In the previous two posts we looked into tangible and intangible long-lived assets and depreciation and amortization methods for long-lived assets. Today we will look at impairment of long-lived assets and their treatment.
IFRS and GAAP both require impaired assets to be written down by recognizing an impairment loss on the income statement. Today we will discuss the recognition of impairment loss in case of tangible and intangible long-lived assets with finite lives, which are held for use and held for sale. We will also discuss impairment of intangible assets with indefinite lives. So let’s tackle them one by one;
Impairment of long-lived assets with finite lives, held for use
Under IFRS, a firm must annually check for impairment of an asset’s value. An asset is considered impaired if its carrying value i.e. original cost minus accumulated depreciation is higher than the recoverable amount. Recoverable value is the higher of fair value minus selling costs and ‘value in use.’ The ‘value in use’ is the present value of its future cash flow stream from continued use.
If an asset is found to be impaired, the asset must be written down to the recoverable value on the balance sheet. An impairment loss should be recognized on the income statement to the extent of the excess of carrying value over the recoverable value.
IFRS permits reversal of impairment loss if the asset’s value recovers in future. However, the loss can be reversed only to the extent of original impairment. An increase in the value of the asset over the carrying value is not recognized as a gain on the income statement. Thus the carrying value can never exceed the original carrying value.
Under US GAAP a asset is considered impaired only if it is believed the firm may not be able to recover the carrying value of the asset through future cash flow streams.
An asset is impaired if its carrying value is greater than its undiscounted future cash flows. The asset is written down to its fair value on the balance sheet. An impairment loss to the extent of the excess of carrying value over the fair value is recognized on the income statement. If fair value is not known, discounted value of future cash flows can be used for the purpose.
Impairment of long-lived assets with finite lives, held for sale
When an asset is reclassified from held for use to held for sale it is tested for impairment. The held for sale asset is impaired if its carrying value is greater than its net realizable value (fair value minus selling costs). The asset is written down to its net realizable value on the balance sheet and an impairment loss (carrying value – net realizable value) is recognized on the income statement.
Both IFRS and GAAP allow the impairment loss to be reversed in case of future recovery in the asset value. However, the loss reversal is restricted to the original impairment loss.
Impairment of intangible assets with indefinite lives
Intangible assets with indefinite lives are not amortized, rather they are tested for impairment at least annually. An impairment loss is recognized when carrying value exceeds fair value.
Recognition of impairment loss is an indication that depreciation and amortization expense have not been sufficiently recognized. Depreciation and amortization assumptions are at the discretion of the management, and therefore they can manipulate impairment decisions.
Recognizing impairment loss in periods of high earnings will tend not to affect the net earnings so much. Alternatively, managements may also recognize more impairment losses in periods when earnings are low due to factors beyond the control of the management such as industry slump so that the management will not be blamed for the low earnings.
De-recognition of long-lived assets
Long-lived assets are de-recognized when they are sold, exchanged or abandoned.
When an asset is sold, it is removed from the balance sheet. A gain or loss is recognized on the income statement to the extent of the difference between sale proceeds and the carrying value of the asset.
If an asset is exchanged for another asset, gain or loss is determined by comparing the carrying value of the old asset with the fair value of the old asset (or fair value of the new asset if that is more easily determinable). The carrying value of the old asset is removed from the balance sheet, and the new asset is recorded at its fair value.
If an asset is abandoned, it is removed from the balance sheet and a loss to that extent is recognized on the income statement.
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In the next installment in the long-lived assets series we will cover leasing in detail…..stay tuned…
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