Long-Lived Assets: Impairment Testing and Recognition

Evaluating and recording impairments for long-lived assets can be a complex and challenging process.

This article provides a comprehensive overview of impairment testing and recognition for long-lived assets, equipping you with the key knowledge needed to effectively apply ASC 350 and ASC 360-10-35 guidance.

You'll learn what constitutes a long-lived asset, when and how impairment testing should be conducted, how to calculate and record impairment losses, and how to address common issues that arise.

Introduction to Long-Lived Asset Impairment Testing

Long-lived assets like property, plant, and equipment (PP&E) that have useful lives greater than one year are tested for impairment when certain indicators are present. Impairment testing determines if the carrying value of an asset on the balance sheet is overstated compared to its fair value. If the carrying value exceeds the fair value, it must be written down to the fair value.

Common indicators that can trigger the need for impairment testing include:

• Declining financial performance or operating losses
• Changes in technology that negatively impact the asset
• Loss of market share to competitors
• Idling an asset or plans to dispose of an asset earlier than expected

Accounting Standards Codification (ASC) 350 and ASC 360-10-35 provide guidance on testing long-lived assets for impairment. Key points include:

• Assets must be tested for impairment when indicators are present
• A two-step impairment test must be performed
• The asset's carrying value is compared to undiscounted and discounted cash flows
• If impaired, the difference between carrying value and fair value is recognized as an expense

Conducting timely impairment testing and properly recognizing impairment losses is important for providing investors an accurate view of a company's assets and financial health.

Defining Long-Lived Assets

Long-lived assets like property, plant, and equipment (PP&E) have useful lives greater than one year. Examples include buildings, machinery, equipment, furniture, fixtures, and vehicles. Intangible assets like patents, trademarks, and copyrights that have finite useful lives are also considered long-lived.

These assets are initially recorded on the balance sheet at historical cost and then depreciated or amortized over their useful lives. Their carrying value is the historical cost less accumulated depreciation or amortization.

Since long-lived assets generate future economic benefits, their carrying value needs to be evaluated if conditions change to ensure they are not overstated on the balance sheet. This is done through impairment testing.

Impairment Testing Overview

Asset impairment testing determines if the carrying value of an asset on the balance sheet exceeds its fair value. Carrying value is what the asset is recorded on the books at, while fair value represents what the asset could be currently sold for.

If the carrying value is higher than the fair value, the asset is impaired and an impairment loss must be recognized on the income statement. This reduces the asset's carrying value down to the fair value on the balance sheet.

For example, if equipment with an original cost of $100,000 and accumulated depreciation of $60,000 has a carrying value of $40,000 but a fair value of only $20,000, there is a $20,000 impairment loss.

Impairment testing involves a two-step process:

1. Compare undiscounted future cash flows to the asset's carrying value
2. If lower, calculate the asset's fair value and recognize an impairment loss for any difference versus the carrying value

Common Impairment Indicators

Here are some common indicators that may trigger the need to test an asset for impairment:

• Financial metrics: Declining financial performance, operating losses, decreasing profit margins, negative cash flows related to the asset's use
• Asset utilization: Idling an asset or plans to dispose of the asset earlier than expected
• Competition: Loss of market share to competitors leading to reduced utilization
• Obsolescence: Changes in technology, processes, or consumer demand that negatively impact the asset
• Legal factors: Laws, regulations, or contracts that negatively affect the asset's value

The presence of one or more indicators prompts an impairment review to determine if the carrying value needs to be reduced to reflect the diminished service potential of the asset.

Understanding ASC 350 and ASC 360-10-35

Guidance for impairment testing is provided in the FASB Accounting Standards Codification (ASC):

• ASC 350 covers intangible assets like patents and trademarks
• ASC 360-10-35 governs impairment of long-lived assets like PP&E

The standards outline when assets need to be tested for impairment, how to calculate undiscounted cash flows and fair value, and when an impairment loss should be recognized.

Understanding these standards is key for properly evaluating assets for impairment and recognizing any necessary impairment losses. This helps provide investors and stakeholders a more accurate view of a company's assets and financial health.

Are long-lived assets required to be reviewed for impairment?

Long-lived tangible assets and intangible assets with finite useful lives are reviewed for impairment whenever changes in events or circumstances indicate that the carrying amount of an asset may not be recoverable.

