Impairment occurs when an asset's market value drops below its book value on the balance sheet, and the decline is considered permanent. When this happens, the company must write down the asset to its fair value and record the difference as a loss.
For example, if a company bought a building for $2 million (book value) but its market value has dropped to $1.5 million due to economic decline, the company records a $500,000 impairment loss.
Impairment tests are done regularly for assets like goodwill, patents, and equipment. It ensures the balance sheet reflects realistic values rather than overstated ones.