Practical guidance in implementing SFAS No. 121: noncurrent asset impairment.
SFAS No. 121 is applicable to determining impairment in all noncurrent assets in GAAP-based financial statements (including assets held by not-for-profit entities) except that the document is not applicable to the following:
(1) Financial instruments
(2) Mortgage servicing rights and certain other intangibles of financial institutions
(3) Deferred taxes
(4) Discontinued operations
(5) Certain assets associated with "special" industries.
The purpose of this paper is to provide practical guidance to practitioners in considering (a) whether noncurrent assets have been impaired, (b) how to measure the impairment loss, and (c) how to display the impairment loss in GAAP-based financial statements.
(Practitioner Note: Since SFAS No. 121 is a measurement document, not a disclosure document only, the provisions of this Statement are not applicable to financial statements prepared on an other comprehensive basis of accounting, e.g., tax basis and cash basis financial statements.)
Assets Held for Sale
Assets that are categorized as "held for sale" should be accounted for as if they were inventory - i.e., they should be accounted for at lower than cost or market. As used in SFAS No. 121, market is considered to be the fair value of the asset less any costs directly associated with the disposition of the asset. If the fair value of the asset (less any disposition costs) exceeds the book value of the asset, no impairment loss recognition is necessary; if the fair value of the asset (less any disposition costs) is less than the book value of the asset, an impairment loss should be recognized in income from continuing operations and the asset should be written down to its fair value.
(Practitioner Note: Impairment losses recognized in this category are considered to be "temporary." As such, if in a subsequent period, the fair value of the asset recovers, the asset may be written up, but never to an amount that exceeds the book value of the asset at the date the initial impairment loss was recognized.)
Selling costs that should be considered in determining the fair value less costs to sell include only the incremental direct costs of selling the asset - e.g., sales commissions, transfer fees, and other closing costs. Costs that are not directly related to the sale (e.g., insurance and property taxes while the asset is being sold) should be charged against income as they are incurred. When estimating cash flows to determine fair value, discounting is necessary only if the sale of the asset is expected to occur outside one year from the financial statement date.
Care should be exercised in determining which assets properly are included in the assets held for sale category. Assets that are part of a disposal of a business segment still should be accounted for as "discontinued operations."
(Practitioner Note: While no guidance is provided in SFAS No. 121 concerning whether an allowance account should be utilized when recognizing asset impairment in the held for sale category of noncurrent assets, since the declines in value in these assets are subject to recovery, practitioners probably should consider using an allowance account to offset any loss recognized in income.)
For example, if an entity owns real estate that is held for sale that has a book value of $100,000, an appraised value of $90,000, and the entity would incur $5,000 in direct costs of disposing of the asset (e.g., commissions, title search, etc.), the entity should recognize a $15,000 impairment loss in income from continuing operations. Subsequent recoveries in the value of the real estate would be recognized except under no circumstances will the carrying amount of the asset ever exceed the carrying amount of the asset at the date the asset initially was considered for impairment ($100,000).
Assets Held for Use
Most practical problems under SFAS No. 121 relate to the provisions of the document that are applicable to assets held for use. Most noncurrent assets of most clients will fall in this category; and, the measurement principles applicable to this category are more difficult to apply. SFAS No. 121 provides no practical guidance related to "how to" implement the assets held for use rules.
The impairment loss recognition rules related to assets classified as "held for use" can be inordinately burdensome to implement. A logical sequence that should be considered by practitioners related to assets in this category is as follows:
(1) Practitioners should consider whether any of the impairment factors defined in SFAS No. 121 have been met. If none of the factors are met, there is no requirement in SFAS No. 121 that practitioners develop an extensive cash flow analysis applicable to these assets. If any one or more of the factors are met, the remaining steps in this sequence should be considered. The impairment factors that should be considered are as follows:
(a) Has there been a significant decrease in the market value of the asset?
(b) Has there been a significant change in the extent or manner in which the asset is used?
(c) Have there been significant changes in legal factors or the business climate that could affect the value of the asset?
(d) Has there been an accumulation of costs significantly in excess of the amount originally expected related to the acquisition or construction of the asset?
(e) Has there been 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 the asset?
Other factors might be considered above and beyond those factors identified by the FASB. In small business engagements, it is likely that operating losses (factor "e") resulting from using assets often will be the first indicator that an asset should be considered for impairment. In many cases, because of the practitioner's familiarity with the client, it may be cost/beneficial simply to "surrender" as relates to these impairment factors and go straight to the cash flow analysis. (Practitioner Note: Entities are not required to routinely perform cash flow analyses on all of their noncurrent assets in attempts to determine if the assets should be considered for impairment; only if one or more of the impairment factors defined in SFAS No. 121 are met will any extensive analysis be necessary.)
