Accounting for Impairment of Long-Lived Assets

Lecture Notes: Accounting for Impairment of Long-Lived Assets (ASC 360) Introduction: - Long-lived assets, such as property, plant, and equipment, are essential for many businesses to operate effectively and generate revenue. - However, these assets may experience a decline in their value due to various factors, such as changes in market conditions, technological advancements, or physical damage. - To accurately reflect the economic reality of a business, accounting standards require the recognition and measurement of impairment of long-lived assets. - In the United States, the Financial Accounting Standards Board (FASB) established Accounting Standards Codification (ASC) 360 to provide guidance on the accounting treatment of impairment of long-lived assets. I. Overview of ASC 360: A. Objective: 1. The primary objective of ASC 360 is to ensure that long-lived assets are reported at their recoverable amount. 2. Recoverable amount refers to the higher of an asset's fair value less costs to sell (FVLCS) or its value in use. 3. Impairment should be recognized if the carrying amount of an asset exceeds its recoverable amount. B. Scope: 1. ASC 360 applies to tangible long-lived assets, such as property, plant, and equipment, including leasehold improvements. 2. It also covers intangible assets with finite lives, except for those accounted for under ASC 350 (Intangibles - Goodwill and Other). C. Key Concepts: 1. Carrying Amount: The net book value of the asset on the balance sheet, representing its historical cost less accumulated depreciation and impairment losses. 2. Fair Value: The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. 3. Value in Use: The present value of expected future cash flows from the asset's continued use. 4. FVLCS: Fair value less the costs directly associated with the sale or disposal of an asset. II. Recognition of Impairment: A. Indicators of Impairment: 1. Internal Indicators: Obsolescence, physical damage, or a significant decrease in the asset's market value. 2. External Indicators: Changes in market conditions, legal factors, or technological advancements that affect the asset's value. B. Two-Step Impairment Test: 1. Step 1: Identify potential impairment by comparing the carrying amount of the asset with its recoverable amount. 2. Step 2: If the carrying amount exceeds the recoverable amount, recognize an impairment loss equal to the difference. 3. The impairment loss is reported as a separate line item on the income statement and reduces the carrying amount of the asset. III. Measurement of Impairment: A. Fair Value Measurements: 1. When fair value is used as the recoverable amount, it should be based on the best available information, such as market prices or valuation techniques. 2. If an active market doesn't exist, valuation techniques like discounted cash flow analysis or market multiples can be used. B. Value in Use: 1. When value in use is used as the recoverable amount, it requires estimating the asset's future cash flows and applying an appropriate discount rate. 2. Cash flow projections should consider factors like expected sales volume, pricing, operating costs, and terminal value. IV. Subsequent Measurement and Reversal of Impairment: A. Subsequent Measurement: 1. After recognizing an impairment loss, the asset's carrying amount is adjusted to its new value. 2. The depreciation expense is then recalculated based on the revised carrying amount over the asset's remaining useful life. B. Reversal of Impairment: 1. An impairment loss can be reversed if there's a change in circumstances indicating that the asset's recoverable amount has increased. 2. The reversal is limited to the original impairment loss amount and should be recognized as income but not exceed the asset's carrying amount. Conclusion: - ASC 360 provides guidance on accounting for the impairment of long-lived assets, ensuring that their carrying amount accurately reflects their recoverable amount. - Recognizing and measuring impairment is crucial for providing users of financial statements with relevant and reliable information. - By adhering to the principles outlined in ASC 360, businesses can enhance the transparency and comparability of their financial reporting, leading to better decision-making.