Lessons

Impairment of Long-lived Assets

A long-lived asset has become impaired when the book value of the asset as recorded on the balance sheet is not expected to be recovered during future operations.

Example

A call center operator recently capitalized a $2 million investment in production fixtures at a leased building. The call center company’s primary client in this site cancels the existing business contract two months after the investment is made. The call center firm’s capitalized assets associated with this building may have become impaired, if the company feels that it cannot place new business in this site and must cease operations there.

Events that may cause a “lack of asset value recoverability” could be:

A decrease in the asset’s market value.
Adverse changes in the law.
Adverse changes in the business climate involving the asset.
Cost overruns on a project associated with the asset.
The experience or anticipation ofincome statement or cash flow losses associated with the asset.

Both IFRS and US GAAP require impaired assets to be written down and losses recognized in the income statement. However, there are some differences.

	IFRS	US GAAP
Criteria	Must annually assess for circumstances indicating impairment and then test for impairment	Test for impairment only if events and circumstances indicate so.
Impairment condition	Carrying value > Recoverable amount Recoverable amount = Fair value (less selling cost) or value in use, whichever is higher. The value in use is the present value of its future cash flow stream from continued use.	US GAAP has a two-step process for determining if an asset impairment charge is required: Recoverability Test– An asset impairment must be recognized once the UNDISCOUNTED future cash flows from an asset fall below the book value of the asset on the balance sheet. Loss Measurement– The amount by which an impaired asset it to be reduced equals the difference between its book value and its fair market value (this can be called “mark to market accounting”).
Impact on Balance Sheet	Asset is written down on the balance sheet to the recoverable amount	Asset value is written down to fair value.
Impact on Income Statement	An impairment losses is recorded on the income statement equal to Carrying value – Recoverable amount	A loss charge is taken on the income statement equal to the reduction in asset value on the balance sheet. If fair value is not known, discount value of future cash flows is used.
Loss reversal	Loss can be reversed if value of impaired assets recovers in the future. Loss reversal is limited to original impairment loss.	Loss reversal is not permitted.

Types of Asset Impairment

Write-downs– Asset values have changed as a result of changing market conditions.
Restructurings – Asset value declines associated with the re-organization of business operations.

The US approach to impairment of long-lived assets has flaws because company management retains the ability to determine the assumptions, which go into performing a recoverability test.

In a period of economic recession, an analyst should be suspicious of a firm that does not experience any asset impairment, as management may be sticking to older, more optimistic assumptions about the expected future cash flows generated by its assets.

Intangible Assets with Indefinite Lives

These assets are not amortized but tested for impairment at least annually.

If carrying value exceeds fair value, assets are written down in balance sheet and a loss is recognized in income statement.

Long-lived Assets Held for Sale

The assets held-for-sale are impaired if their carrying value exceeds net realizable value. If carrying value exceeds net realizable value, assets are written down in balance sheet and a loss is recognized in income statement.

Under both IFRS and US GAAP, loss can be reversed if asset value recovers. Loss reversal is limited to original impairment loss.

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