EXECUTIVE SUMMARY
| TO ESTABLISH A SINGLE MODEL
BUSINESSES CAN follow, FASB issued
Statement no. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets. FASB
intends it to resolve implementation issues that
arose from its predecessor, Statement no. 121,
Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed
Of.
IMPAIRMENT EXISTS WHEN THE
CARRYING AMOUNT of a long-lived asset
or asset group exceeds its fair value and is
nonrecoverable. CPAs should test for impairment
when certain changes occur, including a
significant decrease in the market price of a
long-lived asset, a change in how the company uses
an asset or changes in the business climate that
could affect the asset’s value.
FAIR VALUE IS THE AMOUNT AN
ASSET COULD be bought or sold for in a
current transaction between willing parties.
Quoted prices in active markets are the best
evidence of fair values. Because market prices are
not always available, CPAs should base fair-value
estimates on the best information available or use
valuation techniques such as the
expected-present-value method or the
traditional-present-value method.
WHEN A COMPANY RECOGNIZES AN
IMPAIRMENT loss for an asset group, it
must allocate the loss to the assets in the group
on a pro rata basis. It must also disclose in the
notes to the financial statements a description of
the impaired asset and the facts and circumstances
leading to the impairment.
COMPANIES MUST PRESENT
LONG-LIVED ASSETS HELD for sale
separately in the financial statements and not
offset them against liabilities. Statement no. 144
requires certain disclosures in the notes to the
financial statements including the circumstances
leading to the disposal, the manner and timing and
the gain or loss on sale. | DAVID T. MEETING, CPA, DBA, is professor
of accounting at Cleveland State University. His
e-mail address is d.meeting@csuohio.edu
. RANDALL W. LUECKE, CPA, CMA, CFM, is
vice-president, finance, at CSA Group in Toronto.
His e-mail address is randall.luecke@csagroup.org
. | |
or many years, companies and other
entities accounted for the disposal or expected
disposal of long-lived assets that were a segment of
a business using one set of rules and the disposal
of long-lived assets that were not a segment of a
business using another standard. To establish a
single model for all long-lived assets, FASB issued
Statement no. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets. |
The new standard supersedes
Statement no. 121, Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of and a portion of APB Opinion
no. 30, Reporting the Results of
Operations—Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and
Transactions. FASB intends Statement no. 144
to resolve significant implementation issues that
arose from Statement no. 121. This article explains
the new guidance and how CPAs can implement it.
LONG-LIVED ASSETS TO BE HELD AND USED
Businesses recognize
impairment when the financial statement carrying
amount of a long-lived asset or asset group
exceeds its fair value and is not recoverable. A
carrying amount is not recoverable if it is
greater than the sum of the undiscounted cash
flows expected from the asset’s use and eventual
disposal. FASB defines impairment loss as the
amount by which the carrying value exceeds an
asset’s fair value. CPAs need not check
every asset an entity owns in each reporting
period. When circumstances change indicating a
carrying amount may not be recoverable, CPAs
should test the asset for impairment. A test may
be called for when one or more of these events
occur:
A significant decrease in the market
price of a long-lived asset.
A significant change in how a company
uses a long-lived asset or in its physical
condition.
A significant change in legal factors
or in the business climate that could affect an
asset’s value, including an adverse action or
assessment by a regulator (such as if the EPA
rules that a company is polluting a stream and
must change its manufacturing process, thereby
decreasing the value of its plant or equipment).
An accumulation of cost significantly
greater than the amount originally expected to
acquire or construct a long-lived asset.
A current-period operating or cash
flow loss combined with a history of such losses
or a forecast demonstrating continued losses
associated with use of a long-lived asset.
An expectation the entity will sell
or otherwise dispose of a long-lived asset
significantly before the end of its previously
estimated useful life. Companies must
group long-lived assets with other assets and
liabilities at the lowest level for which there
are identifiable cash flows. An asset group to be
tested for impairment must include goodwill only
if the group is, or includes, a reporting unit, as
defined in FASB Statement no. 142, Goodwill
and Other Intangible Assets. An asset group
that comprises only part of a reporting unit
should exclude goodwill. Entities must adjust
assets such as accounts receivable and inventory
and liabilities such as accounts payable,
long-term debt and asset retirement obligations
according to other applicable GAAP before testing
the group for recoverability.
