Impaired Capital: What It Is, How It Works

What Is Impaired Capital?

Impaired capital is a balance sheet condition where a company’s total capital becomes less than the par value of its capital stock.

Impaired Capital Explained

Similar to the impairment of an asset, which is a permanent reduction in the value of a company's asset, a company's capital can also become impaired. Impaired capital affects a company’s balance sheet when stockholders’ equity is worth less than the par value of the stock.

What Causes Impaired Capital?

Impaired capital can be the result for a firm that experiences losses and whose retained earnings are negative. These negative earnings are also called a retained deficit. Retained earnings are affected by dividend distributions, so if a company gives out too much in dividends this may cause a negative balance in the reduced earnings. Incorporation laws often prohibit companies from paying dividends before they can eliminate any deficit in retained earnings.

Unlike the impairment of an asset that never recovers, impaired capital can naturally reverse itself when a company's total capital rises again and is above the par value of its capital stock.

With respect to a bank or trust company's capital accounts, impaired capital means that charges or losses have been sufficient to eliminate all their allowance for loan and lease loss, undivided profits, surplus fund, and any other capital reserves. The charges or losses have brought the book amount of the capital stock below the par value of the capital stock.

How to Remedy Impaired Capital?

In a situation where severely impaired capital has resulted from excessive loan losses and other flawed practices, a bank or trust company will be called upon by regulatory agencies to make up the deficiency by raising new capital, usually within 90 days from notice, or liquidating.

One option for making up the deficiency is for the board of directors to levy an assessment on the common stockholders sufficient to restore the capital stock. If stockholders do not pay the assessments within a specified time frame, the board of directors can choose to sell enough of the stockholder's shares to collect the assessment.