Under what condition is a loan considered impaired?

A loan is considered impaired when it is probable that all amounts due under the original contract will not be received. This assessment is crucial because, under generally accepted accounting principles (GAAP), impairment indicates that the value of the loan has declined due to increased risk that the borrower will not fulfill their payment obligations.

Impairment is analyzed based on the present value of future cash flows expected from the loan, which may fall short of the recorded amount on the balance sheet. This determination often involves evaluating the borrower's financial condition, past payment history, and current economic conditions. Consequently, if it becomes evident that the lender will not recover all amounts originally expected, it triggers the impairment assessment, leading to potential write-downs in the carrying amount of the loan to reflect its fair value.

In contrast, conditions like a loan being unlikely to receive any payments or a principal balance exceeding collateral value do not directly indicate impairment unless they impact the probability of receiving the full amounts due. Similarly, having an interest rate below market rate does not contribute to loan impairment but rather may affect the loan's attractiveness or profitability. Thus, the definition linked to the probability of non-receipt of the full amounts is the key aspect that confirms loan impairment.