Lecture Notes for Acct 592

Professor Teresa Gordon

FASB 144 Impairment of Assets

Assets held for use
Includes land, building, equipment, natural resources, and intangible assets FASB 147 specifies that intangibles from the banking industry are covered by FASB 144 rules:
Long-term customer relationship assets such as Depositor-relationships intangible assets Borrower-relationships intangible assets Credit card holder Intangible assets

When should impairment be recognized?

Testing each asset each period would be too costly Events or changes in circumstances indicate that its carrying amount may not be recoverable TRIGGERING EVENTS: Decline in market value Change in way asset is used or physical change in asset Adverse changes in legal factors or business climate Accumulated costs in excess of amounts originally expected to construct or acquire asset Current expectation that, more likely than not, a long-lived asset will be sold or disposed of significantly before the end of its previously estimated useful life Current period losses with history of operating or cash flow losses associated with asset

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Lecture Notes for Acct 592

Professor Teresa Gordon

To apply impairment tests

A long-lived asset shall be grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Primary asset approach
FASB 144 establishes a "primary-asset" approach to determine the cash flow estimation period for a group of assets and liabilities that represents the unit of accounting for a long-lived asset to be held and used Goodwill is included in the asset group only if the asset group is a reporting unit (defined in FASB 142) Other assets and liabilities (inventory, accounts payable, longterm debt, etc) are to be properly valued in accordance with GAAP prior to testing the asset group for recoverability

An impairment loss is recognized if . . .

Carrying amount of asset (book value) is greater than undiscounted future cash flows related to use and disposal of asset In other words, the carrying value is not recoverable Note that an impairment can exist (that is, carrying value can be less than fair value) but it is not recognized as long as the future cash flows (undiscounted) are greater than the carrying value. The asset is written down to fair value The fair value becomes the new carrying value (book value) and depreciation is recorded over remaining useful life Restoration of a previously recognized impairment loss is prohibited.

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Lecture Notes for Acct 592

Professor Teresa Gordon

Determining fair value

FASB 144 describes a probability-weighted cash flow estimation approach to deal with situations in which
alternative courses of action to recover the carrying amount of a long-lived asset are under consideration, or a range is estimated for the amount of possible future cash flows

Assets to be Sold vs. Abandoned

New rules in FASB 144 distinguish between assets to be sold and those to be abandoned, exchanged or spun-off

Problems with FASB 121

Under the old rules, there were two possible valuation procedures
Net realizable value Fair value less cost to sell

The effect was to recognize future operating losses FASB decided that this violated the definition of a liability

Long-lived assets to be disposed of by sale

Classified as held for sale in period in which all of the following criteria are met:
1. 2. 3. 4. 5. 6. Management commits to a plan to sell the asset Asset is available for immediate sale in its present condition Active program to locate a buyer has been initiated Sale is probable within one year Asset is being actively marketed for a reasonable price It is unlikely that the plan to sell will be changed

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Lecture Notes for Acct 592

Professor Teresa Gordon

Measurement
Write asset down to the LOWER of Carrying amount Fair value less cost to sell (see definitions below) Stop depreciating the asset Costs to sell Includes incremental direct costs to transact the sale
Broker commissions Legal & title transfer fees Closing costs

Generally does not include costs to protect or maintain asset

Insurance Security services Utility expenses The cost to sell are discounted to present in special circumstances when the sale is more than one year in the future

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Lecture Notes for Acct 592

Professor Teresa Gordon

Do events and circumstances indicate a need to assess impairment?

Yes

Is carrying value > anticipated cash flows (undiscounted)?

Yes

No

No

Yes

Are quotes prices in active markets available as basis for fair value determination?

No impairment is recorded. Asset is reported at its carrying value

No

Yes

Can fair value be estimated based on Mkt Value of similar assets?

FASB 144 Impairment of Assets To Be Held and Used

Record impairment loss = to excess of carrying value over fair value

No

Determine FV by discounting anticipated future cash flows

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Lecture Notes for Acct 592

Professor Teresa Gordon

Assets to be disposed of other means

Situations include:
Abandonment Exchange for similar productive asset Distribution to owners in a spinoff

The asset shall continue to be classified as held and used until it is disposed of

Assets to be disposed of other means

Asset stays in PP&E
Depreciation estimates should be revised to reflect shortened life

Depreciation ends and a gain or loss is recorded when the property is disposed of

The disposed of date:

Abandoned
The date it ceases to be used

Exchanged or distributed to owners through a spinoff

The date when it is exchanged or distributed

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Lecture Notes for Acct 592

Professor Teresa Gordon

Impairment Example 1
Johnson Company purchased equipment 8 years ago for $1,000,000. The equipment has been depreciated using the straight-line method with a 20-year useful life and 10% residual value. Johnson's operations have experienced significant losses for the past 2 years and, as a result, the company has decided that the equipment should be evaluated for possible impairment. The management of Johnson Company estimates that the equipment has a remaining useful life of 7 years. Net cash inflow from the equipment will be $80,000 per year. The fair value of the equipment is $240,000. No goodwill was associated with the purchase of the equipment. (a) Determine if an impairment loss should be recognized.

What is the book value of the asset? (We need to first figure out how much is in accumulated depreciation.)

What are the projected cash flows from asset?

(b)

Determine the amount of the loss and prepare the journal entry to record the loss. Debit Credit

(c)

What journal entry should Johnson Company make if future cash flows related to the equipment were $980,000 in total? Debit
Credit

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Lecture Notes for Acct 592

Professor Teresa Gordon

Impairment Example/Homework 2 Howard Company purchased a manufacturing facility 8 years ago on January 8, 1994 for $10,000,000. The facility has been depreciated using the straight-line method with a 20-year useful life and 10% residual value. Howards operations have experienced significant losses for the past 2 years and, as a result, the company has decided that the facility should be evaluated for possible impairment at December 31, 2001. The management of Howard Company estimates that the facility has a remaining useful life of 7 years. Net cash inflow from the facility will be $800,000 per year. The fair value of the facility (using present value techniques) is estimated to be $3,400,000. No goodwill was associated with the purchase of the equipment. (a) Determine if an impairment loss should be recognized.

(b)

If appropriate, determine the amount of the loss and prepare the journal entry to record the loss.

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Lecture Notes for Acct 592

Professor Teresa Gordon

Johnson Co. - Impairment of Assets Example 1 solution

(a) Annual depreciation for the equipment has been $45,000 ($1,000,000 - $100,000)/20 years. Current book value of the equipment is: Original cost ........................................ $1,000,000 Accumulated depreciation ($45,000 8 years) ......... 360,000 Book value ........................................... $ 640,000 According to FASB 144, the existence of impairment is determined by comparing book value of $640,000 to the undiscounted future cash flows of $560,000. The fair value is lower, so an impairment loss should be recognized. (b) The impairment loss is equal to the $400,000 ($640,000 - $240,000) difference between the book value of the equipment and its fair value. The impairment loss would be recorded as follows: Debit Credit Accumulated Depreciation--Equipment ........ 360,000 Loss on Impairment of Equipment ............ 400,000 Equipment ($1,000,000 - $240,000) ........ 760,000 (c) Since the future cash flows (undiscounted) equal $980,000 and this amount is greater than the book value of $640,000, Johnson Company will not do anything. No impairment is recognized and no upward revaluation is recorded.

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