TESTING LONG-LIVED ASSETS FOR
RECOVERABILITY
CPAs should test an asset for recoverability by
comparing its estimated future undiscounted cash
flows with its carrying value. The asset is
considered recoverable when future cash flows
exceed the carrying amount. No impairment is
recognized. The asset is not recoverable when
future cash flows are less than the carrying
amount. In such cases the company recognizes an
impairment loss for the amount the carrying value
exceeds fair value. The estimated cash
flows a CPA uses to test for recoverability must
include only future flows (cash inflows less cash
outflows) directly associated with use and
eventual disposal of a given asset. The company
should exclude interest charges it will expense as
incurred. Cash flow estimates are based on the
entity’s assumptions about employing the
long-lived asset for its remaining useful life.
When an asset group consists of long-lived
assets with different remaining useful lives,
determining the group’s life is critical to
estimating cash flows. Remaining useful life is
based on the life of the primary asset—the most
significant asset from which the group derives its
cash flow generating capacity. The primary asset
must be the principal long-lived tangible asset
being depreciated (or intangible asset being
amortized). CPAs should consider these
factors when determining which is the primary
asset:
Whether the entity would have
acquired other assets in a group without this
asset.
The investment required to replace
the asset.
The asset’s remaining useful life
relative to other assets in the group. If
the primary asset does not have the longest
remaining life of the group, the cash flows from
operating the group still are based on that
asset’s estimated life—on the assumption the
company will dispose of the entire group at the
end of the primary asset’s life.
Example. An asset group
consists of asset X with an estimated remaining
life of five years, asset Y with an estimated life
of seven years and asset Z (the primary asset)
with a four-year life. The cash flows a CPA uses
to test for impairment would assume the company
uses the asset group for four years and disposes
of it. To test for impairment, CPAs would include
the group’s salvage value at the end of year 4 in
the cash flow computations. Future cash
flows must be based on the asset group’s current
service potential (four years for the three assets
above) at the date of the impairment test. Future
cash flows should include expenditures to maintain
the current service potential, including replacing
component parts of the long-lived asset and assets
other than the primary one. CPAs should exclude
cash flows that increase service potential but
include maintenance costs.
ESTIMATING FAIR VALUE
Fair value is an
asset’s purchase or sale price in a current
transaction between willing parties. The best
evidence of fair value is prices quoted in active
markets, such as the price for a stock listed on a
stock market. CPAs must use this amount to value
assets if it is available. Because market prices
are not available for many long-lived assets such
as equipment, fair value estimates must be based
on the best information available, including
prices for similar assets. While CPAs can use
other valuation techniques, present value is often
the best for estimating fair value. FASB Concepts
Statement no. 7, Using Cash Flow Information
and Present Value in Accounting Measurements,
discusses two present-value techniques CPAs
may use.
DISCLOSING IMPAIRMENT LOSSES
When a company
recognizes an impairment loss for an asset group,
it must allocate the loss to the long-lived assets
in the group on a pro rata basis using their
relative carrying amounts. There is an exception
when the loss allocated to an individual asset
reduces its carrying amount below fair value. If
CPAs can determine fair value without undue cost
and effort, the asset should be carried at this
amount. This requires an additional allocation of
the impairment loss (explained below). The
adjusted carrying value after the allocation
becomes the new cost basis for depreciation
(amortization) over the asset’s remaining useful
life. A business must include an
impairment loss in the income from continuing
operations before income taxes line on its income
statement. (A not-for-profit organization (NPO)
would include the loss in income from continuing
operations in the statement of activities.) When a
subtotal such as income from operations is
present, CPAs should include the impairment loss
in determining that amount. Other required
information companies must disclose in the notes
to the financial statements includes
A description of the impaired
long-lived asset and the facts and circumstances
leading to its impairment.
If not separately presented on the
face of the statement, the amount of the
impairment loss and the caption in the income
statement or the statement of activities that
includes the loss.
The method or methods used to
determine fair value.
If applicable, the segment in which
the impaired long-lived asset is reported under
FASB Statement no. 131, Disclosures about
Segments of an Enterprise and Related
Information.
