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5.2 Impairment of long-lived assets to be held and used

Publication date: 31 Oct 2022

us PP&E and other assets guide

Long-lived assets that are held and used are tested for impairment at the asset group level. The ASC Master Glossary defines an asset group.

Definition from ASC Master Glossary

Asset Group: An asset group is the unit of account for a long-lived asset or assets to be held and used, which represents the lowest level for which identifiable cash flows are largely independent of the cash flows of other groups of assets and liabilities.

The determination of the asset group is critical because cash flows from one asset group should not be used to offset shortfalls in another asset group when applying the recoverability test of ASC 360-10. PPE 5.2.1 includes further details regarding the determination of the asset group.

When an asset group includes assets that are not covered by ASC 360-10, the appropriate order of impairment testing must be followed as it could impact the accounting. Refer to PPE 5.2.2 for further discussion regarding the order of impairment testing.

Impairment testing is required when events occur that indicate an asset (asset group) may not be recoverable. Such events are commonly referred to as triggering events. PPE 5.2.3 includes considerations regarding when to test a long-lived asset (asset group) for impairment.

An asset (asset group) should be tested for recoverability by comparing the net carrying value of the asset (asset group) to the entity-specific, undiscounted net cash flows to be generated from the use and eventual disposition of that asset (asset group). PPE 5.2.4 includes details regarding the recoverability test for long-lived assets that are held and used.

If the carrying amount of an asset (asset group) is not recoverable, an impairment loss is recognized if the carrying amount of the asset (asset group) exceeds its fair value. See PPE 5.2.5 for further details on measuring and recognizing an impairment loss for long-lived assets that are held and used.

Figure PPE 5-2 illustrates the model for assessing impairment of long-lived assets that are held and used.

Figure PPE 5-2
Model for assessing impairment of long-lived assets that are held and used

5.2.1 Determining the asset group for long-lived assets

Some long-lived assets may have largely independent cash flows and, as a result, should be tested for impairment individually. However, most long-lived assets are used in conjunction with other assets and do not generate cash flows that are largely independent of the other assets in the group. In these situations, the asset group should be considered the unit of account for impairment testing. Additionally, many asset groups include not only long-lived assets, but also other assets outside of the scope of ASC 360-10 (e.g., inventories, indefinite-lived intangible assets, goodwill). See PPE 5.2.2 for information on the order of impairment testing for asset groups including assets outside the scope of ASC 360-10.

The determination of a reporting entity’s asset groups involves judgment and all relevant facts and circumstances should be considered. In making this determination, a number of entity-specific operating characteristics should be assessed, including the interdependency of revenues between assets, shared cost structures, the interchangeability of assets used in operations, and how assets are managed and utilized by the business.

Interdependency of revenue producing activities refers to the extent to which the revenues of a group of assets are dependent on or intermingled with the revenue producing activities of another group of assets. If relationships among revenue producing activities hinder a reporting entity’s ability to suspend the revenue producing activities of one group of assets because it would cause a significant adverse impact on the revenues generated by another group of assets, a higher level grouping that combines these interdependent revenue producing activities into one asset group may be necessary. Interdependent revenues may sometimes result from a reporting entity’s operating structure, contractual requirements, or other factors.

The concept of interdependent revenues when determining asset groups is illustrated in Example PPE 5-1.

EXAMPLE PPE 5-1
Interdependent revenues when determining asset groups

Bus Corp operates a bus transportation business that provides service under a single contract with a municipality that requires minimum service on each of five separate routes. Assets devoted to serving each route and the cash flows from each route are discretely identifiable and measurable. One of the routes operates at a significant operating deficit that results in the inability to recover the carrying amount of the route’s dedicated assets.

What is the appropriate level at which to group assets to test for impairment?

Analysis

The revenues of the other four routes depend upon continuing to operate the unprofitable route (i.e., the contract would not permit Bus Corp to curtail any one of the bus routes); therefore, the five bus routes would be the appropriate level at which to group assets to test for and measure impairment.

The existence of a shared cost structure may also be a factor when determining the appropriate level at which to group assets for impairment testing. Shared costs are costs incurred by the entity that relate to more than one group of assets and for which costs cannot be discretely identified for allocation to an applicable lower level asset group. If cash flows from a group of assets result from significant shared operations (e.g., shared sales force or manufacturing functions), it may be necessary to group assets at a higher level. However, the existence of shared service activities, such as back-office support activities (e.g., a shared payroll function) would not necessarily support grouping assets at a higher level. This is because in many instances, routine shared services can objectively be allocated to a lower level or may not be considered significant to the cash flows of the asset group.

Further, allocated direct costs would not typically be considered shared costs when assessing whether a reporting entity should group assets at a higher level. For example, assume a reporting entity is assessed an aggregate annual fee by the Environmental Protection Agency (EPA) for its carbon emissions from operation of three production facilities (at a fixed rate per metric ton of carbon dioxide). The amount of the EPA fee, which can be allocated based on the carbon dioxide emitted by each of the entity’s facilities, would be considered an allocated direct cost rather than a shared cost even though the annual EPA assessment is a single amount.

ASC 360-10 does not specifically address how to measure cash flows resulting from intercompany purchase and sale transactions. Generally, cash flows from intercompany sales are determined based on normal purchase prices paid to and sale prices received from third parties. However, when purchases and sales among vertically integrated operations are significant, the appropriate level of independent, identifiable cash flows may become more difficult to identify. In such cases, it may be appropriate to consider whether the asset group should be identified at a higher level.

5.2.1.1 Entity-wide asset groups for long-lived assets

A reporting entity may have long-lived assets that are shared among several asset groups, such as a corporate headquarters facility, a shared distribution center, or a shared research facility. Such assets are commonly referred to as entity-wide or enterprise assets. When an enterprise asset does not have its own separately identifiable cashflows, the carrying amount of the asset should not be allocated to lower-level asset groups for impairment testing under ASC 360-10. Instead, the recoverability of the enterprise asset should generally be evaluated for impairment on an entity-wide basis and, as a result, the recoverability of the enterprise asset depends on the net cash flows of the lower level asset groups. Enterprise assets should be tested for recoverability after testing for any lower level asset groups is performed, as necessary. Management could utilize multiple approaches to perform the impairment test for enterprise assets.

One approach, commonly referred to as the residual approach, would be to first test the lower level asset groups across the enterprise for recoverability based on undiscounted cash flows, imputing an appropriate charge, if any, for the use of the shared assets. Next, the excess undiscounted cash flows from the recoverability tests of the lower level asset groups would be accumulated. Cash flows attributable to the enterprise assets would equal the aggregated excess undiscounted cash flows of the lower level asset groups, after adding back any imputed charge to the lower level asset groups for the use of the enterprise assets, and reducing the cash flows for any expenses directly attributable to the enterprise assets. If the carrying amount of the enterprise assets (asset group) exceeds the aggregated excess undiscounted cash flows available from the lower-level asset groups and the cash flows for any expenses directly attributable to the enterprise assets, an impairment loss should be recognized. See PPE 5.2.4 and PPE 5.2.5 for information on testing a long-lived asset for recoverability and measuring a long-lived asset impairment loss, respectively.

