Among the countless lessons companies have learned in recent years, expect the unexpected should be toward the top of the list. Things happen, surprises fall out of the sky, and the marketplace throws massive, roll-off-the-table sinkers that leave organizations swinging at air.
In other words, things change, so it’s critical for accounting and finance leaders to know how to address such changes, both big and small. And as you might guess, asset impairment is a prime example of the best of plans going sideways, putting your accounting for long-lived asset impairment under a bright spotlight.
But that’s where Embark enters the fray. With a few insights and best practices leading the way, we promise long-lived asset impairment is nothing more than a manageable bump in the accounting road – scout’s honor. So let’s dig right in.
What are Impaired Long-lived Assets?
A long-lived asset includes line items like buildings, equipment, ROU assets, and intangible assets. In your financial statements, you consider these assets “impaired” when their fair value is less than their carrying value. From a more practical sense, when the future cash flows that an individual asset (or asset group – more on that later) show a significant decrease or completely dry up, there’s a very good chance the carrying value on the balance sheet exceeds the actual fair value of an asset.
This can occur for many reasons, from shoddy physical condition, changes in the marketplace, or use of the asset, to running through an asset’s useful lifespan faster than you thought you would. That’s why long-term assets are especially at risk of impairment – there’s more time for things to go astray. Asset impairment isn’t exclusive to only long-lived assets, though, also rearing its inopportune head for indefinite-lived intangible assets and goodwill.
While we’ll zero-in on the impairment of long-lived assets in a bit, we encourage you to read our past thoughts on goodwill impairment testing for a deeper dive on that critical topic, especially in light of the financial repercussions the pandemic continues to exact on many companies. Also, for those considering impairments specific to any indefinite-lived intangible asset, ASC 350-30 provides the relevant guidance on its impairment model.
Asset Depreciation vs. Asset Impairment
We know what you’re thinking – our brief description of asset impairment has you wondering why you would impair a long-lived asset when you’re already depreciating or amortizing it. And you’re certainly not incorrect for thinking that because, at least from a distance, they do appear quite similar. However, impairment and depreciation have different purposes under US GAAP.
The most obvious distinction between the two is the predetermined nature of depreciation. Anyone that’s spent some time with a good ol’ fashioned straight-line or ACRS/MACRS schedule knows that the purpose of depreciation is to distribute the cost of long-lived assets over its estimated lifespan in a systematic or rational manner. This allows companies to distribute the cost from use of the asset equitably over the period in which it benefits from the use of that asset.
But impairment doesn’t roll like that – it likes to keep you on your toes and pop up unexpectedly, much like a flat tire on your car or a hemorrhaging pipe underneath your kitchen sink. Put another way, depreciation – a form of cost allocation – addresses normal wear and tear on a fixed asset while impairment – a valuation premise – accounts for sudden, unforeseen dips in an asset’s value.
Accounting for Impaired Assets
Now that we have the basics out of the way, let’s take a closer look at the actual financial accounting process for impaired assets, starting with identifying whether or not you have an impaired asset on your hands. Or, more accurately, on your books.
1. When to Test for Impairment
As we said above, US GAAP only considers a long-lived asset impaired when it’s not recoverable and the carrying amount of the asset exceeds its fair value. However, an important first step is recognizing if impairment exists in the first place.
For long-lived assets, GAAP indicates the impairment model and related testing is event-driven. Thus, you’ll need a hefty bit of judgment to assess when a “triggering” event occurs. When it’s time to dig in and see if you have a triggering event on your hands, companies should look at things like:
- Your cash flow from the asset: Have you incurred either operating losses or cash flow losses because of the asset, or are you forecasting continued losses?
- Costs associated with the asset: Have you incurred excessive costs to acquire, build, or maintain the asset?
- Disposal value and timeline: Is there a better-than-average chance you’ll sell or dispose of the asset before its estimated useful life is up?
- Legalities: Are there legal factors that might negatively impact the value of the asset?
- The asset’s market-going price: Have you seen a significant drop in the asset’s market value?
- The asset’s useability: Have things changed in the way you can use the asset or even where it’s located?