(2) Assets should be segregated at the lowest level for which there are identifiable cash flows associated with the asset or asset group where those cash flows clearly are segregable from the remaining cash flows generated by the entity.
(Practitioner Note: While SFAS No. 121 is written in away to indicate that noncurrent assets should be considered for impairment at the individual asset level, as a practical matter it seldom will be possible to estimate cash flows resulting from the use of a single asset since most entities do not track cash flows to that level of detail. For example, oil and gas entities may consider cash flows at the "field" level, and a convenience store chain may consider cash flows at the store level, etc.)
(3) Undiscounted net cash flows that are estimated to be generated by the asset or asset group should be determined. based on experience with the asset or asset group, or experience with similar assets or asset groups, these cash flows should be estimated over the remaining period of time that the asset or asset group is expected to be utilized by the entity. A shorter period of time than the remaining useful life of the asset may be used; in these cases, practitioners should consider some "terminal" value of the asset at the end of this shorter period of time.
(Practitioner Note: In estimating undiscounted net cash flows, practitioners should consider "operating" cash flows associated with the asset or asset group. The cash flow "guesstimates" under SFAS No. 121 are forecasts, not projections. Practitioners should refer to the 1993 AICPA Audit and Accounting Guide entitled Guide for Prospective Financial Information for guidance in making these forecasts. Of primary importance, "what has been" should not be modified when attempting to estimate "what will be" unless there is documentary evidence to the contrary - generally, it will not be assumed that a client will lose customers, but it will not be assumed that the client will increase a customer base unless there is documentary evidence to support a changed assumption.)
If the undiscounted net cash flows associated with the asset or asset group equals or exceeds the recorded amount of the asset or asset group, no impairment loss is required to be recognized (i.e., the asset or asset group is not considered to be impaired). If the undiscounted net cash flows associated with the asset or asset group are expected to be less than the recorded amount of the asset or asset group, the asset or asset group is considered to be impaired.
(Practitioner Note: Undiscounted net cash flows are utilized only in determining whether an asset or asset group is impaired; if the asset or asset group is impaired, the assets should be written down to fair values which may be approximated by the present value of these cash flows.)
Assets that are considered impaired should be written down to their fair values, and any impairment loss should be recognized in income.
(Practitioner Note: These impairment losses are considered to be "permanent" and a new cost basis should be established for the asset or asset group. As such, an allowance account probably should not be used related to these impairment losses; rather, any accumulated depreciation associated with these assets should be eliminated and a new cost basis for the assets should be established.)
The Goodwill Issue
The noncurrent assets that are considered for impairment under SFAS No. 121 include not only tangible assets but also encompass intangible assets, including goodwill. The issue concerning how goodwill should be considered for impairment was a matter of considerable debate. The FASB concluded that goodwill should not be considered for impairment by itself; rather, goodwill should be considered as part of the asset group that was acquired in a purchase transaction that led to the recording of the goodwill. In determining whether cash flows are sufficient to recover the recorded amounts of noncurrent assets, the recorded amount of any goodwill associated with those assets should be included in the analysis. As such, there could be cash flows associated with an asset or asset group sufficient to recover the recorded amount of the assets without the goodwill, but not sufficient cash flows to recover the recorded amount of the assets including the goodwill. In those cases, with one exception, goodwill should be written down to zero and the remaining noncurrent assets in the group should be written down to their fair values. The only case where goodwill would not be written off. entirely when there is a cash flow deficiency would be the case where the fair value of the identifiable assets included in the group exceeds the book value associated with those assets; in those cases, goodwill should be written down to the difference between the fair value and the book value of the identifiable assets.
Example No. 1
Real Company operates a large retail store in Somewhere, Alabama. A national chain in the same industry has just opened a "mega-store" in the same city. There is no doubt that the opening of this new store will have an impact on revenues and cash flows generated by Real Company. In fact, cash flows have deteriorated somewhat in the two months that the mega-store has been in existence. Real Company incurred significant costs (perhaps too much) in acquiring the land and buildings related to the store, and because of the new competition, there is a question concerning the recoverability of the recorded amounts of the assets associated with the store (see factor "c"). Real Company has developed cash flow estimates related to the store assuming 15%, 20%, and 30% declines in revenues and cash flows. Since it is not possible to determine the "best estimate" of the reduction in cash flows, Real Company has decided to project cash flows related to recoverability of assets using a range of cash flows that encompasses all three of the potential percentage declines.
Real Company has been generating cash flows at a level that would indicate that $4 million in undiscounted net cash flows would be generated over the remaining useful lives of the store facilities. Real Company management believes that there is a 60% probability that revenues/cash flows will decline by 15% (to $3.4 million), a 20% probability that revenues/cash flows will decline by 20% (to $3.2 million), and a 20% probability that revenues/cash flows will decline by 30% (to $2.8 million). As a result of this analysis, Real Company has projected a weighted-average undiscounted net cash flow associated with the store as follows:
60% x $3,400,000 = $2,040,000 20% x $3,200,000 = 640,000 20% x $2,800,000 = 560,000 $3,240,000
If the book value of the noncurrent assets associated with the store exceeds $3,240,000, the noncurrent assets will be considered impaired.