Example PPE 5-2 illustrates the asset group determination for an enterprise asset.

EXAMPLE PPE 5-2
Asset group determination for enterprise assets

Retail Corp operates retail clothing stores in malls and shopping centers throughout the continental United States. Retail Corp considers each individual retail store to be its own asset group, as this is the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Retail Corp also operates a large flagship store located in a prominent tourist destination in a major metropolitan city. The flagship store is twice as large as Retail Corp’s typical retail stores, its décor includes high-end furnishings, and it carries limited inventories.

Should Retail Corp’s flagship store be assessed for impairment as an enterprise asset?

Analysis

Retail Corp may conclude that the flagship store is an enterprise asset for the purpose of performing long-lived asset impairment testing, particularly if management concludes that the flagship store serves primarily as a marketing vehicle to raise brand awareness for other retail stores. In evaluating whether the flagship store should be assessed for impairment as an enterprise asset, management may consider the location of the flagship store, the size of the flagship store in comparison to the company’s typical retail stores, whether management anticipated negative cash flows over the life of the store at the time it was opened, the nature of furnishings and décor in comparison to other retail stores, the level and nature of inventories carried at the flagship store, and other factors indicating the flagship store supports the revenue-generating activities of other, lower-level asset groups.

5.2.1.2 Changes to asset groups for long-lived assets

When a reporting entity experiences a significant change in its operations or in the way it utilizes long-lived assets that causes a change to the interdependency of cash flows (e.g., a significant acquisition or disposition), the reporting entity should consider whether a change to its asset groups is necessary. For example, when a lessee subleases all or a part of a right-of-use asset that was previously used in operations, a reassessment of the asset group to which the right-of-use asset is assigned may be necessary (see PPE 5.2.7).

Changes in asset groups that result from changes in facts and circumstances should be accounted for prospectively as a change in accounting estimate following the guidance of ASC 250-10. When a reporting entity determines facts and circumstances warrant a change in asset groups, the reporting entity should consider whether the change also represents an impairment indicator for the impacted asset group(s).

5.2.2 Order of impairment testing for long-lived assets held and used

Long-lived assets that are held and used should be reviewed for impairment following the guidance in ASC 360-10-35. Under this guidance, the carrying amounts of any assets that are not within the scope of ASC 360-10, other than goodwill, should be adjusted for impairment (as necessary) prior to testing long-lived assets for impairment. The order of performing impairment testing is important as this may impact the amount of impairment recognized as a result of the next sequential impairment test.

Impairment testing should be performed in the following order:

Test other assets (e.g., accounts receivable, inventory) under applicable guidance and indefinite-lived intangible assets (other than goodwill) under ASC 350
Test long-lived assets (asset group) under ASC 360-10
Test goodwill of a reporting unit that includes the aforementioned assets under ASC 350. Goodwill should only be included in an asset group if the asset group is or includes a reporting unit. If an asset group includes only a portion of a reporting unit, the carrying amount of goodwill should not be included in the asset group. For details regarding the identification of reporting units see BCG 9.2.

The carrying values are adjusted, if necessary, for the result of each impairment test prior to performing the next test. This order differs from the held for sale impairment model discussed in PPE 5.3.2, which requires that goodwill and other assets that are not in the scope of ASC 360-10 be tested for impairment prior to measuring the fair value less cost to sell of the disposal group.

5.2.3 When to test long-lived assets for impairment

Unlike indefinite-lived intangible assets and goodwill, which are required to be tested for impairment at least annually, ASC 360-10 does not require annual impairment testing for long-lived assets that are held and used. Instead, a long-lived asset (asset group) that is held and used should be tested for recoverability whenever events or changes in circumstances indicate that the carrying amount of the asset group may not be recoverable regardless of whether such carrying amount is zero or negative.

As detailed in ASC 360-10-35-21, the following are examples of such events or changes in circumstances that may require impairment testing (commonly referred to as impairment indicators or triggering events):

Excerpt from ASC 360-10-35-21

A significant decrease in the market price of a long-lived asset (asset group)
A significant adverse change in the extent or manner in which a long-lived asset (asset group) is being used or in its physical condition
A significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset (asset group), including an adverse action or assessment by a regulator
An accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of a long-lived asset (asset group)
A current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of a long-lived asset (asset group)
A current expectation that, more likely than not, a long-lived asset (asset group) will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. The term more likely than not refers to a level of likelihood that is more than 50 percent.

The above impairment indicators are examples and should not be considered the only potential indicators that an asset (asset group) may not be recoverable. If a reporting entity identifies additional impairment indicators for its specific operations, those indicators should also be considered (e.g., decline in stock price or goodwill impairment). The existence of an individual indicator outlined above is not automatically conclusive that the asset (asset group) may not be recoverable. Instead, reporting entities will need to exercise judgment and consider the combined effect of all indicators and developments, both positive and negative, when determining whether an asset (asset group) may not be recoverable.

If a reporting entity believes the carrying amount of an asset (asset group) may not be recoverable, it should determine whether the asset (asset group) is impaired in accordance with ASC 360-10.

5.2.3.1 Impairment indicators for individual assets in an asset group

A reporting entity may identify an impairment indicator for an individual asset within a broader asset group. For example, a reporting entity may become aware that lease payments for a piece of equipment under a long-term operating lease used in a larger manufacturing facility are “above market,” indicating that the fair value of the related right-of-use asset may be below its carrying amount.

When a reporting entity identifies an impairment indicator for an individual asset included in a broader asset group, the reporting entity should consider the significance of the asset in relation to the overall asset group and the facts and circumstances surrounding the impairment indicator. If the reporting entity concludes that the individual asset is insignificant to the broader asset group, it may conclude that an impairment indicator does not exist for the asset group, and thus no impairment testing would be necessary. Alternatively, if the reporting entity concludes that the individual asset is significant in relation to the larger asset group, or the impairment indicators impacting the individual asset more broadly impact the overall asset group, impairment testing at the asset group level may be required.

5.2.4 Determining whether long-lived assets are recoverable

The first step in the impairment test is to determine whether the long-lived assets are recoverable, determined by comparing the net carrying value of the asset group to the entity-specific, undiscounted net cash flows to be generated from the use and eventual disposition of that asset group. This is commonly referred to as the recoverability test.

If the assets are recoverable (i.e., the undiscounted net cash flows exceed the net carrying value of the asset group), an impairment should not be recognized, even when the net carrying value of the long-lived assets exceeds their fair value. If the assets are not recoverable (i.e., the net carrying value of the asset group exceeds the undiscounted net cash flows), an impairment loss should be recognized based on the amount by which the carrying value of the asset group exceeds its fair value. See PPE 5.2.5 for details on recognition and measurement of an impairment loss.

Even when an asset is determined to be recoverable, changes in the estimate of the asset’s useful life should be considered in light of the change in circumstances that led to the recoverability assessment. Consistent with ASC 360-10-35-22, it may be necessary to review depreciation and amortization estimates and to adjust the useful life of an asset, or of multiple assets within an asset group. See PPE 4.2.3 for further details on accounting for changes in useful lives of long-lived assets.