According to GAAP, you must perform impairment tests for long-lived assets at the lowest level that independent cash flows exist or, generally speaking, according to asset groups. Therefore, before setting sail on the impairment seas, management must first look at the company’s asset groups to know where they must assess for triggering events and test for impairment.
This process will vary from company to company, so, for instance, your asset groups won’t necessarily be similar to a competitor’s. Also, asset groupings aren’t fixed so a company may occasionally revise its asset groupings based on internal reorganizations or activities around the acquisition and disposal of long-lived assets. However, once you determine that you do, in fact, have an event-based trigger for your long-lived asset group, it’s time to perform the two-step impairment model under GAAP.
But before we move on, we need to reiterate a crucial point – not all assets are equal. In fact, there’s an order to your impairment testing and write-offs in GAAP, where you start with other assets like accounts receivable (AR) and inventory, following the relevant guidance for each. Next, you test indefinite-lived intangible assets if you have any. From there, you move on to your long-lived assets before finally capping the impairment testing off with goodwill.
2. Assessing Recoverability & Measuring Impairment
At this point, you know that you have a business asset – or asset group – that may not be recoverable due to any number of factors and circumstances. Now, to gauge whether you need to record any actual amount of impairment, you perform two different tests – (Step 1) recoverability and (Step 2) measurement.
- Recoverability: Determine if the asset’s (or asset group’s) undiscounted cash flows are less than the carrying value on your books. If so, then you have failed the recoverability test and must then measure the impairment loss.
- Measuring impairment loss: Determine the impairment loss, if any, by calculating the difference between the carrying amount of the asset group – or asset – and its fair value.
It’s important to remember a couple of key differences between any cash flows used in Step 1 for testing recoverability and Step 2 for measuring any impairment loss:
- Cash flows used in Step 1 are based on company-specific assumptions, whereas cash flows in Step 2 are from a market-participant perspective.
- Cash flows used in Step 1 are undiscounted, whereas cash flows used in Step 2 – under an income approach – are discounted.
3. Accounting for Your Impairment Loss
Now that you’ve measured your loss on impairment, it’s time to record the loss. In many cases, an impairment loss will pertain to several assets included in an asset group. Under ASC 360—Property, Plant, and Equipment, you need to allocate any impairment loss on a pro-rata basis to all assets in the asset group in the scope of the standard.
In other words, if there are other assets included in the asset group that aren’t long-lived assets – e.g. working capital – then you do not allocate impairment to those particular assets. Also, keep in mind that when allocating any impairment loss to in-scope long-lived assets, you cannot write down any asset below its fair value measurement. Because of this constraint on the loss allocation, some assets in the asset group may be written down to their fair value and some may be recorded at a new carrying amount of an asset that’s still in excess of the fair value of the asset.
The write-down of any long-lived asset following impairment also creates a new cost-basis for the asset – i.e., any accumulated amortization or depreciation is written off with the allocated impairment loss to arrive at the new basis. You then depreciate or amortize this new cost-basis over the remaining useful life of the asset.
4. Reevaluating Assets for Impairment Loss
As we said, US GAAP states that once an asset’s value is impaired, you cannot reverse that impairment charge in future periods to subsequently increase the asset’s carrying value. Note, however, that we specifically said increase, not decrease. To that point, an impairment charge is not a one-and-done concept. A company must continually monitor its long-lived assets and, in some cases, record additional impairment losses in future periods, especially in an environment with continual market declines or other triggering event indicators.
Asset Impairment Example in the Real World
Discussing the accounting basics to impairment losses is important to understanding the concept, the process involved, and what it might mean for your accounting and finance teams. But there’s something to be said for using a real-world example to drive it all home.
Given the countless examples that 2020 unfortunately provided us, we thought it would be best to pull a relevant impairment charge from an industry both under a regulator’s microscope and hit especially hard in recent years – oil and gas.
Back in Q2 2020, Shell’s management reviewed how the pandemic was impacting the commodity price environment, causing the company to revise its crude forecast from $60 a barrel down to $35. Of course, this would significantly impact projected cash flows and, thus, likely generate impairment losses stemming from the drastic downturn in oil prices.
