What is the main purpose of impairment testing?

Impairment testing primarily serves to determine whether the carrying amount of an asset exceeds its recoverable amount. This process is essential in ensuring that assets are not overstated on the balance sheet. When the carrying amount, which is the value at which an asset is recognized in the accounts, surpasses the recoverable amount, which is the higher of fair value less costs to sell or value in use (the present value of expected cash flows derived from the asset), an impairment loss needs to be recognized. This requirement is established in the accounting standards to ensure that financial statements provide a true and fair view of the company's financial position.

By conducting impairment testing, companies can adjust the book value of assets to reflect their economic realities, thereby avoiding misleading stakeholders regarding the company’s financial health. This testing is crucial in maintaining compliance with accounting principles and providing accurate information for decision-making purposes.