Example PPE 5-3 illustrates when depreciation estimates should be updated in conjunction with impairment testing.

EXAMPLE PPE 5-3
Revising depreciation estimates with impairment testing

Chemical Co operates two chemical refineries that produce the same product, which is sold to the same group of customers. Both chemical refineries also share the same group of suppliers. One plant is on the east coast and the second plant is on the west coast. Management has determined that the two chemical refineries represent one asset group. During the fourth quarter, Chemical Co ceased production at the east coast plant due to adverse economic conditions and management determined it will recommend to the board of directors a permanent closure of the plant, which is required to be approved by the board of directors. Management expects the board of directors will approve the permanent closure of the plant.

The board of directors met after year-end and approved the permanent closure of the east coast plant effective immediately.

How should Chemical Co management test the asset group for recoverability in the fourth quarter?

Analysis

In conjunction with the decision to cease production in the fourth quarter, Chemical Co management should test the chemical refineries asset group for recoverability in accordance with ASC 360-10-35-21. If it is determined that the asset group, consisting of both refineries, passes the recoverability test due to the significant continuing undiscounted cash flows at the west coast plant, Chemical Co would not record an impairment.

However, Chemical Co should adjust the useful life of the east coast plant beginning when management determines the useful life is shortened which, depending on the facts and circumstances, will likely be before the board of directors’ approval. Consideration of whether acceleration of depreciation is warranted at the time the asset group is tested for impairment is consistent with ASC 360-10-35-22 because management has determined the useful life of the east coast plant has been shortened significantly. Revising the depreciation in the current period is consistent with ASC 270-10-45-14, which indicates that accounting for a change in estimate should commence in the period in which the change in estimate is made. Chemical Co should also consider whether the useful life of the west coast plant remains appropriate given the adverse economic conditions leading to the change in useful life of the east coast plant.

5.2.4.1 Estimates of future cash flows used in the recoverability test

Cash flows used in the recoverability test may differ from the cash flows used in measuring the fair value of the asset group. The recoverability test is based on the entity-specific, undiscounted cash flows expected to result from the entity’s use and eventual disposition of the asset group, rather than on market-participant assumptions that would be used in measuring the asset group’s fair value. Cash flow estimates should reflect conditions and assumptions that existed as of the measurement date (i.e., as of the triggering event date) and should not reflect subsequent events.

Estimating cash flows for purposes of the recoverability test is subjective and requires judgment. As described in ASC 360-10-35-30, estimates of future cash flows should be reasonable in relation to the assumptions used to develop other information the entity uses for comparable periods, such as internal budgets and projections, accruals related to incentive compensation plans, or information communicated to others. Additionally, key assumptions, such as price and volume levels, should consider expected changes in market conditions. Projections of expected future cash flows should include:

All cash inflows expected from the use of the long-lived asset (asset group) over its remaining useful life, based on its existing service potential (i.e., taking into account the asset’s cash-flow-generating capacity and physical output capacity, but excluding future capital improvements and other expenditures that would increase the service potential of the asset).
Any cash outflows necessary to obtain the projected cash inflows, including future expenditures to maintain the asset (asset group). The cash outflows should include costs directly attributable to the asset group based on the nature of the expense rather than who incurs it (e.g., expenses directly attributable to the asset group incurred at the corporate level may need to be allocated when testing for recoverability).
Cash flows associated with the eventual disposition, including selling costs, of the long-lived assets that would typically represent the salvage or residual value of those assets. The proceeds from eventual disposition may include the terminal value of the assembled group of assets that constitute a business. However, such terminal value may be less than the terminal value determined for business valuation purposes because it would reflect only the value after maintaining the existing service potential of the business during the period the asset group is used, as required by ASC 360-10.

ASC 360-10 requires that only the existing service potential of an asset group on the test date be considered when testing an asset group for recoverability. An increase in utilization that does not require an increase in existing service potential of the asset group may be included in management’s estimate of undiscounted cash flows. For example, for an asset group in which the primary asset is a plant operating at 70% of capacity, it may be appropriate for management to assume that utilization of the plant will increase to 80% due to new orders, provided management can support its assertion of increased order volume. Conversely, if an increase in the utilization would require an increase in the existing service potential of the asset group (e.g., a major expansion of the plant would be required to meet this increased utilization), the inclusion of the incremental cash flows in management’s estimate of undiscounted cash flows would not be appropriate.

5.2.4.2 Cash flow estimation period used in the recoverability test

The period of time used to determine estimates of future cash flows for the recoverability test is based on the remaining useful life of the primary asset in the asset group. This should be the period over which the asset will be depreciated and is not the asset’s potentially longer remaining economic life.

Excerpt from ASC 360-10-35-31

[T]he primary asset is the principal long-lived tangible asset being depreciated or intangible asset being amortized that is the most significant component asset from which the asset group derives its cash-flow-generating capacity.

The primary asset cannot be land, an indefinite-lived asset, or an internally-generated intangible asset that has been expensed as incurred. The primary asset of an asset group is generally the asset that has the longest remaining useful life, would require the greatest level of investment to replace, and without which some or all of the other assets of the group might not have been acquired by the entity.

The ASC 360-10 recoverability test is intended to test the recoverability of the overall asset group, not just the primary asset. As such, there may be assets used with the primary asset that continue to have value at the end of the life of the primary asset. According to ASC 360-10-35-32(c), if an asset group’s primary asset is not the asset that has the longest remaining useful life, estimates of future cash flows for the asset group should be based on the assumption that the asset group will be sold at the end of the remaining useful life of the primary asset. This is referred to as the residual value of the asset group.

When calculating the residual value of the asset group at the end of the life of the primary asset (i.e., at the end of the undiscounted cash flow period), the recoverability test should consider how to maximize the value of the asset group. Cash flow estimates should be based on the existing service potential of the asset group, and therefore should include cash flows associated with future expenditures necessary to maintain that service potential, such as repairs and maintenance and replacements. Accordingly, budgets that contemplate major capital expansion during the life of the primary asset, rather than normal, ongoing maintenance and capital replacements, generally should not be used as the basis for cash flow estimates when testing recoverability.

The residual value of the asset group may be estimated using discounted cash flows to determine the value of the asset group at the end of the undiscounted cash flow period (i.e., at the end of the primary asset’s useful life). When the asset group constitutes a business, the residual value may need to be estimated using a pricing multiple or discounted cash flows. The estimate should consider that expansionary growth was excluded during the undiscounted cash flow period and should consider the costs necessary to replace the primary asset.