This means that companies are required to regularly assess if there have been any indicators of impairment for their long-lived assets. Some examples of impairment indicators include:

• A significant decrease in the market value of the asset
• A significant change in the extent or manner an asset is used
• A significant physical change in the asset
• A significant adverse change in legal factors or in the business climate that affects the value of an asset
• An accumulation of costs significantly in excess of the amount originally expected to acquire or construct an asset
• A current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection of continuing losses associated with an asset used for the purpose of producing revenue

If any such indicators are present, then the company must test the asset for impairment by:

1. Estimating the future undiscounted cash flows expected to result from the asset
2. Comparing that to the carrying amount of the asset on the balance sheet

If the estimated future cash flows are less than the carrying amount, the asset is deemed impaired and an impairment loss must be recognized on the income statement equal to the difference between the carrying amount and the fair value of the asset.

In summary, impairment testing and recognition for long-lived assets is mandatory whenever there are signs that the asset's carrying value may not be fully recoverable. This protects the accuracy of the balance sheet and prevents overstatement of assets.

How do you calculate impairment of long-lived assets?

Once the Fair Value of the asset group is determined, it is compared to the carrying amount of the asset group in order to derive an impairment loss. The excess of the carrying amount of the long-lived asset (asset group) over its Fair Value should be recognized as the impairment loss.

To calculate impairment, follow these key steps:

1. Identify the asset (or asset group) that may be impaired and determine its carrying amount. This includes assets like property, plant and equipment and intangible assets.

2. Estimate the future undiscounted cash flows expected to result from the asset group. This involves projecting revenues, expenses, capital expenditures etc. associated with the asset.

3. Determine the Fair Value of the asset group. Common approaches include market multiples, discounted cash flows, replacement costs etc.

4. Compare the carrying amount to the Fair Value to determine if an impairment exists.

5. If the carrying amount exceeds Fair Value, recognize an impairment loss equal to the excess carrying value over Fair Value.

6. The loss reduces the carrying amount of the long-lived asset to its new Fair Value.

For example, Company A has equipment with a carrying amount of $2 million. Due to decreased demand, the equipment's Fair Value falls to $1.2 million. This means an impairment exists since the carrying amount exceeds Fair Value. The impairment loss would equal $2 million minus $1.2 million = $800,000. This $800,000 loss would reduce the equipment's carrying amount to $1.2 million.

Properly identifying and measuring impairment involves judgment around future cash flow projections, Fair Value models and asset grouping. Guidance like ASC 360-10-35 provides further details on calculating and recognizing impairment losses for long-lived assets.

When should a long-lived asset be tested?

A long-lived asset should be tested for recoverability when any of the following occur:

• External financial statements are being prepared. As part of the financial reporting process, long-lived assets must be evaluated to determine if impairment exists. This is done to ensure assets are not overstated on the balance sheet.

• The asset's fair value has decreased, and the decrease is judged to be permanent. A significant, permanent drop in an asset's market value often indicates impairment may exist. Changes in technology, demand, competition, or economic conditions can trigger fair value decreases.

• Events or changes in circumstances indicate that its carrying amount may not be recoverable. Factors like obsolescence, physical damage, worse-than-expected performance, or a likely sale/disposal could signal that future cash flows will not support the asset's carrying value. This triggers the need for impairment testing.

The key trigger for impairment testing is a likelihood that the asset's carrying amount exceeds its future cash flows or service utility. Since accounting standards require assets to be carried at no more than recoverable value, testing must be performed upon any reasonable indication of impairment.

What is the impairment test for long-term plant assets?

IFRS uses a one-step impairment test to determine if a long-lived asset needs to be written down.

The carrying amount of the asset is compared to its recoverable amount, which is defined as the higher of:

1. The asset's fair value less costs of disposal
2. The asset's value in use

If the carrying amount exceeds the recoverable amount, an impairment loss must be recognized to write down the asset to its recoverable amount.

Some key points on impairment testing under IFRS:

• Assets subject to impairment testing include property, plant & equipment, intangible assets, and goodwill
• Impairment testing is performed annually or when impairment indicators are present
• Value in use is based on discounted estimated future cash flows from the asset
• Fair value uses market data and valuations to estimate what the asset could be sold for
• Impairment losses are recorded as operating expenses on the income statement

Conducting and documenting a robust impairment test is important under IFRS to ensure assets are not overstated on the balance sheet.

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When to Conduct Impairment Testing

This section outlines specific events and changes in circumstances that indicate a potential impairment, requiring a recoverability test.