Example. There is a
significant adverse change in the business climate
in one of the industries North Bay Inc. operates
in. The company believes this change could impair
some of its long-lived assets. The company groups
assets at the lowest level with identifiable cash
flows and tests them for impairment. One group is
the ScioTech operation, which is not a reporting
entity. Current conditions have reduced the fair
value of inventory, which has a carrying value of
$175,000. Using applicable GAAP (lower of cost or
market rule), North Bay determines the inventory’s
fair value is $150,000. It must make inventory
adjustments before testing for long-lived asset
impairment. It adjusts inventory down by $25,000
and reports this amount in the income statement.
ScioTech’s long-lived assets consist of A,
B, C, D and E; D is the primary asset. Exhibit 1
shows the assets’ individual carrying value and
remaining lives. They are deemed impaired because
their fair value and future undiscounted value are
less than their carrying value. If future
undiscounted cash flows were greater than carrying
value, North Bay would recover the carrying value
by using the asset group and would not recognize
an impairment. |
Exhibit 1: Asset Carrying
Values and Remaining Lives
|
Long-lived asset |
Carrying value | Remaining life
| Asset A |
$100,000 | 6 years |
Asset B |
$200,000 | 10 years |
Asset C |
$600,000 | 9 years |
Asset D (Primary asset)
| $950,000 | 8 years |
Asset E |
$350,000 | 12 years |
Total |
$2,200,000 |
| | |
Asset D, the primary asset, has a
remaining life of eight years. This determines the
period over which the company will estimate cash
flows to see if the carrying amount is recoverable.
Assume future cash flows for the next eight years
are $1,700,000 with an additional $75,000 realized
from disposing of the group at the end of the
period. Since the $1,775,000 cash flow is less
than the $2,200,000 carrying amount and the
group’s fair value is $1,450,000—also less than
the carrying amount—the company should recognize a
$750,000 impairment loss in income from continuing
operations before taxes on its income statement.
In exhibit 2 the $750,000 impairment loss is
allocated pro rata to assets A, B, C, D and E.
Exhibit 2: Loss
Allocation |
Long-lived asset
| Adjusted
carrying value |
Pro rata
allocation factor
| Allocation of
impairment loss |
Adjusted carrying
value |
Asset A |
$100,000 |
.05 |
$37,500 |
$62,500 |
Asset B |
$200,000 |
.09 |
$67,500 |
$132,500
| Asset
C | $600,000
| .27 |
$202,500 |
$397,500
| Asset
D (Primary asset)
| $950,000 |
.43 |
$322,500 |
$627,500
| Asset
E |
$350,000
| .16
|
$120,000
|
$230,000
|
Total |
$2,200,000 |
1.00 |
$750,000 |
$1,450,000
| | | |
The impairment loss allocated to
a long-lived asset should not reduce its carrying
value below fair value. Assuming asset B’s fair
value is $160,000, the pro rata allocation reduces
its carrying value below fair value (carrying value
is $132,500—$27,500 below fair value). The company
needs to increase B’s fair value by $27,500 to
$160,000 and allocate an additional $27,500 loss pro
rata to assets A, C, D and E. Exhibit 3 shows the
assets’ new cost basis. CPAs should review
depreciation estimates and methods for the assets
according to the requirements of APB Opinion no.
20, Accounting Changes.
Exhibit 3: New
Cost Basis of Assets
|
Long-lived
asset |
Adjusted carrying
value | Pro
rata allocation factor
| Allocation of
impairment loss |
Adjusted carrying
value |
Asset A |
$62,500 |
.05 |
$(1,375) |
$61,125 |
Asset C |
$397,500 |
.30 |
$(8,250) |
$389,250
| Asset
D (Primary asset)
| $627,500 |
.48 |
$(13,200) |
$614,300
| Asset
E |
$230,000
| .17 |
$(4,675)
|
$225,325
|
Subtotal |
$1,317,500 |
1.00 |
$(27,500)
|
$1,290,000
|
Asset B |
$132,500
| |
$27,500 |
$160,000
|
Total |
$1,450,000 |
| —
| $1,450,000
| | | |
ASSETS DISPOSED OF OTHER THAN BY SALE
A company must continue
to classify long-lived assets it plans to dispose
of by some method other than by sale as held and
used until it actually gets rid of them. Other
disposal methods include abandonment, exchange for
a similar productive asset or distribution to
owners in a spin-off. A company should
report long-lived assets to be abandoned or
distributed to owners that consist of a group of
assets (and liabilities) that are a “component of
an entity” in the income statement as discontinued
operations. If the assets are not a component,
CPAs should report their disposal as part of the
company’s income from continuing operations.