If the asset group is a reporting unit, the valuation under both ASC 350 and ASC 360 will include a residual value that represents the value of the business at the end of the discrete cash flow period. However, the residual value under ASC 360 and ASC 350 will differ. This is because the residual value calculation for the goodwill impairment test in ASC 350 uses market participant assumptions and reflects the value that the reporting unit is expected to generate at the end of the discrete projection period (assumed to be in perpetuity because business enterprises are generally assumed to have perpetual lives) and would include expansionary growth during the life of the primary asset when applicable to the business. However, the starting point for the projections used to calculate the residual value for the impairment test in ASC 360 should reflect only the value to be generated after maintaining the existing service potential of the business through the life of the primary asset. The calculation of the residual value in ASC 360 would still include expansionary growth and market participant assumptions; however, this would be from a different starting point than under ASC 350. Additionally, the discount rates and other assumptions used may differ under ASC 360 as the terminal value used in the goodwill impairment test under ASC 350 commences at the point in time when projections reflect the maturity of the business and future long-term growth levels have been reached whereas the residual value calculated in the ASC 360 impairment test is at the end of the remaining useful life of the primary asset.

5.2.4.3 Probability-weighted cash flow estimates in the recoverability test

If alternative courses of action to recover the carrying amount of a long-lived asset or asset group are under consideration, or a range is estimated for the amount of possible future cash flows, the likelihood of those possible outcomes should be considered. Therefore, the use of an expected cash flow approach may be appropriate, because it uses a set of cash flows that, in theory, represents the probability-weighted average of all possible cash flows. On the other hand, the use of a single set of cash flows that represents management’s best estimate of the most likely outcome within a range of possible estimated amounts may be appropriate. See ASC 820-10-55-5 through ASC 820-10-55-20 for additional guidance on these techniques.

Cash flows used in a recoverability test should be based on conditions that exist as of the testing date. If the asset is held and used but the entity is contemplating a sale, the cash flows should consider the various courses of action weighted for their respective probabilities. See PPE 5.3.1.1 for considerations for asset group sales occurring after the balance sheet date.

See Example PPE 5-4 for an illustration of the probability-weighted approach used when performing the recoverability test under ASC 360-10.

EXAMPLE PPE 5-4
Probability-weighted approach in the recoverability test (ASC 360-10)

Manufacturing Co owns a manufacturing facility that is included in an asset group that is tested for recoverability. At the balance sheet date, the asset group has a carrying amount of $60 million. Management is contemplating selling the asset group after either two or five years. Management has determined that the cash flows under both scenarios depend on the whether a key contract is renewed. Using the probability-weighted approach, the cash flows associated with each scenario are as follows.

	Operating cash flows (in millions)	Cash flows upon sale	Total cash flows	Probability assessment	Possible cash flows
Two years
No renewal	$21	$44	$65	40%	$26
Renewal	$26	$44	$70	60%	$42
					$68
Five years
No renewal	$63	$13	$76	50%	$38
Renewal	$71	$13	$84	50%	$42
Total					$80

Management determined there is a 25% probability that the asset group will be sold after two years and 75% probability it will be sold at the end of five years.

Does the asset group pass the recoverability test?

Analysis

Management would determine the expected undiscounted cash flows as follows.

	Possible cash flows (in millions)	Probability assessment	Probability-weighted cash flows
Two years	$68	25%	$17
Five years	$80	75%	$60
Total			$77

Since the undiscounted cash flows of $77 million exceed the carrying value of $60 million, the carrying amount of the asset group is recoverable, and an impairment would not be recognized.

5.2.4.4 Assets under development in the recoverability test

Long-lived assets that are under development will generally not generate cash inflows until the asset is substantially complete. As a result, cash flow estimates used to test the recoverability of an asset group that is under development should be based on the expected service potential of the asset group when development is substantially complete. Those estimates should include cash flows associated with all future expenditures necessary to complete the development of the asset, including interest payments that will be capitalized as part of the cost of the asset. This is different for estimates for cash flows associated with long-lived assets already completed and in-use, which would exclude interest payments (see PPE 5.2.4.5).

5.2.4.5 Debt and other obligations in the recoverability test

Principal and interest payments on debt obligations should generally be excluded from cash flows used in assessing the recoverability of an asset group because they do not represent the lowest level of identifiable cash flows. This is because debt obligations are typically funded at the corporate level and are not attributable to a specific asset group.

If debt obligations are directly related to the funding of specific assets within an asset group, or the asset group is a business or reporting unit, there may be instances when it is appropriate to include the cash flows associated with the debt obligations when assessing recoverability. When debt is included in the carrying amount of an asset group, only the cash outflows for principal payments should be included when assessing recoverability. Interest payments should be excluded because they relate to the capitalization of the entity, not its operations. The principle underlying this concept is that similar asset groups should not yield different results in the recoverability test because of different capital structures. As a result, the inclusion or exclusion of debt obligations in an asset group and the related cash flows should generally not result in a different conclusion when performing the recoverability test. See PPE 5.2.7.1 for information on the treatment of lease liabilities in the recoverability test.

5.2.4.6 Long-term operating obligations in the recoverability test

Payments associated with long-term operating obligations should be considered in the cash flow estimates of the asset group(s) that gave rise to the liabilities. When the cash flows to settle such obligations are equal to the recorded liability, there should be no impact to the recoverability test.

When the cash outflows exceed a recorded liability (e.g., due to the liability being recorded on a discounted basis), we believe that the excess portion of the cash outflows represents accretion and should be excluded from the cash outflows of the asset group when testing for recoverability. We believe the intent of ASC 360-10-35 is to maintain consistency when comparing the undiscounted cash flows to the carrying value of asset group being tested for recoverability. That is, if the liability is considered a part of the asset group, then the associated cash flows that were used to determine the recorded liability should be considered as cash outflows, excluding the portion representing accretion.

Pension obligations should generally be excluded from the carrying amount of an asset group as they represent nonoperating liabilities that are not specifically attributable to an asset group. However, if pension obligations are determined to be specifically attributable to an asset group being assessed for recoverability, only the service cost component of net periodic pension cost should be included as an operating cash flow in the recoverability test. Any other components of net periodic pension cost (e.g., interest cost) are considered nonoperating in nature and should therefore be excluded from cash flow estimates when performing the recoverability test, similar to other financing costs.

5.2.4.7 Contingent obligations in the recoverability test

In situations in which a loss contingency is not probable, and thus no liability is recorded under ASC 450-10, but the expected cash outflow related to the contingency is greater than zero (i.e., a loss is possible), the cash outflows of the asset group should include management’s best estimate of future cash flows related to the loss contingency.

5.2.4.8 Consideration of income tax effects in the recoverability test

ASC 360-10 is silent as to whether estimates of expected future net cash flows for the recoverability test should be estimated on a pre-tax or a post-tax basis. In practice, many reporting entities perform the recoverability test on a pre-tax basis. However, there may be unusual situations in which incremental tax effects directly attributable to a specific asset should be considered in assessing an asset’s recoverability. Examples might include low income housing tax credits or shale oil tax credits. Such tax attributes should only be included in the recoverability test if the tax effects are important to the asset’s economics. When assessing recoverability of an asset group using cash flows on a post-tax basis, any related deferred taxes should be included in the carrying amount of the asset group. This approach generally results in the same recoverability conclusion whether cash flows are considered on a pre-tax or post-tax basis.

