purchase price. While depreciation accounts for the normal decrease in value over time, a sudden and significant drop is known as impairment. An impairment loss is recognized when an asset’s carrying value on financial statements is higher than its recoverable amount, reflecting that it will no longer generate the cash flows previously expected.

Although an impairment loss is a negative event, it is not always permanent. If circumstances change and a previously impaired asset’s value recovers, accounting rules may allow for a reversal of that loss. This ability depends on the accounting standards a company follows. International Financial Reporting Standards (IFRS) permit reversals for most assets if specific criteria are met, while U.S. Generally Accepted Accounting Principles (U.S. GAAP) prohibit this for long-lived assets held for use.

Conditions for Reversing an Impairment Loss

Under IFRS, a reversal of an impairment loss is guided by specific criteria. A company can only reverse a previously recognized impairment if there has been a tangible change in the economic estimates used to determine the asset’s recoverable amount since the last impairment was recorded. The reasons for the original write-down must have demonstrably changed for the better, as identified through internal and external indicators.

External indicators point to favorable shifts in the broader business environment, while internal indicators relate to the asset’s specific performance. Examples of these indicators include:

• A positive change in the technological, market, or legal framework in which the company operates.
• A notable increase in the market price of a similar asset.
• A decrease in market interest rates, which lowers the discount rate used in calculating an asset’s value.
• Clear evidence that the asset’s performance has improved beyond original expectations.
• A corporate decision to invest further in the asset or a restructuring plan that enhances its utility.

Calculating the Reversal Amount Under IFRS

Determining the amount of an impairment reversal under IFRS involves a calculation with a limitation. The reversal can only increase the asset’s carrying amount up to a “ceiling.” This ceiling is the carrying amount that the asset would have had if no impairment loss had ever been recognized, adjusted for any subsequent depreciation. This rule prevents a company from inflating an asset’s value beyond its depreciated historical cost.

For example, a company following IFRS purchased a machine for $200,000 with a 10-year useful life and no salvage value, resulting in annual depreciation of $20,000. At the end of year 3, the machine’s carrying amount is $140,000 ($200,000 cost – $60,000 accumulated depreciation). Due to a market downturn, the company determines the machine’s recoverable amount is only $90,000 and recognizes a $50,000 impairment loss.

The new carrying amount is $90,000, and depreciation for the remaining seven years is recalculated to approximately $12,857 per year. Two years later, at the end of year 5, market conditions have improved, and the company assesses the machine’s new recoverable amount to be $110,000. Before booking the reversal, the company must calculate the ceiling.

Had the impairment never occurred, the machine’s carrying amount at the end of year 5 would have been $100,000 ($200,000 cost – $100,000 accumulated depreciation for five years). The current carrying amount of the impaired asset is $64,286 ($90,000 – $25,714 in depreciation for years 4 and 5).

The reversal amount is limited to the lesser of the new recoverable amount ($110,000) and the ceiling ($100,000). Therefore, the asset’s value can only be increased to $100,000. The reversal amount to be recognized is $35,714 ($100,000 ceiling – $64,286 current carrying amount).

Accounting and Reporting the Reversal

Once the reversal amount is calculated under IFRS, it must be properly recorded. The accounting entry increases the asset’s value on the balance sheet and recognizes the gain on the income statement. The journal entry is a debit to the asset’s accumulated depreciation account to reduce its balance and a credit to a “Reversal of Impairment Loss” account, which increases the company’s net income.

The reversal is recognized immediately in the profit or loss section of the income statement in the period the reversal occurs. For assets that are carried at a revalued amount under IFRS, the reversal is typically treated as a revaluation increase.

Financial statement disclosures provide transparency regarding the reversal. Companies are required to disclose the amount of the reversal recognized in profit or loss during the period. They must also describe the specific events and changes in circumstances that led to the reversal of the impairment loss.

The Non-Reversal Rule for Goodwill

A significant exception to the rule of impairment reversal applies to goodwill. Under both U.S. GAAP and IFRS, an impairment loss recognized for goodwill can never be reversed in a subsequent period. While the two standards diverge on the treatment of most long-lived assets, they are aligned in their stance on goodwill.

The primary rationale for this rule is that any increase in the recoverable amount of a business unit after a goodwill impairment is considered to be the result of internally generated goodwill. Accounting standards prohibit companies from recognizing internally generated goodwill as an asset on their balance sheets. Allowing a reversal would effectively permit the capitalization of this new, internally created goodwill.

For example, if a company acquires another business, the excess purchase price over the fair value of the identifiable net assets is recorded as goodwill. If that business unit later underperforms, leading to a goodwill impairment, the write-down is permanent. Even if the business unit’s performance and value subsequently rebound, the previously impaired goodwill cannot be written back up.