Statement no. 144 defines a component of an
entity as operations and cash flows that can be
clearly distinguished both operationally and for
financial reporting purposes from the rest of the
entity. A component may be a
Reportable segment or an operating
unit, as defined in Statement no. 131.
A reporting unit, as defined in
Statement no. 142.
A subsidiary or an asset group.
Statement no. 144 defines asset group as “assets
to be disposed of together as a group in a single
transaction and liabilities directly associated
with those assets that will be transferred in the
transaction.” A long-lived asset a company
will abandon is considered disposed of when the
company stops using it. A temporarily idle asset
is not accounted for as abandoned. If an entity
plans to abandon a long-lived asset before its
estimated useful life, it will treat the asset as
held and used, test it for impairment and revise
depreciation estimates in accordance with Opinion
no. 20. Continued use of such a long-lived asset
demonstrates service potential (the unit is
useable), and hence, fair value would be zero only
in unusual circumstances. During use before
abandonment, the company should depreciate the
asset so that at disposal or abandonment, its
carrying value equals its salvage value. This
amount should not be less than zero. A
long-lived asset to be distributed to owners or
exchanged for a similar productive asset is
considered disposed of when it is distributed or
exchanged. When the asset is classified as held
and used, any test for recoverability must be
based on using the asset for its remaining useful
life, assuming disposal will not occur. If the
carrying amount exceeds fair value at disposal,
the company must recognize an impairment loss.
LONG-LIVED ASSETS TO BE SOLD
A company must
classify a long-lived asset it will sell as held
for sale in the period it meets all of these
criteria:
Management with the authority to
approve the action commits to a plan to sell.
The asset is available for immediate
sale in its present condition, subject only to
terms that are usual and customary when selling
such assets.
The company has initiated an active
program to locate a buyer.
The sale is probable and the asset
transfer is expected to qualify as a completed
sale within one year (there are some circumstances
beyond the entity’s control that may extend the
time for completion beyond one year).
The company is actively marketing the
asset at a reasonable price in relation to its
current fair value. If the company meets
the above criteria after the balance-sheet date
but before it issues its financial statements, it
must continue to classify the asset as held and
used. In the notes to the financial statements,
the company must disclose the facts and
circumstances leading to the expected disposal,
the likely manner and timing of the disposal
and—if not separately shown on the face of the
statement—the carrying amount(s) of the major
classes of assets and liabilities included in the
disposal group. If the company tests the asset for
recoverability at the balance-sheet date, it
should do so on a held-and-used basis. Future cash
flow estimates used to test for recoverability
must take into account the possible outcomes that
existed at the balance-sheet date, including a
future sale. CPAs should not revise this
assessment for a sale decision made after the
balance-sheet date and should collect
documentation and supporting evidence on a timely
basis for events near such a date. An impairment
loss is calculated and reported in the same way it
is for assets held and used because this is the
asset’s status at the balance-sheet date.
Companies must adjust the carrying amounts of
assets (including goodwill) that are part of a
disposal group classified as held for sale not
covered by Statement no. 144 in accordance with
other applicable GAAP before measuring the group’s
fair value. A long-lived asset held for sale must
be measured at the lower of its carrying amount or
fair value less cost to sell—the incremental
direct costs the company would not have incurred
if not for the decision to sell. Examples of such
costs include broker commissions, legal and title
transfer fees and closing costs necessary to
transfer title. Exclude expected future losses
from operations. Assets classified as held for
sale are not depreciated or amortized.
Example. ABC Corp. decides
in October of year 1 to dispose of an asset group
that is a component of an entity. It meets all the
requirements to classify the group as a long-lived
asset to be disposed of by sale. The group’s
carrying amount is $750,000, its fair value
$600,000 and the estimated cost to sell is
$45,000. The loss to be recognized in October of
year 1 is $750,000 – ($600,000 – $45,000) =
$195,000. The new carrying amount is $555,000.
