10.2 Impairment and Disposal of PP&E
Key Takeaways
- Impairment of PP&E held and used is evaluated using a two-step test under ASC 360 when triggering events indicate carrying value may not be recoverable.
- Step 1 (Recoverability Test): An asset is impaired if its carrying value exceeds the sum of its undiscounted future cash flows.
- Step 2 (Measurement): If impaired, the impairment loss equals the excess of carrying value over fair value. Once written down, restoration of previously recognized impairment losses is prohibited for assets held and used.
- Assets classified as held for sale are measured at the lower of carrying value or fair value less cost to sell, and depreciation ceases immediately.
10.2 Impairment and Disposal of PP&E
Long-lived tangible assets, such as Property, Plant, and Equipment, are subject to impairment under US GAAP when circumstances indicate that their carrying value may not be recoverable. ASC 360-10 governs the accounting for the impairment and disposal of long-lived assets. It divides assets into two categories: those to be held and used, and those to be disposed of (such as held for sale).
Testing for Impairment of Assets Held and Used
Unlike goodwill or indefinite-lived intangible assets, PP&E is not tested for impairment annually. Instead, long-lived assets are tested for impairment only when a "triggering event" occurs. A triggering event is an indicator that suggests the carrying amount of the asset (or asset group) may not be recoverable. Examples of triggering events include:
- A significant decrease in the market price of the long-term asset.
- A significant adverse change in the physical condition of the asset or the extent or manner in which it is being used.
- A significant adverse change in legal factors or in the business climate that could affect the asset's value.
- An accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of the asset.
- A current-period operating or cash flow loss combined with a history of operating or cash flow losses associated with the asset.
- A current expectation that it is more likely than not that the asset will be sold or otherwise disposed of significantly before the end of its previously estimated useful life.
When a triggering event occurs, the company must perform a two-step impairment test:
Step 1: The Recoverability Test
The recoverability test determines whether an impairment has actually occurred. The company compares the carrying value (net book value) of the asset to the sum of the expected future undiscounted cash flows directly resulting from the use and eventual disposal of the asset.
- Not Impaired: If the sum of undiscounted cash flows is greater than or equal to the carrying value, the asset is considered recoverable. No impairment loss is recognized, though a review of depreciation estimates (useful life or salvage value) may be warranted.
- Impaired: If the sum of undiscounted cash flows is less than the carrying value, the carrying amount is not recoverable. The asset is impaired, and the company must proceed to Step 2.
Note: Undiscounted cash flows are used in Step 1 to provide a high threshold for recognizing impairment, ensuring that temporary market fluctuations do not trigger frequent accounting write-downs.
Step 2: Measurement of the Impairment Loss
Once an asset is determined to be impaired in Step 1, the impairment loss must be measured. The impairment loss is the amount by which the carrying value of the asset exceeds its fair value: Fair value is determined under ASC 820 using observable market prices. If a market price is unavailable, present value techniques (discounting future cash flows at an appropriate discount rate) are used.
Example: A company owns equipment with a carrying value of $500,000. Due to technological obsolescence, a triggering event is identified. Undiscounted future cash flows are estimated at $450,000. The equipment's fair value is estimated at $380,000.
- Step 1: $500,000 \text{ (Carrying Value)} > $450,000 \text{ (Undiscounted Cash Flows)}$. The asset is impaired.
- Step 2: $\text{Impairment Loss} = $500,000 \text{ (Carrying Value)} - $380,000 \text{ (Fair Value)} = $120,000$. The journal entry to record this loss is:
Debit: Impairment Loss 120,000
Credit: Accumulated Depreciation 120,000
Subsequent Accounting After Impairment
After an impairment loss is recognized, the reduced carrying value becomes the new cost basis for the asset. The company must depreciate this new cost basis over the asset's remaining useful life.
Prohibition on Reversals: Under US GAAP, restoring previously recognized impairment losses for assets classified as "held and used" is strictly prohibited. Even if the fair value of the asset recovers significantly in subsequent periods, the asset cannot be written back up.
Assets Classified as Held for Sale
When management commits to a plan to dispose of an asset (or asset group) by sale, it must be reclassified as "held for sale" if it meets six specific criteria under ASC 360:
- Management commits to a plan to sell the asset.
- The asset is available for immediate sale in its present condition.
- An active program to locate a buyer has been initiated.
- The sale is probable and expected to be completed within one year.
- The asset is actively marketed for sale at a price that is reasonable in relation to its current fair value.
- Actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn.
Upon classification as held for sale, the following accounting rules apply:
- Depreciation Ceases: Depreciation is no longer recorded.
- Measurement: The asset is measured at the lower of carrying value or fair value less cost to sell.
- Impairment and Write-Ups: An impairment loss is recognized for any initial write-down. However, unlike held-and-used assets, subsequent increases in fair value less cost to sell can be recognized as gains (write-ups), but only up to the amount of cumulative impairment losses previously recognized (both while held for sale and prior write-downs).
| Metric | Assets Held and Used | Assets Held for Sale |
|---|---|---|
| Depreciation | Continues based on remaining useful life. | Ceases immediately upon reclassification. |
| Measurement Base | Historical cost less accumulated depreciation. | Lower of carrying value or fair value less cost to sell. |
| Impairment Test | Two-step test (Recoverability, then Fair Value). | Single-step comparison (Carrying Value vs. FV less cost to sell). |
| Impairment Reversal | Strictly prohibited. | Permitted, limited to cumulative losses previously recognized. |
| Balance Sheet Presentation | Presented within Property, Plant, and Equipment. | Presented separately as a current asset (if sale within one year). |
Disposal of PP&E
Long-lived assets are removed from the books when sold, abandoned, or involuntarily converted (due to fire, theft, or condemnation):
- Sale: The gain or loss is the difference between the sale proceeds and the carrying value of the asset.
- Gain: Proceeds > Carrying Value (Credit Gain on Sale)
- Loss: Proceeds < Carrying Value (Debit Loss on Sale)
- Abandonment: If an asset is retired without sale, it is written off. A loss is recognized equal to the carrying value.
- Involuntary Conversion: If an asset is lost due to a casualty or condemnation, a gain or loss is recognized for the difference between the insurance/compensation proceeds and the carrying value, even if the cash is immediately used to purchase a replacement asset.
A company owns a manufacturing plant with a carrying value of $1,200,000. Due to market shifts, the plant is tested for impairment. The undiscounted future cash flows expected from the plant's operations and disposal total $1,100,000. The plant's fair value is estimated to be $800,000. What is the impairment loss, if any, that the company should recognize under ASC 360?
A company recognized an impairment loss of $150,000 on equipment held and used in Year 1, reducing its carrying value to $450,000. In Year 2, the equipment's fair value recovered to $550,000. What amount of gain should be recognized to reverse the impairment under US GAAP?
On July 1, Year 3, a company sells equipment for $45,000. The equipment was originally purchased on January 1, Year 1, for $100,000. It had an estimated useful life of 5 years, zero salvage value, and was depreciated using the straight-line method. What is the gain or loss on the sale?
On November 1, Year 1, a company decides to sell a machine and classifies it as held for sale. The machine has a carrying value of $200,000. Its estimated fair value is $170,000, and estimated costs to sell are $10,000. What is the carrying value of the machine on the December 31, Year 1 balance sheet, and is depreciation recorded for November and December?