Ultimately, the company took a $16.8 billion post-tax impairment charge, primarily across its integrated gas reporting units but also in upstream assets and its refining portfolio. Granted, those are staggering figures but, considering what was going on in the world at the time, there are a couple of key takeaways that we want to point out:
- Shell’s management correctly understood that, thanks to an extremely volatile commodities market driven by the coronavirus pandemic, they needed to reassess the asset values across their operating segments in light of plummeting crude prices. in other words, they identified multiple triggering events.
- Just as we said above, a significant change to estimated cash flows across the company’s assets necessitated the impairment losses since they failed their recoverability test and then measured their impairment losses.
Yes, this is an extreme example of a sudden and significant adverse change that doesn’t exactly occur every day. As a matter of fact, 2020 was the worst year on record for oil industry write-downs, totaling nearly $150 billion in the first three quarters alone. However, this example also speaks to how unexpected indicators of impairment can be, cash flow forecasting during uncertainty, and the need to keep your head on a swivel, no matter what industry you’re in.
Other Insights & Best Practices on the Impairment of Long-Lived Assets
Finally, we wouldn’t be doing you much justice if we left everything so high-level without adding some of the tips we’ve picked up in the accounting trenches. So on that note, let’s look at some practical insights you can use to make the impairment loss process a bit more efficient.
Be Aware of the Relevant Guidance
Keep in mind there is a slightly different approach to impairments for long-lived assets that are classified as held-for-sale. The two-step impairment model we detailed above is for the more common impairment framework – assets you’re holding and using – but it’s not the only game in town.
An asset group held-for-sale is recorded at its fair value less cost to sell in the period a company determines it met the held-for-sale criteria. Any impairment loss on this group is simply the difference between the carrying amount of a long-lived asset and its fair value, less cost to sell. Naturally, it’s important to be aware of the relevant guidance and follow the framework that fits your circumstances.
Future Cash Flows
While it’d be nice if your cash flow projections were always spot-on, that’s just not realistic. Thus, there’s a significant amount of judgment involved when using cash flow projections to assess and measure impairment.
Of course, this means auditors will pay especially close attention to the judgment you use in calculating impairment loss. For that reason, you want to be consistent with the assumptions you use in your impairment analysis and avoid using contradicting cash flow models for different needs like, for example, the forecasts for realizability of deferred taxes. Your story should remain the same or, at the very least, the information you use should make sense and be supportable.
Read the Room and Act Accordingly
Once again, GAAP states you must reassess for impairment loss when events or conditions occur that suggest the carrying value of an asset or asset group may not be recoverable. In “ordinary” times, if those even exist anymore, you probably won’t have to conduct those detailed impairment assessments too often, at least with long-lived assets.
However, during recent years, when everything seemed upside down and right-side up, circumstances might’ve changed more often than usual – just look at our Shell example as proof of that notion. That’s why it’s so important to stay aware of the environment, the many variables out there, and reassess for possible impairment whenever necessary.
US GAAP vs. IFRS
We’ve concentrated on US GAAP accounting standards thus far, but it’s a big world out there. Companies with international operations that must comply with IFRS don’t adhere to FASB's two-step impairment model as spelled out in ASC 360-10. Instead, they use the one-step model described in IAS 36. We won’t go much further than that right now but, needless to say, if the IFRS standards apply to you, then it’s an excellent idea to familiarize yourself with the relevant guidance as there can be numerous differences in applying the differing accounting concepts.
Embark’s Final Word
No, we didn’t take a very nuanced look at accounting for asset impairments, but that’s for a very good reason – a thorough discussion could very well consume half of the internet. Obviously, when it comes to addressing your own impairment accounting and the subsequent financial reporting, you’ll need to understand the relevant accounting principles, your cash flows and operations, and, most importantly, have the in-house expertise to handle the countless ins and outs involved.
Sounds like a lot, right? Well, that’s because it is. However, don’t think for a moment that you’re on your own, a boat with an uncertain rudder. Embark’s team of specialists is ready to steer you to shore, no matter how adrift you might feel. It’s what we do.