5.2.4.9 Customer relationships in the recoverability test

New customer relationships that are expected to arise after the recoverability testing date should be evaluated to determine whether the related undiscounted cash flows should be included in the recoverability test. If anticipated new customer relationships can be supported based on the existing service potential of the asset group, the cash flows from the new customer relationships should be included when assessing recoverability. However, if the new customer relationships require an increase in the asset group’s service potential (e.g., capital expansion is required to acquire the new customer relationships), it would not be appropriate to include the cash flows from the new customer relationships when assessing recoverability.

When the primary asset is a group of customer relationships recognized as a single customer relationship intangible asset, the undiscounted cash flow period would be the remaining useful life of the recognized customer relationship asset. The reporting entity would consider the cash flows from customers existing as of the impairment test date, including both those that existed when the customer relationship intangible asset was originally acquired and new customers that exist as of the impairment testing date. Anticipated new customers would only include those expected to be obtained during the undiscounted cash flow period that are able to be supported by the existing service potential of the asset group in the undiscounted cash flow period. The undiscounted cash flows would also include any expected residual value of the customer relationship asset.

For example, if at the impairment test date the remaining estimated useful life of the recognized customer relationship is two years, then the undiscounted cash flow period would be two years, even if the reporting entity anticipates adding new customers after the testing date. A reporting entity would then need to determine the residual value for the asset group as a whole at the end of two years. The residual value of the asset group would include the cash flows associated with the eventual disposition of the entire asset group at the end of the undiscounted cash flow period. Residual value may incorporate value related to new customer relationships developed after the undiscounted cash flow period and other customer relationships developed after the impairment test date that could be supported by the asset group.

5.2.4.10 Leasehold improvements in the recoverability test

When the primary asset in an asset group is leasehold improvements, the undiscounted cash flow period would be the remaining useful life of the leasehold improvements, which would generally correspond with the remaining term of the lease. See PPE 5.2.7 through PPE 5.2.7.3 for long-lived asset impairment considerations relating to right-of-use assets.

5.2.4.11 Impact of bankruptcy filing on the recoverability test

Cash flow forecasts utilized in the impairment test by a reporting entity considering a bankruptcy filing may extend beyond the expected bankruptcy filing date (i.e., cash flows may include projecting the undiscounted cash flows beyond the expected emergence from bankruptcy, provided the entity has a scenario supporting the continued operation of the asset group beyond emergence). When forecasting future cash flows, consideration should be given to the factors that might lead to the bankruptcy filing, as well as the impact the filing could have on the reporting entity’s future operations.

For example, if the reporting entity is having difficulty financing its operations, and if customers will be unwilling to purchase from, or suppliers will be unwilling to sell to, a company in bankruptcy, these facts should be considered in the cash flow projections used to test the assets for impairment. It may also be appropriate for the reporting entity to consider multiple possible cash flow scenarios utilizing the probability-weighted approach as discussed in PPE 5.2.4.3. One of the potential scenarios would likely reflect the reporting entity’s sale of the asset group in the event that it does not receive the necessary financing to emerge from bankruptcy.

5.2.4.12 Impact of going concern considerations on the recoverability test

Management’s conclusion that there is substantial doubt about a reporting entity’s ability to continue as a going concern would not limit the cash flow projection period used in the impairment test to one year from the financial statement issuance date. Instead, cash flow forecasts may extend beyond one year to reflect the life of the primary asset, provided the reporting entity expects to operate though the primary asset’s useful life. Although there may be substantial doubt about the reporting entity’s ability to continue as a going concern, the financial statements have been presented assuming the reporting entity will continue as a going concern and do not reflect any adjustments that might result from the outcome of this uncertainty (i.e., they are not prepared on a liquidation or other basis of accounting). As a result, the cash flow projections may consider a period greater than one year. However, consideration should be given to the factors that gave rise to the going concern in preparing the cash flow projections. If the reporting entity has plans to change its strategic direction or focus as a result of its financial circumstances, the useful lives of the assets and the expected cash flows may need to be re-evaluated.

5.2.4.13 Environmental contingencies in the recoverability test

ASC 360-10-55-7 through ASC 360-10-55-18 includes guidance for the treatment of environmental costs in the recoverability test. As detailed in ASC 360-10-55-8 to ASC 360-10-55-10, environmental costs should be excluded from the recoverability test in the following situations:

Management intends to operate the asset for the asset’s remaining depreciable life, future cash flows exceed the asset’s carrying amount, and management does not expect the disposition to result in a cash outflow.
Management expects to operate the asset indefinitely, the asset is currently generating positive cash flows and profitability is expected to continue, and there are no known constraints on the asset’s economic life.
Management expects to close the asset permanently at the end of its useful life as the remediation costs exceed the potential proceeds to be received in a disposal and remediation costs are only incurred if the asset is sold or abandoned (cash flows related to idling the plant would need to be considered).
Management expects to sell the asset and the sale will not require remediation costs to be incurred.

ASC 360-10-55-13 to ASC 360-10-55-18 describes the following situations in which environmental costs should be included in the recoverability test:

Management expects to incur remediation costs, however, there are uncertainties related to the application of regulatory requirements. The amount included should consider the estimate, based on probability, of incurring costs.
The useful life is limited by actual or expected technological advances or contractual or regulatory provisions and management is required to dispose of the asset after the service potential has ended, which will cause environmental remediation costs to be incurred.
The asset has cash flow losses that are expected to continue and, although management expects the asset to be profitable in the future, management may not be able to fund the losses until it turns profitable and management would likely dispose of the asset in a forced liquidation, which will cause environmental remediation costs to be incurred.
Management intends to sell, abandon, or close an asset in the future, any of which will result in environmental costs being incurred.
Management expects to operate the asset over its useful life and expects to incur related asset retirement costs over the life of the asset.

5.2.4.14 Asset retirement obligations in the recoverability test

ASC 360-10-35-18 requires capitalized asset retirement costs (ARCs) to be included in the carrying amount of the asset group being tested for impairment. However, the estimated cash outflows related to the liability for an asset retirement obligation (ARO) that has been recognized in the financial statements should be excluded from the cash flows used in the recoverability test and the determination of the asset’s fair value.

We believe that the intent of this guidance is that the asset being tested for impairment would not be reduced by the recorded ARO (i.e., the carrying amount of the ARC would not be “netted down” by the related ARO). Because the cash outflows related to the recorded liability are excluded from the asset group’s undiscounted cash flows, the recorded liability should also be excluded from the asset group’s carrying amount. However, the same result is generally expected due to the consistent comparison of cash flows to the carrying amount of the asset group being tested. That is, if the ARO was included in the carrying value of the asset group, the associated cash flows used to determine the liability should be considered as cash outflows when assessing recoverability, excluding the portion representing accretion.

See Example PPE 5-5 for an illustration of the recoverability test for an asset group that includes an ARO.

EXAMPLE PPE 5-5
Consideration of AROs when assessing long-lived asset recoverability

PPE Corp has an asset group with a carrying value of $11 that consists primarily of long-lived assets. The carrying value of $11 includes asset retirement costs of $1 and excludes the ARO of $3. The cash outflows associated with the ARO are $3.50, which exceed the ARO liability recorded due to discounting. PPE Corp is performing a recoverability test and determines that the net cash inflows, excluding the costs of the ARO, are expected to be $12.50.

