8.4 Impairment of long-lived assets
6 min read•august 20, 2024
Long-lived assets can lose value over time, requiring companies to assess and record impairment losses. This process ensures financial statements accurately reflect asset values, impacting both the balance sheet and income statement.
Impairment occurs when an asset's exceeds its . Companies must test for impairment when circumstances indicate potential value loss, measuring and recognizing losses to align book values with economic reality.
Impairment of long-lived assets
- Impairment occurs when the carrying amount of a long-lived asset exceeds its fair value
- Impairment testing is required when events or changes in circumstances indicate that the carrying amount may not be recoverable
- Impairment losses are recognized to align the asset's carrying amount with its fair value, ensuring the balance sheet reflects the asset's true economic value
Identifying impaired assets
Indicators of impairment
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- Significant decline in the asset's market value
- Adverse changes in the business climate or legal factors affecting the asset's value
- Accumulation of costs significantly exceeding the original budget for acquiring or constructing the asset
- Current period operating or cash flow losses combined with a history of such losses or a forecast of continuing losses associated with the asset's use
- Plans to dispose of the asset before the end of its previously estimated useful life
Grouping assets for impairment testing
- Assets are grouped at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities
- This grouping is known as the asset group or
- Grouping assets helps determine the level at which impairment testing should be performed and losses allocated
Measuring impairment loss
Determining fair value
- Fair value is the price that would be received to sell an asset in an orderly transaction between market participants
- Techniques for estimating fair value include the market approach (using prices and other relevant information from market transactions), income approach (converting future cash flows to a single discounted present value), and cost approach (current replacement cost)
- If fair value cannot be determined, the asset's value in use (present value of future cash flows) is used instead
Comparing fair value to carrying amount
- The carrying amount (book value) of the asset is compared to its fair value
- If the fair value is less than the carrying amount, an is recognized
- The impairment loss is calculated as the difference between the asset's carrying amount and its fair value
Recognizing impairment loss
Adjusting carrying amount
- When an impairment loss is recognized, the asset's carrying amount is reduced to its fair value
- The reduction in carrying amount is recorded as an impairment loss in the income statement
- The new carrying amount becomes the asset's new cost basis and is depreciated over its remaining useful life
Allocating loss to asset groups
- If an asset group is impaired, the impairment loss is allocated to the individual assets within the group
- The allocation is based on the relative carrying amounts of the assets, except that the carrying amount of an individual asset cannot be reduced below its fair value
- Any remaining unallocated impairment loss is allocated to within the asset group
Presentation and disclosure
Income statement presentation
- Impairment losses are presented as a separate line item in the income statement, typically within operating expenses
- If the impairment is significant or unusual, it may be presented as a component of other gains and losses or disclosed in the notes to the financial statements
Required disclosures for impaired assets
- Description of the impaired asset and the facts and circumstances leading to the impairment
- Amount of the impairment loss and the method used to determine fair value
- Caption in the income statement or statement of activities where the impairment loss is aggregated
- If applicable, the segment in which the impaired asset is reported
Reversing impairment losses
Criteria for reversal
- In some jurisdictions (), impairment losses may be reversed if there is evidence of recovery in the asset's value
- Reversal is permitted only if there has been a change in the estimates used to determine the asset's recoverable amount since the last impairment loss was recognized
- Reversal is prohibited for impairment losses on goodwill
Accounting for reversals
- The increased carrying amount due to reversal should not exceed the carrying amount that would have been determined (net of depreciation) had no impairment loss been recognized
- The reversal is recognized in the income statement and the asset's cost basis is adjusted accordingly
- Depreciation is adjusted prospectively to allocate the asset's revised carrying amount over its remaining useful life
Impairment of goodwill
Goodwill impairment testing
- Goodwill is tested for impairment at least annually, or more frequently if events or changes in circumstances indicate potential impairment
- Testing involves comparing the fair value of a (operating segment or component) to its carrying amount, including goodwill
- If the fair value is less than the carrying amount, goodwill is impaired and an impairment loss is recognized
Allocating goodwill to reporting units
- Goodwill is allocated to the reporting units that are expected to benefit from the synergies of the business combination
- Allocation is based on the relative fair values of the reporting units