(Practitioner Note: Real Company would estimate cash flows at a level no lower than the "store" level - i.e., there is no way that cash flows could be estimated for display racks, etc. If it were determined that the noncurrent assets of Real Company were impaired, a logical approach to determining the fair value of these assets would be the determination of the present value of these cash flows. Other methods - e.g., option-pricing models, matrix pricing, option-adjusted spread models, etc. - are available for use under SFAS No. 121; however, in small business engagements, if there is no readily determinable fair value for the noncurrent assets, a present value calculation probably is the most cost/beneficial way to make a justifiable estimate of fair value.)
Example No. 2
Because one or more of the SFAS No. 121 impairment factors have been met, Real Company has aggregated its assets in attempts to determine whether undiscounted net cash flows associated with the assets allow recoverability of the recorded amount of the assets. The assets being considered for impairment were acquired in a purchase transaction that resulted in the recording of goodwill. At the date the assets are being considered for impairment, book values are as follows:
Identifiable Assets = $1,000,000 Goodwill = $ 400,000
(Practitioner Note: Goodwill should be allocated to assets and asset groups acquired in a purchase transaction based on relative fair values of the assets at acquisition.)
Assumption No. 1 - Fair values of the identifiable assets have been determined to be $625,000. Projected undiscounted net cash flows (UCF) = $1,500,000. Since the UCF exceed the book values of the assets ($1,400,000), no impairment loss needs to be recognized even though the fair value of the assets is significantly less than the book value of those assets.
(Practitioner Note: Before performing an extensive cash flow analysis related to an asset or asset group, if fair values associated with the assets easily are determined to be in excess of the book values of the assets, there is no need to perform the cash flow analysis since, even if there is a cash flow deficiency, no impairment loss would be recognized.)
Assumption No. 2 - Fair values of the identifiable assets have been determined to be $625,000. Projected UCF = $1,200,000. Since the UCF are less than the book value of the assets ($1,400,000), an impairment .loss must be recognized for the difference between the book value and the fair value of the asset group ($1,400,000 - $625,000 = $775,000). Notice that even though the UCF exceed the book value of the assets without the goodwill, the entire $775,000 difference between the book value and fair value of the asset group must be recognized as an impairment loss. When the book value of the identifiable assets exceeds the fair value of the identifiable assets, goodwill must be eliminated and the remaining assets must be written down to fair value.
Assumption No. 3 - Fair values of the identifiable assets have been determined to be $1,100,000. Projected UCF = $1,300,000. The impairment loss to be recognized is $300,000 ($1,400,000 - $1,100,000). Since the fair value of the identifiable assets exceeds the book value of those assets, the exception case related to goodwill discussed above, the entire impairment loss will be charged against goodwill. As such, goodwill will have a carrying amount (after recognition of the impairment loss) of $100,000 and the identifiable assets still will be recorded at $1,000,000.
(Practitioner Note: Most impairment losses related to noncurrent assets will not be deductible for tax purposes at the same time the impairment losses are recognized for. financial reporting purposes. Rather, these assets usually will retain their historical tax bases, resulting in temporary differences. These temporary differences will reverse as the assets are depreciated/amortized or at ultimate disposition of the assets. As such, it will be necessary, when dealing with material amounts, to establish deferred taxes associated with these differences.)
(Practitioner Note: Practitioners should be reminded that even when it is determined that impairment losses need not be recognized in a current reporting period, there may be disclosures required applicable to the potential for future impairment losses under the provisions of SOP 94-6, entitled "Disclosure of Certain Significant Risks and Uncertainties." Practitioners should refer to the SOP 94-6 discussion of disclosures related to "certain significant estimates.")
SFAS No. 121 is effective for measuring impairment in noncurrent assets in financial statements for fiscal years beginning after December 15, 1995. Impairment losses resulting from the initial implementation of SFAS No. 121 should be reported in the period in which the recognition criteria first are applied - i.e., there is no retroactive restatement. For "assets held for sale***;' the provisions of SFAS No. 121 should be implemented as a cumulative effect-type change in principle; for "assets held for use," the provisions of SFAS No. 121 should be implemented essentially as if there is a change in estimate-i.e., the initial impairment loss will be recognized in income from continuing operations.
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|Title Annotation:||Statement of Financial Accounting Standards|
|Author:||Ratcliffe, Thomas A.; Munter, Paul|
|Publication:||The National Public Accountant|
|Date:||Jul 1, 1998|
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