Is the asset group recoverable?

Analysis

Management may use two approaches to test the asset group for recoverability, either excluding or including the ARO from the recoverability test. If management excludes the ARO, it should be excluded from both the carrying amount and undiscounted cash flows of the asset group. In this approach, the carrying amount of the asset group would be $11, and the undiscounted cash inflows are $12.50 (an excess of $1.50).

Alternatively, management could include the ARO in both the carrying amount and undiscounted cash flows of the asset group. Under this approach, the ARO cash outflows, net of accretion, should be included in the cash outflows, resulting in net inflows of $9.50 ($12.50 - $3). The carrying value of the asset group should also be reduced by the ARO, resulting in net assets of $8 ($11 - $3). The result would be an excess of $1.50 (gross asset of $8 compared to cash flows of $9.50).

The inclusion or exclusion of the ARO will not impact the results of the recoverability test as long as the ARO is treated consistently when determining both the carrying amount of the asset group and the undiscounted net cash flows.

5.2.4.15 Consideration of AOCI in the recoverability test

ASC 360-10 and ASC 830-30-45-13 do not specifically address whether cumulative foreign currency translation adjustments (CTA) included in accumulated other comprehensive income (AOCI) should be included when measuring the carrying amount of an asset group that is held and used. In the absence of specific guidance, we believe that CTA and other amounts included in AOCI should be excluded when measuring the carrying amount of an asset group that is held and used. Such amounts should only be considered when measuring the carrying amount of a disposal group that meets the held for sale criteria (see PPE 5.3.3.4).

5.2.5 Measuring and allocating an impairment loss—held and used

If the asset (asset group) fails the recoverability test, an impairment loss is measured as the amount by which the carrying amount of the asset (asset group) exceeds its fair value. An impairment loss that results from applying ASC 360-10 should reduce only the carrying amounts of the long-lived assets in the asset group. The other assets in the asset group (other than goodwill) that are not in the scope of ASC 360-10 should be tested for impairment in accordance with other GAAP prior to performing the impairment test on the long-lived assets (see PPE 5.2.2).

ASC 360-10-35-23 provides guidance for the grouping of long-lived assets for purposes of recognition and measurement of an impairment loss, whereas ASC 360-10-35-28 provides guidance on the allocation of impairment losses to the long-lived assets of the group.

Grouping Long-Lived Assets Classified as Held and Used

ASC 360-10-35-23

For purposes of recognition and measurement of an impairment loss, a long-lived asset or assets shall be grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. However, an impairment loss, if any, that results from applying this Subtopic shall reduce only the carrying amount of a long-lived asset or assets of the group in accordance with paragraph 360-10-35-28.

Allocating Impairment Losses to an Asset Group

ASC 360-10-35-28

An impairment loss for an asset group shall reduce only the carrying amounts of a long-lived asset or assets of the group. The loss shall be allocated to the long-lived assets of the group on a pro rata basis using the relative carrying amounts of those assets, except that the loss allocated to an individual long-lived asset of the group shall not reduce the carrying amount of that asset below its fair value whenever that fair value is determinable without undue cost and effort. See Example 1 (paragraph 360-10-55-20) for an illustration of this guidance.

One acceptable interpretation of this guidance is that differences between the fair values and carrying values of assets and liabilities of the asset group, other than long-lived assets to be held and used, should impact the impairment loss for those long-lived assets. Another acceptable view is that the intent of the guidance is to measure the impairment of the long-lived assets only; for purposes of determining the amount of the impairment loss, the loss should therefore be measured by comparing the fair value of the group of long-lived assets subject to impairment testing within the scope of ASC 360 to its net carrying amount.

Example PPE 5-6 and Example PPE 5-7 illustrate the measurement of impairment losses for long-lived assets.

EXAMPLE PPE 5-6
Measuring an impairment loss — loss recognized

Construction Co owns a construction facility in Europe that qualifies as an asset group under ASC 360. Included in the asset group are long-lived assets consisting of PP&E, a customer relationship asset, and a patent. The carrying amount of the asset group exceeds its undiscounted future cash flows and as a result, the entity failed the recoverability test. The carrying amounts and management’s estimated fair value of the long-lived assets within the asset group subject to impairment testing within the scope of ASC 360 are as follows:

	Carrying amount	Fair value	Difference
PP&E	$600	$100	($500)
Customer relationship	200	300	100
Patent	0	100	100
Total	$800	$500	($300)

What is the amount, if any, of the impairment loss?

Analysis

Following the approach in ASC 360-10-35, an impairment loss of $300 would be recognized since the aggregate carrying amount of $800 exceeds the aggregate fair value of $500. Although the carrying amount of the PP&E exceeds its fair value by $500, only a $300 impairment should be recorded and allocated to PP&E. None of the impairment should be allocated to the customer relationship asset or patent because their fair values are readily determinable and exceed their carrying amounts.

EXAMPLE PPE 5-7
Measuring an impairment loss — no loss recognized

The carrying amounts and management’s estimated fair value of the long-lived assets within the asset group subject to impairment testing within the scope of ASC 360 are as follows:

	Carrying amount	Fair value	Difference
PP&E	$600	$100	($500)
Customer relationship	200	300	100
Patent	0	450	450
Total	$800	$850	$50

What is the amount, if any, of the impairment loss?

Analysis

Although the carrying amount of the PP&E is more than its fair value by $500, no impairment should be recognized since the aggregate carrying amount of the long-lived assets is less than their fair value.

The impairment loss should be allocated among the long-lived assets in the asset group on a pro rata basis using their relative carrying amounts, except that the loss allocated to an individual long-lived asset should not reduce the carrying amount of that asset below its fair value whenever that fair value is determinable without undue cost and effort. If certain assets within the asset group are to be abandoned, it is generally not appropriate to allocate the entire held and used impairment loss to those assets, even though the adjusted carrying value of those assets may be in excess of their fair values at the impairment date.

ASC 360-10-55-21 and ASC 360-10-55-22 show an example of the allocation of an impairment loss to the long-lived assets of an asset group.

ASC 360-10-55-21

An entity owns a manufacturing facility that together with other assets is tested for recoverability as a group. In addition to long-lived assets (Assets A–D), the asset group includes inventory measured using first-in, first-out (FIFO), which is reported at the lower of cost and net realizable value in accordance with Topic 330, and other current assets and liabilities that are not covered by this Subtopic. The $2.75 million aggregate carrying amount of the asset group is not recoverable and exceeds its fair value by $600,000. In accordance with paragraph 360-10-35-28, the impairment loss of $600,000 would be allocated as shown below to the long-lived assets of the group.