- Goodwill impairment testing is performed at the reporting unit level
Impairment of indefinite-lived intangibles
Identifying indefinite-lived intangibles
- (certain trademarks, licenses, etc.) have an indefinite useful life and are not amortized
- These assets are tested for impairment annually or more frequently if events or changes in circumstances indicate potential impairment
Testing for impairment
- The fair value of the indefinite-lived intangible asset is compared to its carrying amount
- If the fair value is less than the carrying amount, an impairment loss is recognized equal to the difference
- After an impairment loss, the asset's new carrying amount becomes its new accounting basis
Impairment vs depreciation
Key differences
- Depreciation systematically allocates an asset's cost over its useful life, while impairment is a one-time reduction in value due to specific circumstances
- Depreciation is a non-cash expense that does not affect cash flows, while impairment losses impact both net income and cash flows
- Depreciation is based on historical cost, while impairment is based on fair value or value in use
Impact on financial statements
- Depreciation expense is recognized in the income statement and accumulated depreciation is presented as a contra-asset account in the balance sheet
- Impairment losses are recognized as expenses in the income statement and reduce the carrying amount of the asset in the balance sheet
- Impairment losses can have a significant impact on a company's financial position and results of operations
Tax considerations
Deductibility of impairment losses
- Tax treatment of impairment losses varies by jurisdiction
- In some cases, impairment losses may be tax-deductible, providing a tax benefit in the form of lower taxable income
- In other cases, impairment losses may not be tax-deductible, creating a permanent difference between book and tax income
Deferred tax assets and liabilities
- Differences in the timing of impairment loss recognition for financial reporting and tax purposes can create deferred tax assets or liabilities
- Deferred tax assets arise when impairment losses are recognized for financial reporting before they are deductible for tax purposes
- Deferred tax liabilities arise when impairment losses are deductible for tax purposes before they are recognized for financial reporting
Real-world examples
Case studies of asset impairment
- Energy companies often record impairment losses on oil and gas properties when energy prices decline significantly
- Retailers may recognize impairment losses on store assets when a location is underperforming or expected to close
- Technology companies may record impairment losses on (patents, trademarks) if their value declines due to rapid changes in the industry
Financial statement analysis
- Analysts and investors should consider the impact of impairment losses on a company's financial statements
- Impairment losses can signal deterioration in the value of a company's assets and future cash flow prospects
- Comparing a company's impairment losses to those of its peers can provide insight into the relative quality of its assets and risk profile
Key Terms to Review (19)
ASC 360: ASC 360 refers to the Accounting Standards Codification topic that covers the accounting for property, plant, and equipment, as well as other long-lived assets. It provides guidance on how to measure and report these assets, ensuring that they are accurately represented in financial statements. This includes determining when to dispose of assets and how to assess impairment, which are critical for maintaining financial transparency and integrity.
Carrying Amount: Carrying amount refers to the value at which an asset is recognized on the balance sheet, after deducting any accumulated depreciation, amortization, or impairment costs. It reflects the net value of an asset and plays a crucial role in assessing financial health, particularly in relation to effective interest rates, impairment of intangible assets, goodwill, and long-lived assets.
Cash-Generating Unit (CGU): A cash-generating unit (CGU) is the smallest identifiable group of assets that generates cash inflows independently of other assets or groups of assets. In accounting, CGUs are crucial for assessing the recoverability of long-lived assets and determining if any impairment losses need to be recognized. This concept helps in evaluating how specific assets contribute to the overall financial performance of a company, especially during impairment testing.
Disclosure Requirements: Disclosure requirements refer to the rules and guidelines that dictate how companies must report financial information to stakeholders. These requirements ensure transparency and allow users of financial statements to understand a company’s financial health, risks, and other relevant factors. Proper disclosure is critical for maintaining trust and compliance with regulatory standards, especially in the contexts of intangible assets and the evaluation of long-lived assets.
Fair Value: Fair value is the estimated price at which an asset or liability could be bought or sold in a current transaction between willing parties, reflecting current market conditions. It connects to the valuation of both long-term and intangible assets, as well as the recognition of changes in value due to impairment or disposition. Understanding fair value is essential for accurate financial reporting, as it affects the presentation of various assets and liabilities on financial statements.
