FINANCIAL ACCOUNTING

New accounting guidance for long-lived assets.

Asset Impairment and Disposal

--------------------------------------------------------------------------------
BY DAVID T. MEETING AND RANDALL W. LUECKE
--------------------------------------------------------------------------------

EXECUTIVE SUMMARY
TO ESTABLISH A SINGLE MODEL BUSINESSES CAN follow, FASB issued Statement no. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets. FASB intends it to resolve
implementation issues that arose from its predecessor, Statement no. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.
IMPAIRMENT EXISTS WHEN THE CARRYING AMOUNT of a long-lived asset or asset group
exceeds its fair value and is nonrecoverable. CPAs should test for impairment when certain changes occur,
including a significant decrease in the market price of a long-lived asset, a change in how the company uses
an asset or changes in the business climate that could affect the asset’s value.

FAIR VALUE IS THE AMOUNT AN ASSET COULD be bought or sold for in a current transaction
between willing parties. Quoted prices in active markets are the best evidence of fair values. Because
market prices are not always available, CPAs should base fair-value estimates on the best information
available or use valuation techniques such as the expected-present-value method or the traditional-present-
value method.

WHEN A COMPANY RECOGNIZES AN IMPAIRMENT loss for an asset group, it must allocate the
loss to the assets in the group on a pro rata basis. It must also disclose in the notes to the financial
statements a description of the impaired asset and the facts and circumstances leading to the impairment.

COMPANIES MUST PRESENT LONG-LIVED ASSETS HELD for sale separately in the financial
statements and not offset them against liabilities. Statement no. 144 requires certain disclosures in the notes
to the financial statements including the circumstances leading to the disposal, the manner and timing and
the gain or loss on sale.

DAVID T. MEETING, CPA, DBA, is professor of accounting at Cleveland State University. His e-mail
address is d.meeting@csuohio.edu. RANDALL W. LUECKE, CPA, CMA, CFM, is vice-president,
finance, at CSA Group in Toronto. His e-mail address is randall.luecke@csagroup.org.

or many years, companies and other entities accounted for the disposal or expected disposal of long-lived
assets that were a segment of a business using one set of rules and the disposal of long-lived assets that
were not a segment of a business using another standard. To establish a single model for all long-lived
assets, FASB issued Statement no. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.
The new standard supersedes Statement no. 121, Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of and a portion of APB Opinion no. 30, Reporting the Results of
Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions. FASB intends Statement no. 144 to resolve significant
implementation issues that arose from Statement no. 121. This article explains the new guidance and how
CPAs can implement it.
LONG-LIVED ASSETS TO BE HELD AND USED

Businesses recognize impairment when the financial statement carrying amount of a long-lived asset or
asset group exceeds its fair value and is not recoverable. A carrying amount is not recoverable if it is
greater than the sum of the undiscounted cash flows expected from the asset’s use and eventual disposal.
FASB defines impairment loss as the amount by which the carrying value exceeds an asset’s fair value.
CPAs need not check every asset an entity owns in each reporting period. When circumstances change
indicating a carrying amount may not be recoverable, CPAs should test the asset for impairment. A test
may be called for when one or more of these events occur:

A significant decrease in the market price of a long-lived asset.

A significant change in how a company uses a long-lived asset or in its physical condition.

A significant change in legal factors or in the business climate that could affect an asset’s value, including
an adverse action or assessment by a regulator (such as if the EPA rules that a company is polluting a
stream and must change its manufacturing process, thereby decreasing the value of its plant or equipment).

An accumulation of cost significantly greater than the amount originally expected to acquire or construct a
long-lived asset.

A current-period operating or cash flow loss combined with a history of such losses or a forecast
demonstrating continued losses associated with use of a long-lived asset.

An expectation the entity will sell or otherwise dispose of a long-lived asset significantly before the end of
its previously estimated useful life.

Companies must group long-lived assets with other assets and liabilities at the lowest level for which there
are identifiable cash flows. An asset group to be tested for impairment must include goodwill only if the
group is, or includes, a reporting unit, as defined in FASB Statement no. 142, Goodwill and Other
Intangible Assets. An asset group that comprises only part of a reporting unit should exclude goodwill.
Entities must adjust assets such as accounts receivable and inventory and liabilities such as accounts
payable, long-term debt and asset retirement obligations according to other applicable GAAP before testing
the group for recoverability.

TESTING LONG-LIVED ASSETS FOR RECOVERABILITY

CPAs should test an asset for recoverability by comparing its estimated future undiscounted cash flows
with its carrying value. The asset is considered recoverable when future cash flows exceed the carrying
amount. No impairment is recognized. The asset is not recoverable when future cash flows are less than the
carrying amount. In such cases the company recognizes an impairment loss for the amount the carrying
value exceeds fair value.

The estimated cash flows a CPA uses to test for recoverability must include only future flows (cash inflows
less cash outflows) directly associated with use and eventual disposal of a given asset. The company should
exclude interest charges it will expense as incurred. Cash flow estimates are based on the entity’s
assumptions about employing the long-lived asset for its remaining useful life.

When an asset group consists of long-lived assets with different remaining useful lives, determining the
group’s life is critical to estimating cash flows. Remaining useful life is based on the life of the primary
asset—the most significant asset from which the group derives its cash flow generating capacity. The
primary asset must be the principal long-lived tangible asset being depreciated (or intangible asset being
amortized).

CPAs should consider these factors when determining which is the primary asset:

Whether the entity would have acquired other assets in a group without this asset.

The investment required to replace the asset.

The asset’s remaining useful life relative to other assets in the group.
If the primary asset does not have the longest remaining life of the group, the cash flows from operating the
group still are based on that asset’s estimated life—on the assumption the company will dispose of the
entire group at the end of the primary asset’s life.

Example. An asset group consists of asset X with an estimated remaining life of five years, asset Y with an
estimated life of seven years and asset Z (the primary asset) with a four-year life. The cash flows a CPA
uses to test for impairment would assume the company uses the asset group for four years and disposes of
it. To test for impairment, CPAs would include the group’s salvage value at the end of year 4 in the cash
flow computations.

Future cash flows must be based on the asset group’s current service potential (four years for the three
assets above) at the date of the impairment test. Future cash flows should include expenditures to maintain
the current service potential, including replacing component parts of the long-lived asset and assets other
than the primary one. CPAs should exclude cash flows that increase service potential but include
maintenance costs.

ESTIMATING FAIR VALUE