Asset Group	Carrying Amount (in $000s)	Pro Rata Allocation Factor	Allocation of Impairment (Loss) (in $000s)	Adjusted Carrying Amount (in $000s)
Current assets	$400	—	—	$400
Liabilities	(150)	—	—	(150)
Long-lived assets:
Asset A	590	24%	($144)	446
Asset B	780	31	(186)	594
Asset C	950	38	(228)	722
Asset D	180	7	(42)	138
Subtotal — long-lived assets	2,500	100	(600)	1,900
Total	$2,750	100%	($600)	$2,150

ASC 360-10-55-22

If the fair value of an individual long-lived asset of an asset group is determinable without undue cost and effort and exceeds the adjusted carrying amount of that asset after an impairment loss is allocated initially, the excess impairment loss initially allocated to that asset would be reallocated to the other long-lived assets of the group. For example, if the fair value of Asset C is $822,000, the excess impairment loss of $100,000 initially allocated to that asset (based on its adjusted carrying amount of $722,000) would be reallocated as shown below to the other long-lived assets of the group on a pro rata basis using the relative adjusted carrying amounts of those assets.

Long-Lived Assets of Asset Group	Adjusted Carrying Amount (in $000s)	Pro Rata Reallocation Factor	Reallocation of Excess Impairment (Loss)(in $000s)	Adjusted Carrying Amount after Reallocation (in $000s)
Asset A	$446	38%	($38)	$408
Asset B	594	50	(50)	544
Asset D	138	12	(12)	126
Subtotal	1,178	100%	(100)	1,078
Asset C	722		100	822
Total	$1,900		$ -	$1,900

Long-lived assets may include property subject to nonrecourse debt. The fair value of the property should be assessed without regard to the nonrecourse provisions. If the carrying amount of the property that reverts to the lender is less than the amount of nonrecourse debt extinguished, a gain would be recognized on extinguishment. Example PPE 5-8 illustrates the consideration of nonrecourse debt when measuring the fair value of an asset group.

EXAMPLE PPE 5-8
Impact of nonrecourse debt when measuring the fair value of an asset group

PPE Corp borrows $5 million from a bank on a nonrecourse basis to purchase a building. The building is the only long-lived asset in the asset group. Three years after the acquisition, the asset group is tested for impairment and fails the recoverability test. At that time, the building’s carrying amount is $4.7 million, fair value is $2 million, and the balance of the loan due to the lender is $3.7 million.

What impairment charge should be recorded in year 3?

Analysis

The fair value of the property should be assessed without regard to the nonrecourse provisions (in which PPE Corp would transfer the building to the lender in full satisfaction of the debt). An impairment charge of $2.7 million ($4.7 million carrying amount less $2 million fair value) should be recorded. It would not be appropriate to limit the impairment charge to $1 million based on an assumption that the building owner could transfer ownership of the building to the bank in satisfaction of the nonrecourse debt.

If PPE Corp subsequently defaults on the debt and transfers ownership of the building to the lender, assuming the carrying amount and fair value of the building are still $2 million and the carrying amount of the loan is $3.7 million, a gain of $1.7 million would be recognized by PPE Corp on the extinguishment of the debt.

If an impairment loss on an asset to be held and used is recognized, that loss should be included in income from continuing operations before income taxes and within income from operations, if such an amount is presented. After recognition of an impairment loss, the adjusted carrying amount of a long-lived asset becomes that asset’s new accounting basis. Subsequent reversal of a previously recorded impairment loss is prohibited. The adjusted carrying amount of the long-lived asset should be depreciated or amortized over the asset’s remaining useful life.

When a reporting entity has failed the recoverability test, any impairment of the asset group must be recognized in the applicable reporting period. There is no option to record an estimate subject to finalization in a subsequent period, as is permitted for goodwill impairment tests by companies that apply ASC 350-20-35-18 (i.e., those that have not yet adopted ASU 2017-04). It is expected that both steps of the impairment test will be completed in the period in which the asset group is tested for impairment.

5.2.6 Fair value considerations – long-lived assets held and used

ASC 360-10 requires that the fair value of the asset group be determined in order to recognize and measure the amount of any impairment loss. Consistent with the guidance of ASC 820-10, the fair value of the asset group should be determined from the perspective of a market participant considering, among other things, appropriate discount rates, valuation techniques, the most advantageous market, and assumptions about the highest and best use of the asset group.

The fair value should incorporate both recognized and unrecognized long-lived assets within the asset group. For example, unrecognized customer relationships that are part of the asset group should be considered when determining the fair value of the long-lived assets if it is reasonable that a market-participant would ascribe value to them.

If an income approach is used to measure the fair value of the asset group, the cash flows should be based on market-participant assumptions, rather than a reporting entity’s own assumptions about how it intends to use the asset group. Therefore, cash flows used to determine fair value may differ from the cash flows used in the recoverability test. Management may start with cash flow estimates used in the recoverability test but should then incorporate the perspective of market participants. Reporting entities should not presume that entity-specific cash flow estimates are representative of market participant assumptions. Because the continued use of a long-lived asset demonstrates the presence of service potential, it would be unusual that the fair value of a long-lived asset would be zero while it is still being used. See FV 7.4 for further guidance regarding fair value measurements when recognizing and measuring long-lived asset impairments.

5.2.7 Right-of-use asset impairment considerations

As discussed in PPE 4.2.4, under ASC 842, the subsequent measurement of a right-of-use asset is subject to guidance under ASC 842 and ASC 360. For further details of ASC 842, including the initial accounting and subsequent measurement of a lease, see the Leases guide. A right-of-use asset is also subject to the Impairment or Disposal of Long-Lived Assets subsection of ASC 360.

Right-of-use assets should be assigned to an asset group for purposes of applying the impairment guidance in ASC 360. See PPE 5.2.1 for guidance related to determining asset groups. There may be limited circumstances when a right-of-use asset is its own asset group.

Lease accounting should be applied at the lowest component level. See LG 2.5 for information on determining lease components. If the lessee determines that the lease has more than one lease component, the lessee will need to determine if the lease components should be included in different asset groups for purposes of testing for impairment.

A lessee should reassess its asset groupings when there is a change in facts and circumstances in the interdependency of cash flows. For a right-of-use asset, a reassessment of the asset group to which the right-of-use asset is assigned might be necessary if the lessee subleases all or a part of the underlying asset. For example, assume a lessee has two manufacturing facilities that it leases to make widgets. The manufacturing facilities are in the same asset group. The company decides it no longer needs one facility for production and subleases it. Because the cash inflows from the sublease are not dependent on the widget manufacturing, the lessee might determine that the facility should no longer be included in the widget asset group.

A decision to sublease, or a plan to abandon (see PPE 6.3.1 and PPE 6.3.1.1), may not, in isolation, cause a reassessment of an asset grouping, particularly if the lessee is continuing to use the underlying asset in substantially the same manner for a period of time after the decision (i.e., the level of identifiable cash flows have not yet materially changed).