Financial statement impact: Financial statement impact refers to the effect that certain transactions, events, or conditions have on a company's financial statements, including the balance sheet, income statement, and cash flow statement. This impact is crucial for understanding a company's financial health and performance, especially when assessing assets like long-lived assets that may undergo impairment. Recognizing how these changes reflect on financial statements aids stakeholders in making informed decisions about the organization.
GAAP: GAAP, or Generally Accepted Accounting Principles, is a collection of commonly followed accounting rules and standards for financial reporting. It establishes a framework for consistent financial reporting, ensuring that companies present their financial statements in a way that is understandable and comparable across different organizations. This standardization is crucial for investors, regulators, and other stakeholders who rely on accurate financial information to make informed decisions.
Goodwill: Goodwill is an intangible asset that represents the excess value of a business beyond its identifiable net assets at the time of acquisition. It often reflects factors such as brand reputation, customer relationships, and employee relations that contribute to future earnings. Goodwill is important in understanding types of intangible assets and plays a role in amortization, impairment assessments, and consolidation processes.
IFRS: International Financial Reporting Standards (IFRS) are accounting standards developed by the International Accounting Standards Board (IASB) that aim to bring transparency, accountability, and efficiency to financial markets around the world. These standards provide a common global language for business affairs so that financial statements are comparable across international boundaries, promoting cross-border investment and economic growth.
IFRS 36: IFRS 36 refers to the International Financial Reporting Standard that addresses the impairment of assets. It provides guidance on how to assess whether an asset's carrying amount exceeds its recoverable amount and outlines the steps for recognizing and measuring impairment losses, which are crucial for ensuring that financial statements reflect the true economic value of long-lived assets.
Impairment Loss: An impairment loss occurs when the carrying amount of an asset exceeds its recoverable amount, meaning the asset has lost value and can no longer generate expected future cash flows. This concept is crucial for assessing both long-term assets and intangible assets, as it impacts investment decisions, asset valuations, and financial reporting.
Indefinite-lived intangible assets: Indefinite-lived intangible assets are non-physical assets that do not have a finite useful life and are not subject to amortization. These assets, such as trademarks or certain brand names, can provide value to a company indefinitely, as long as they continue to be used and maintained. Understanding these assets is crucial when considering their classification, valuation, and the implications of impairment assessments.
Intangible assets: Intangible assets are non-physical assets that provide long-term value to a company, including items such as patents, trademarks, copyrights, and goodwill. These assets play a crucial role in a company's valuation and can significantly impact its financial position and performance over time.
Market decline: Market decline refers to a significant and sustained decrease in the value of a market, often reflected through falling asset prices, reduced demand, and declining revenues. This situation can negatively impact the financial performance of companies and may lead to the impairment of long-lived assets, as the recoverable amount of these assets may fall below their carrying value.
Recoverability test: The recoverability test is an accounting procedure used to determine whether the carrying amount of a long-lived asset can be recovered through its future cash flows. This test assesses if the asset’s future undiscounted cash flows exceed its carrying value, indicating whether an impairment loss should be recognized. It’s a crucial step in identifying potential impairments in long-lived assets, ensuring that their values accurately reflect their ability to generate cash for the company.
Reduced Cash Flows: Reduced cash flows refer to a decrease in the expected future cash inflows from an asset, which may indicate that the asset is not performing as anticipated. This decline can be a critical signal for companies, especially when assessing the impairment of long-lived assets, as it may suggest that the carrying amount of the asset exceeds its recoverable amount.
Reporting unit: A reporting unit is a component of an entity for which financial information is reported and evaluated, typically in the context of assessing impairment of long-lived assets. This term is important because it helps in identifying the smallest identifiable group of assets whose performance can be evaluated separately, making it easier to assess whether those assets have been impaired or not.
Reversal of impairment: Reversal of impairment occurs when the value of a long-lived asset, previously reduced due to impairment, is increased back to its recoverable amount. This situation arises when there is a change in circumstances that affects the asset's future cash flows, leading to a reassessment of its value. Understanding this concept is crucial for financial reporting as it ensures that the carrying amount of assets reflects their true economic value over time.
Write-down: A write-down is an accounting process that reduces the book value of an asset when its market value falls below its carrying value. This adjustment reflects the decreased value of an asset on the financial statements, ensuring they provide a true and fair view of a company's financial position. It is particularly relevant in scenarios where assets may be overvalued, requiring a realistic assessment for reporting purposes.