SFAS. No. 144
SFAS No. 144
Accounting for Asset Impairment
Guidance on the accounting for asset impairment, using U.S. GAAP, is provided in FASB Statement No.
144, issued in 2001, which addresses the following four questions 8:
1. When should an asset be reviewed for possible impairment?
2. When is an asset impaired?
3. How should an impairment loss be measured?
4. What information should be disclosed about an impairment?
1. When should an asset be reviewed for possible impairment? Conducting an impairment review of every
asset at the end of every year would be unlikely to provide sufficiently improved financial information to
justify the cost of the reviews. Instead, companies are required to conduct impairment tests whenever there
has been a material change in the way an asset is used or in the business environment. In addition, if
management obtains information suggesting that the market value of an asset has declined, an impairment
review should be conducted.
2. When is an asset impaired? According to the FASB, an entity should recognize an impairment loss only
when the undiscounted sum of estimated future cash flows from an asset is less than the book value of the
asset. Any recorded goodwill associated with the acquisition of an asset should be added to the book value
of the asset in determining whether impairment exists. As illustrated in the following example, this is rather
a strange impairment threshold—a more intuitive test would be to compare the book value to the fair value
of the asset. Because the undiscounted cash flows do not incorporate the time value of money, the sum of
undiscounted future cash flows will always be greater than the fair value of the asset.
3. How should an impairment loss be measured? The impairment loss is the difference between the book
value of the asset and the fair value. The fair value can be approximated using the present value of
estimated future cash flows from the asset. Any impairment loss amount should first be used to reduce the
recorded value of goodwill associated with an asset purchase.
Caution! The existence of an impairment loss is determined using undiscounted future cash flows.
The amount of the impairment loss is measured using fair value, or discounted, future cash flows.
4. What information should be disclosed about an impairment? Disclosure should include a description of
the impaired asset, reasons for the impairment, a description of the measurement assumptions, and the
business segment or segments affected. An impairment loss should be included as part of income from
continuing operations, and note disclosure of the amount should be made if the impairment loss is not
shown as a separate income statement item.
Application of the impairment rules is illustrated with the following example. Guangzhou Company
purchased a building five years ago for $600,000. The building has been depreciated using the straight-line
method with a 20-year useful life and no residual value. Several other buildings in the immediate area have
recently been abandoned, and Guangzhou has decided that the building should be evaluated for possible
impairment. Guangzhou estimates that the building has a remaining useful life of 15 years, that net cash
inflow from the building will be $25,000 per year, and that the fair value of the building is $230,000.
Annual depreciation for the building has been $30,000 ($600,000 ÷ 20 years). The current book value
of the building is computed as follows:
Original cost ............................................................................................................................... $600,000
Accumulated depreciation ($30,000 × 5 years).............................................................................. 150,000
Book value ................................................................................................................................. $450,000
The book value of $450,000 is compared to the $375,000 ($25,000 × 15 years) undiscounted sum of future
cash flows to determine whether the building is impaired. The sum of future cash flows is less, so an
impairment loss should be recognized. The loss is equal to the $220,000 ($450,000 – $230,000) difference
1
SFAS. No. 144
between the book value of the building and its fair value. The impairment loss would be recorded as
follows:
Accumulated Depreciation—Building ................................................................................
Loss on Impairment of Building .........................................................................................
Building ($600,000 – $230,000) ..............................................................................
150,000
220,000
370,000
The new recorded value of $230,000 ($600,000 – $370,000) is considered to be the cost of the asset.
After an impairment loss is recognized, no restoration of the loss is allowed even if the fair value of the
asset recovers.
The odd nature of the undiscounted cash flow threshold can be seen if the facts in the Guangzhou
example are changed slightly. Assume that net cash inflow from the building will be $35,000 per year, and
that the fair value of the building is $330,000. With these numbers, no impairment loss is recognized, even
though the fair value of $330,000 is less than the book value of $450,000, because the undiscounted sum of
future cash flows of $525,000 ($35,000 × 15 years) exceeds the book value.