Significant Decrease in Market Value

A substantial drop in the market price of an asset may suggest that its fair value has declined below carrying value. Some examples include:

• A public company's market capitalization falling significantly below its book value
• A 20% or greater decline in an asset's market value over a quarter or fiscal year

If such a price decline is coupled with other impairment indicators, it likely necessitates an impairment test.

Prolonged Period of Reduced Asset Usage

If an asset has seen significantly lower utilization for an extended time, its estimated fair value may have decreased. For instance:

• Manufacturing equipment sitting idle for over a year due to reduced production volumes
• A retail space remaining vacant for multiple quarters with no serious tenants

In such cases of prolonged underutilization, the asset's value and cash flow potential may be impaired.

Significant Adverse Changes Impacting Operations

Events like pending litigation, loss of key personnel, or economic changes may negatively impact expected cash flows. Some examples requiring impairment consideration:

• A major lawsuit alleging safety issues with a pharmaceutical company's leading drug
• The sudden departure of a start-up's founding engineering team
• A severe industry downturn caused by a recession

Material adverse developments that affect operations necessitate recoverability testing.

Recoverability Test Impairment Indicators

Exploring the specific indicators that necessitate a recoverability test for impairment under ASC 360-10-35.

Overview of the Recoverability Test Process

The recoverability test involves comparing an asset's carrying value to the sum of its undiscounted expected future cash flows to see if impairment exists. This comparison helps determine if the asset can generate sufficient future economic benefits to recover its current book value.

Estimate Undiscounted Future Cash Flows

To estimate future cash flows for recoverability testing under ASC 360-10-35, companies should:

• Project the asset's remaining useful life and any residual value at the end of that life
• Estimate future cash inflows directly associated with the asset over its remaining life
• Estimate any future costs related to the asset such as maintenance, taxes, insurance, etc.
• Use reasonable and supportable assumptions about key inputs like prices, volumes, costs, etc.
• Document the methodology, data sources, and assumptions used

Compare Carrying Value to Estimated Cash Flows

The sum of the expected future cash flows is then compared to the asset's carrying value on the balance sheet. If the undiscounted cash flows are less than the carrying amount, impairment may exist. Additional analysis is required.

Calculating Fair Value

If impairment is indicated in the recoverability test, the next step is to calculate the asset's fair value, usually based on discounted cash flows or other valuation methods. The fair value is compared to the carrying value to measure and record the amount of impairment loss.

Recoverability Test Example

As an example, consider a piece of equipment with a carrying value of $100,000. The company estimates future cash inflows of $20,000 per year for the next 10 years related to leasing out the asset. They also estimate future costs of $5,000 per year for maintenance and repairs over the 10 years.

• Undiscounted cash flows = (Annual inflows of $20,000 - Annual costs of $5,000) x 10 years = $150,000
• Since $150,000 is greater than the $100,000 carrying value, no impairment exists per the recoverability test.

If the undiscounted cash flows were only $90,000 in this example, impairment would be indicated, requiring the company to determine fair value and record any necessary impairment charges.

Impairment Loss Measurement and Recognition

If the recoverability test determines that an impairment exists, the next step is to measure the amount of impairment loss to be recognized.

Measuring the Impairment Loss

The impairment loss is measured as the amount by which the asset's carrying amount exceeds its fair value. For example, if an asset has a carrying value of $100,000 on the balance sheet but its fair value is determined to be only $80,000, the impairment loss would be $20,000.

To determine fair value, companies often use discounted cash flow analyses or market comparisons to similar assets. Independent appraisals may also be obtained. It is important to use reasonable estimates and assumptions when measuring fair value.

Recording and Reporting the Impairment Loss

Once the impairment loss is measured, it must be recorded in the company's accounts and financial statements. Specifically:

• The loss is recognized as an operating expense on the income statement in the period incurred
• The asset's carrying amount on the balance sheet is reduced by the same amount
• Notes to the financial statements should describe the impairment loss, including the events and circumstances leading to it

By recording the impairment accurately and in a timely manner, the financial statements will better reflect the economic realities facing the business.

Reversing Previously Recognized Impairment Losses

For assets held for use in operations, companies are not allowed to reverse previously recognized impairment losses in future periods, even if conditions improve. The reasoning is that the original impairment appropriately adjusted the asset's carrying value to its fair value at that time.

