In this series, we bust the jargon and explain a popular investing term or theme. Here it’s Impairments.
Yes. This accounting term is appearing more frequently in City reporting as the outlook for the economy darkens due to rising inflation and the war in Ukraine.
If evidence suggests that there has been a permanent drop in the value of an asset, an impairment charge is made in the company’s accounts.
This charge affects profits. There are two type of asset: tangible (plant and machinery) and intangible (copyrights, loans, patents, trademarks and suchlike).
What would trigger an impairment charge?
If a loan has gone bad or seems highly likely to do so, an impairment charge will be made. Such a write-down may also be necessary if demand for a brand has slumped, or an event has occurred that will put the asset out of use, such as a fire or hurricane destroying a major production facility.
War or conflict can also be the reason for an impairment charge.
How does impairment differ from depreciation?
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The value of tangible assets is systematically written down every year in a company’s accounts to reflect fair wear and tear over their lifespan. Intangible assets are ‘amortised’ in a similar way.
An impairment charge is made if an asset suddenly becomes worthless for the reasons given above – and this change is seen as irreversible.
Has it affected the banks?
Yes. Lloyds has recently warned that impairments for bad loans were set to rise (albeit from a low base) as a result of the cost of living squeeze on households.
The bank has already taken a £177million charge against the impact of economic slowdown. It has noted that customers are cancelling subscriptions to gyms and streaming services and that their food bills are higher.
By contrast, NatWest has released a £38million charge reflecting lower-than-expected losses.
Any other companies?
Yes. BP reported a $25billion (£19.9billion) impairment following its exit from its stake in Rosneft, the Russian oil giant.
General Electric has taken a $230million charge, having shut down its Russian aviation and power businesses. Pepsi Co, another US group, has ceased to sell Pepsi and 7Up in that country and taken a charge of close to $500million.
When did we last see impairments on this scale?
In 2008, US banks took more than $25billion in impairments from acquisitions whose value had slumped.
According to a report from the Financial Conduct Authority, impairments at RBS – now NatWest – amounted to £32.5billion between 2007 and 2010. The bank suffered huge losses in many of its businesses, but commercial property loans were the largest source of woe.