If ABC is a calendar-year corporation, on
December 31 of year 1 it needs to review the fair
value and cost to sell to see if it needs to
adjust the group’s carrying amount. If at that
date the fair value has fallen to $575,000 with an
estimated cost to sell of $45,000, the company
would recognize an additional $25,000 loss. The
carrying amount is now $530,000. ABC would report
a total loss of $220,000 on its year 1 income
statement. It sells the disposal group in May of
year 2 for $595,000 with a $50,000 cost to sell.
The disposal proceeds are $545,000—$15,000 more
than the carrying value. ABC would report this
gain on its income statement, as described in the
next section.
REPORTING DISCONTINUED OPERATIONS
An entity must report
the results of operating a component it has either
disposed of or classified as held for sale in
discontinued operations if it meets both of these
conditions:
The component’s operations and cash
flows have been or will be eliminated from the
ongoing operations as a result of the disposal.
The entity will not have any
significant continuing involvement in the
component’s operations after the disposal.
In a period when an entity disposes of a
component, the income statement of a business or
the statement of activities of an NPO must report
the results of the component’s operations as
discontinued operations. The entity would
recognize the gain or loss from classifying the
component as held for sale or disposal in
discontinued operations. If the disposal group is
a component of an entity, as in the earlier ABC
example, the component’s operations results (a
$400,000 loss) are included in discontinued
operations for year 1. The $220,000 loss on the
disposal group is part of discontinued operations
in year 1. The year 2 income statement will
include—as discontinued operations—the component’s
operations for January through disposal in May,
with the $15,000 gain on disposal also reported
here. Discontinued operations less applicable
taxes or benefits must be reported as a separate
component of income before extraordinary items and
the cumulative effect of accounting changes. ABC
will report the results of discontinued operations
in its year 1 income statement, as shown in
exhibit 4. A company must disclose the
gain or loss it recognizes when it classifies an
asset as held for sale or disposal on either the
face of the income statement or in the notes.
Adjustments related to disposing of a component of
an entity in a prior period, which the company
reported as discontinued operations, must be
classified separately in discontinued operations
in the current period. A gain or loss on a
long-lived asset that is not an entity component
must be included in income from continuing
operations before income taxes in the income
statement. If the entity uses a subtotal such as
“income from operations,” it must include the
gains or losses there. |
Exhibit 4: ABC Corp. Year 1
Income Statement |
Income from
continuing operations before
income taxes |
$4,580,000 |
| Income taxes (30%
rate) | 1,374,000
| |
| Income from
continuing operations |
| $3,206,000
| Discontinued
operations (Note T) |
| |
| Loss from operations of
discontinued Component Z
(including $220,000 loss on
classification as held for sale)
| 620,000 |
| |
Income tax benefit |
186,000 |
| | Loss
on discontinued operations |
| 434,000
| Net Income |
| $2,772,000
| | |
PRESENTATION AND DISCLOSURE
A company must present a
long-lived asset held for sale separately in its
financial statements. Major classes of assets and
liabilities held for sale must not be offset and
presented as one amount, they must be separately
disclosed either on the face of the statement
itself or in the notes. Statement no. 144
requires a company to disclose information in the
notes for a period in which it either sells a
long-lived asset or classifies it as held for
sale. Companies must disclose
The facts and circumstances leading
to the expected disposal, the likely manner and
timing and, if not separately presented, the
carrying amount(s) of major classes of assets and
liabilities included in the disposal group.
The loss recognized for any initial
or subsequent write-down to fair value less cost
to sell or a gain not more than the cumulative
loss previously recognized for a write-down to
fair value less cost to sell.
The gain or loss on sale of the
long-lived asset. CPAs should do this if these
gains and losses are not separately presented on
the face of the income statement, the caption in
the income statement or statement of activities.
If applicable, the revenue and pretax
profit or loss reported in discontinued
operations.
If applicable, the segment in which
the long-lived asset is reported under Statement
no. 131. If an entity decides not to sell
a long-lived asset previously classified as held
for sale, or removes an asset or liability from a
disposal group, it must describe in the notes the
facts and circumstances leading to the change in
plan and its effect on operations for that period
and any prior period presented.
IMPLEMENTATION AND EFFECTIVE DATE
The flowchart in exhibit
5 provides CPAs with a process to follow in
implementing the provisions of Statement no. 144.
The new statement is effective for financial
statements issued for fiscal years beginning after
December 15, 2001, and interim periods within
those fiscal years. FASB encourages early
application. | |