However, for assets held for sale, companies can reverse impairment losses up to the amount originally impaired, but only when fair value subsequently increases. Strict criteria apply in these situations.

Guidance from the PwC Impairment Guide

The PwC Impairment Guide provides best practices around measuring and recording impairment losses for long-lived assets. Key aspects include:

• Using reasonable and supportable assumptions, estimates and judgements
• Documenting the measurement procedures and loss calculations
• Disclosing description of impaired assets, amounts, accounting policy etc.
• Ensuring consistency in measurement approaches across accounting periods

Following this guidance can help companies handle asset impairment in an appropriate and compliant manner.

Key Considerations and Challenges

Grouping Assets for Recoverability Testing

When estimating future cash flows to test for asset impairment, companies may need to group related or complementary assets together. This allows for a more accurate representation of the cash flows that will be generated by the asset group as a whole. Some key factors to consider when deciding on asset groups include:

• Assets that operate together to generate joint cash flows
• Shared infrastructure that supports multiple assets
• Common management or operational teams across assets

Companies should be careful not to group assets too broadly, which could mask impairment issues with poorer performing assets. But grouping too narrowly fails to capture synergies across complementary assets. Striking the right balance is key.

Selecting Appropriate Valuation Techniques

Choosing suitable valuation methods is critical for impairment testing. Companies should select techniques that appropriately consider the unique use, characteristics, and circumstances of the asset. Common methods include:

• Discounted cash flow analysis: Projects future cash flows and discounts them to present value using an appropriate rate. Best for assets with defined life spans.
• Market multiple approaches: Uses pricing multiples from comparable assets recently sold or traded. Useful when active markets exist.
• Replacement cost: Estimates current cost to replace the asset's productive capacity. Applicable when markets or cash flow data is limited.

Using multiple methods can provide a more supportable value. And applying the same techniques consistently allows for period-over-period comparability.

Documenting Impairment Decisions and Assumptions

Companies should thoroughly document their impairment testing procedures, asset groupings, valuation models, key assumptions, and conclusions. Strong documentation provides support if questions arise later regarding impairment decisions. Critical items to document include:

• How asset groups were determined
• Selection rationale for valuation techniques
• Source data used in models and analysis
• Key inputs and assumptions
• Sensitivity analysis of assumptions
• Conclusions reached on asset recoverability

Maintaining organized records also aids in consistent application year-over-year.

Challenges in Applying ASC 360-10-35

While ASC 360-10-35 provides guidance on testing assets for impairment, several complexities can make applying it difficult:

• Forecasting future cash flows requires significant judgment and is inherently uncertain
• Limited markets and data complicate valuation analysis
• Small changes in assumptions can dramatically impact results
• Determining appropriate asset groupings involves subjectivity
• Documentation takes time and resources

Frequent communication between accounting, finance, operations, and valuation teams helps navigate these challenges. As does experience conducting impairments tests across business cycles.

Prudent judgment calls, reasoned analysis, and thorough documentation are essential in applying ASC 360-10-35 to support asset impairment decisions. Companies should involve competent specialists if needed.

Conclusion and Summary

In summary, impairment testing requires evaluating long-lived assets for potential declines in value, conducting recoverability tests when impairment indicators are present, recognizing losses if carrying values exceed fair values, and appropriately documenting the decisions made.

Key Triggers for Impairment Testing

Reduced utilization, market declines, and adverse events are signals that impairment may exist, requiring recoverability testing. Companies should be proactive in monitoring both internal and external factors that may trigger the need for impairment testing under ASC 350.

Recoverability Testing Process Overview

When impairment indicators exist, companies must perform a recoverability test by projecting expected future cash flows related to the asset. These cash flow projections are then discounted to arrive at a net present value. This value is compared to the asset's current carrying value on the balance sheet. If the carrying value exceeds the discounted cash flows, impairment exists.

Measuring and Recording Impairment Losses

When impairment is identified, companies must calculate the impairment loss amount as the excess of the asset's carrying value over its fair value. The fair value is typically measured by discounting revised cash flow projections or observing market prices. The impairment loss must be recognized as an operating expense on the income statement in the period when impairment is identified.

Reviewing Key Points from the PwC Impairment Guide

The PwC guide provides best practices such as using reasonable estimates and assumptions when testing for and measuring impairment losses. It also covers documentation requirements, noting that companies should retain support for all conclusions reached during the impairment review process. Following these guidelines can improve compliance and decision usefulness.

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