In many cases, it is more appropriate to estimate a range of possible
future cash flows rather than to make a specific point estimate. In the
example above, assume that instead of estimating future cash flows of
$25,000 per year, it is estimated that the following two cash flow
scenarios are possible, with the indicated probabilities:
Future Cash Inflows
Probability
Scenario 1
$20,000 per year for 15 years
85%
Scenario 2
$50,000 per year for 15 years
15%
In applying the impairment test, the weighted-average undiscounted cash flows are computed as follows:
Probability-Weighted
Undiscounted Future Cash Inflows
Probability
Future Cash Flows
Scenario 1
$20,000 × 15 years = $300,000
85%
$255,000
Scenario 2
$50,000 × 15 years = $750,000
15%
112,500
Total
$367,500
The $367,500 probability-weighted sum of undiscounted future cash flows is compared to the $450,000
book value of the building, indicating that the asset is impaired ($367,500 < $450,000). Assume that in this
case there is no observable market value of the building and that the market value must be estimated using
present value techniques. If the risk-free interest rate is 6.0%, the expected present value is computed as
follows:
Present Value
Future Cash Inflows
Probability-Weighted
(6.0% discount rate)
Probability
Present Value
Scenario 1
$20,000 × 15 years
$194,245
85%
$165,108
Scenario 2
$50,000 × 15 years
485,612
15%
72,842
Estimated fair value
$237,950
The impairment loss would be recorded as follows:
2
SFAS. No. 144
Accumulated Depreciation—Building ................................................................................
Loss on Impairment of Building ($450,000 - $237,950) ......................................................................
Building ($600,000 – $237,950) ..............................................................................
150,000
212,050
362,050
Classifying an Asset as Held for Sale
Often a plan is made to dispose of an asset before the actual sale takes place. Special accounting is required
if the following conditions are satisfied:
 Management commits to a plan to sell a long-term operating asset.
 The asset is available for immediate sale.
 An active effort to locate a buyer is underway.
 It is probable that the sale will be completed within one year.
If these criteria are satisfied, two uncommon accounting actions are required. During the interval between
being classified as held for sale and actually being sold:
1. no depreciation is to be recognized, and
2. the asset is to be reported at the lower of its book value or its fair value (less the estimated cost to sell).
[Footnote: Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or
Disposal of Long-Lived Assets,” Norwalk, CT: Financial Accounting Standards Board, August 2001,
par. 34.]
To illustrate the accounting for a long-term asset that is classified as held for sale, assume that as of July 1,
2005, Haan Company has a building with a cost of $100,000 and accumulated depreciation of $35,000.
Haan commits to a plan to sell the building by March 1, 2006. On July 1, 2005, the building has an
estimated fair value of $40,000, and it is estimated that selling costs associated with the disposal of the
building will be $3,000. On July 1, 2005, Haan must make the following journal entry:
Building -- Held for Sale
Loss on Held-for-Sale Classification
Accumulated Depreciation -- Building
Building
37,000
28,000
35,000
100,000
After this journal entry is made, the building is recorded at its net realizable value of $37,000 ($40,000
selling price - $3,000 selling costs). If the net realizable value had been greater than the book value of
$65,000 ($100,000 - $35,000), no journal entry would have been made. This measurement approach is
exactly the same as that used to record inventory at the lower of cost or market, as illustrated in Chapter 9.
=================
Caution: Recognition of this loss did NOT involve use of the two-step impairment test explained earlier.
Instead, the net selling price of the asset held for sale is compared directly to the book value; no
comparison is made to the sum of future undiscounted cash flows.
==================
On December 31, 2005, no adjusting entry is made for depreciation of the building. As mentioned above,
no depreciation expense is recognized on a long-term asset classified as held for sale. The rationale behind
this approach is that because the asset is now designated for disposal, the key accounting point is no longer
long-term cost allocation using depreciation but is instead proper current valuation of the asset.
Accordingly, in the Haan Company example, the $37,000 carrying value of the building on December 31,
2005 would be compared to a revised estimate of the selling price (less selling cost) on that date. If this
revised estimate is even lower than $37,000, an additional loss would be recognized. If the estimated net
selling price had increased since the initial loss was recognized, a gain would be recognized to the extent of
the $28,000 loss initially recognized. For example, if the estimated selling price as of December 31, 2005
was $58,000 (with $3,000 estimated selling costs), the following journal entry would be necessary:
3
SFAS. No. 144
Building Held-for-Sale
Gain on Recovery of Value – Held for Sale
18,000
18,000
Computation of gain: ($58,000 - $3,000) - $37,000 = $18,000
A gain is recognized only to the extent that it offsets a previously-recognized loss. For example, if the net
selling price of the building on December 31, 2005 was estimated to be $80,000, a gain of only $28,000
would be recognized, instead of the entire indicated gain of $43,000 ($80,000 - $37,000).
=================
Caution: This partial recovery of the loss recognized on the held-for-sale classification is NOT the usual
practice with impairment losses. For regular long-term assets (not being held for sale), no recovery of
impairment losses is allowed.
