Impairment occurs when the carrying amount of an asset, which is its book value as recorded on the financial statement, exceeds its recoverable amount. This recoverable amount is the higher of the asset's fair value less costs of disposal and its value in use (the present value of expected future cash flows generated by the asset). For example, if a company determines that the value of a piece of machinery has dropped significantly because it is outdated or underperforming, the company needs to recognize an impairment loss to reflect the reduced value on its books.

The process for determining impairment involves performing an impairment test, which is required to be done annually for certain types of assets or when there is an indication that an asset may be impaired. If an impairment is identified, it is recorded as an impairment loss on the income statement, reducing the asset's carrying value on the balance sheet.

Understanding impairment is crucial for companies to maintain accurate and reliable financial statements that reflect the true value of their assets. For example, impairment considerations often arise in situations such as changes in market conditions, technological obsolescence, or a significant decline in the operating performance of a cash-generating unit.