==================
Reporting Discontinued Operations
A common below-the-line item involves the disposition of a separately identifiable component of a
business either through sale or abandonment. The component of the company disposed of may be a major
line of business, a major class of customer, a subsidiary company, or even just a single store with separately
identifiable operations and cash flows. The size of the discontinued activity is not the factor that determines
whether it is reported as a discontinued operation. Instead, to qualify as discontinued operations for
reporting purposes, the operations and cash flows of the component must be clearly distinguishable from
other operations and cash flows of the company, both physically and operationally, as well as for financial
reporting purposes. For example, closing down one of five product lines in a plant in which the operations
and cash flows from all of the product lines are intertwined would not be an example of a discontinued
operation. Similarly, shifting production or marketing functions from one location to another would not be
classified as a discontinued operation.
There are many reasons why management may decide to dispose of a component of a business. For
example:
•
•
•
•
The component may be unprofitable.
The component may not fit into the long-range plans for the company.
Management may need funds to reduce long-term debt or to expand into other areas.
Management may be fearful of a corporate takeover by new investors desiring to gain control of
the company.
Regardless of the reason for a company’s selling a business component, the discontinuance of a
substantial portion of company operations is a significant event. Therefore, information about discontinued
operations should be presented explicitly to readers of financial statements.
4
SFAS. No. 144
Reporting requirements for discontinued operations. When a company discontinues operating a
component of its business, future comparability requires that all elements that relate to the discontinued
operation be identified and separated from continuing operations. Thus, in the Techtronics Corporation
income statement illustrated earlier in this chapter, the first category after income from continuing
operations is discontinued operations. The category is further separated into two subdivisions: (1) the
current-year income or loss from operating the discontinued component, in this case a $35,000 loss, plus
any gain or loss on the disposal of the component, in this case a $16,000 loss, and (2) disclosure of the
overall income tax impact of the income or loss associated with the component, in this case a tax benefit of
$15,300. As previously indicated, the below-the-line items are all reported net of their respective tax
effects. If the item is a gain, it is reduced by the tax on the gain. If the item is a loss, it is deductible against
other income and thus its existence saves income taxes. The overall company loss can thus be reduced by
the tax savings arising from being able to deduct the loss from otherwise taxable income.
Frequently the disposal of a business component is initiated during the
year but not completed by the end of the fiscal year. To be classified as a
discontinued operation for reporting purposes, the ultimate disposal must
be expected within one year of the period for which results are being
reported. Accordingly, if a company made a decision in 2005 to dispose
of a business component in April 2006, then in the 2005 income
statement the results of the operations of that business component should
be reported as discontinued operations.
To illustrate the reporting for discontinued operations, consider the following example. Thom
Beard Company has two divisions, A and B. The operations and cash flows of these two divisions are
clearly distinguishable from one another, so they both qualify as business components. On June 20, 2005, it
is decided to dispose of the assets and liabilities of Division B; it is probable that the disposal will be
completed early next year. The revenues and expenses of Thom Beard for 2005 and for the preceding two
years are as follows:
Sales – A
Total Non-Tax Expenses – A
Sales – B
Total Non-Tax Expenses – B
2005
$10,000
8,800
7,000
7,900
2004
$9,200
8,100
8,100
7,500
2003
$8,500
7,500
9,000
7,700
During the later part of 2005, Thom Beard disposed of a portion of Division B, and recognized a pre-tax
loss of $4,000 on the disposal. The income tax rate for Thom Beard Company is 40 percent. The 2005
comparative income statement would appear as follows:
2005
2004
2003
Sales
$10,000
$9,200
$8,500
Expenses
8,800
8,100
7,500
Income before Income Taxes
$1,200
$1,100
$1,000
Income Tax Expense (40%)
480
440
400
Income from Continuing Operations
$ 720
$ 660
$ 600
Discontinued Operations:
Income (loss) from operations
(including loss on disposal
in 2005 of $4,000)
(4,900)
600
1,300
Income tax expense (benefit) – 40%
(1,960)
240
520
Income (loss) on discontinued operations
(2,940)
360
780
Net Income
($2,220)
$1,020
$1,380
Notice that this method of reporting allows users to distinguish between the part of Thom Beard’s business
that will continue to generate income in the future and the part that will not. This reporting format makes it
5
SFAS. No. 144
much easier for financial statement users to attempt to forecast how Thom Beard will perform in
subsequent years.
The reporting requirements for discontinued operations are contained in FASB Statement No. 144,
“Accounting for the Impairment or Disposal of Long-Lived Assets.”13 On the balance sheet, assets and liabilities
associated with discontinued components that have not yet been completely disposed of as of the balance
sheet date are to be listed separately in the asset and liability sections of the balance sheet. Also, in addition
to the summary income or loss number reported in the income statement, the total revenue associated with
the discontinued operation should be disclosed in the financial statement notes. The objective of these
disclosures is to report information that will assist external users in assessing future cash flows by clearly
distinguishing normal recurring earnings patterns from those activities that are not expected to continue in
the future and yet are significant in assessing the total results of company operations for the current and
prior years.
6