If a lessee decides to sublease a portion of a right-of-use asset that the lessee originally accounted for as one unit of account, the lessee should consider whether it needs to reassess the unit of account. Lease accounting should be applied at the lowest component (i.e., unit of account). For example, assume that a lessee originally accounts for a ten-year lease of a five-story building as a single right-of-use asset. In year five, the lessee decides to sublease two of the floors. The lessee may have accounted for the building as a single lease component at lease inception because all floors were intended to have the same use (e.g., as a single administrative office). The lessee should consider whether its subsequent decision to sublease two floors indicates that the lease contains more than one lease component. The lessee should consider the nature and interdependency of the floors covered by the arrangement using the lease component guidance to determine its units of account (see LG 2.5 and LG 3.3.3.3 for further details). If the lessee determines that it has two lease components (three floors used in operations and two floors subleased to a tenant), the lessee needs to allocate the carrying amount of the right-of-use asset and lease liability to the lease components. Generally, we believe the allocation should be based on the relative fair value of the lease components at the lease commencement date (as defined in the ASC Master Glossary). If the lessee does not know the fair value of the lease components at lease commencement, the lessee may base its allocation on the relative fair value on the date that the lessee decides to sublease.

The decision to sublease a portion of a larger right-of-use asset may be an indicator of impairment depending on the nature and magnitude of the lease component relative to the overall asset group. ASC 360-10-35-21 provides indicators of impairment, including a significant adverse change in the extent or manner in which an asset group is being used. See PPE 5.2.3 for details regarding indicators of impairment.

Example PPE 5-9 illustrates the accounting when subleasing a right-of-use asset.

EXAMPLE PPE 5-9
Lease impairment considerations when subleasing a right-of-use asset

A company leases computers that will no longer be used in their current state once replacement computers are put in place. The original term of the lease was for eight years and commenced in January 20X0. The computers are currently used to support the company’s HQ functions (e.g., accounting, finance, human resources).

In October 20X3, the company concludes that by mid-20X4 it will no longer need the leased computers in their current operations; however, a market exists to sublease the computers through the end of the lease term. As such, the company will continue to use the right-of-use asset through the end of the lease term and therefore it does not need to adjust the remaining useful life of the asset.

At June 30, 20X4, the company is no longer using the computers for its current operations and enters into a sublease for the computers through the remainder of the term on the head lease. The total lease payments in the sublease are less than the remaining contractual lease payments under the head lease.

On June 30, 20X4, the company determines that the cash inflows from the sublease represent separate identifiable cash flows that are largely independent of the cash flows of other assets and liabilities. Therefore, the company concludes that the right-of-use asset should be included in its own asset group. Prior to moving the right-of-use asset into its own asset group, the asset group in which the right-of-use asset was included was not impaired.

When the right-of-use asset is included in a new asset group, should the company test the new asset group for impairment?

Analysis

Yes. The expected change in use of the asset group and the sublease payments which are less than the lease payments under the head lease indicate that the carrying amount of the asset group may not be recoverable and are impairment triggers.

For the recoverability test, the company would estimate the expected undiscounted cash flows over the remaining useful life of the right-of-use asset (i.e., the primary asset), which is 42 months (i.e., June 30, 20X4 through December 31, 20X7).

The company determines that the carrying value of the asset group is greater than its undiscounted cash flows. If the carrying value of the asset group is more than the fair value of the asset group, it would record an impairment. If the right-of-use asset is impaired on June 30, 20X4, amortization of the right-of-use asset and lease liability would be delinked in the subsequent accounting (see PPE 5.2.7.3). The right-of-use asset would be amortized on a straight-line basis. The company would continue to account for the lease liability using the same effective interest method as it had prior to the impairment.

Conditions that lead to a right-of-use asset impairment trigger may also lead to the reassessment of the lease term. However, an impairment trigger under ASC 360 does not necessarily cause reassessment of the lease term under ASC 842. The criteria that trigger an ASC 360 impairment test are different than those for a lease term reassessment under ASC 842. For further discussion regarding lease term reassessment, see LG 5.3.1.

5.2.7.1 Right-of-use asset recoverability test

A right-of-use asset is a long-lived asset and as such, the carrying value should be included in an asset group for impairment testing. See PPE 5.2.4 for details on the recoverability test.

When performing the recoverability test, the reporting entity will need to elect to either: (1) include the carrying amount of operating lease liabilities in the asset group and include the associated operating lease payments in the undiscounted cash flows, or (2) exclude the carrying amount of the operating lease liabilities from the asset group and exclude the associated operating lease payments from the undiscounted cash flows. The inclusion of operating lease liabilities in the asset group may result in the asset group having a zero or negative carrying amount. Even then, a recoverability test should still be performed, as noted in PPE 5.2.3.

Although debt payments are generally not included in the cash flows used in a recoverability test (see PPE 5.2.4.5), the rationale for including an operating lease liability in a recoverability test is based on the ASC 842 requirement to separate operating lease liabilities from finance lease liabilities on the balance sheet as they are not “debt like.” Conversely, because operating lease liabilities have characteristics that are similar to finance lease liabilities, a lessee may choose to exclude the operating lease payments from the undiscounted cash flows.

In principle, different results in the recoverability test for similar asset groups should not result from the use of different capital structures. Therefore, the inclusion or exclusion of the lease liability and the related cash flows generally should not result in a different conclusion in the recoverability test.

When performing the recoverability test, if a reporting entity elects to include the operating lease liabilities in the asset group and the associated operating lease payments in the undiscounted cash flows, the reporting entity should also make an accounting policy election to either include or exclude the interest portion of the operating lease payments as a cash outflow in the recoverability test. Including the interest payments as a cash outflow is consistent with the inclusion of rent expense for operating leases prior to the adoption of the new leases standard. In contrast, including only the principal lease payments is similar to the model for debt, in the limited circumstances when debt is considered in the test.

Variable lease payments should generally be included in the undiscounted cash flows in the recoverability test when the variable lease payments are not already included in the measurement of the lease liability. For example, a lease of retail property may specify that lease payments are based on a percentage of the lessee’s retail sales at the property, which would be a variable lease payment not included in the lease liability. The estimate of these variable lease payments would be included in the undiscounted cash flows used for the recoverability test, regardless of the accounting policy election.

If the undiscounted cash flows of the asset group are less than the carrying amount of the asset group, including when the undiscounted cash flows are more negative than the negative carrying amount of the asset group, the asset group fails the recoverability test and the lessee should measure the impairment loss (see PPE 5.2.5).

As discussed in PPE 5.2.4.2, the period of time used to determine estimates of future cash flows for the recoverability test is based on the remaining useful life of the primary asset of the group. ASC 360-10-35-31 states that the primary asset is the principal long-lived tangible asset being depreciated or intangible asset being amortized that is the most significant component asset from which the asset group derives its cash flow-generating capacity. If a right-of-use asset meets this definition, it would be the primary asset of an asset group.

Impact of lease renewals on right-of-use asset recoverability

There may be circumstances when management expects to renew a lease and the remaining useful life of the primary asset does not reflect the additional lease term. For example, the primary asset may not be the right-of-use asset or the right-of-use asset may be the primary asset, but its useful life does not include the lease renewal period because it has not met the lease remeasurement criteria in ASC 842 (see LG 5.3). When there is a lease renewal period and management expects to renew the lease, there are multiple approaches management could use to determine the residual value of the asset group.

One approach would be to consider the cash flows generated by the asset group during the renewal period based on management’s expectation that it will renew the lease. For example, assume the asset group includes a right-of-use asset related to a five-year lease and subsequently management changes its plans and now expects to exercise a five-year renewal option. At the end of the first year of the lease, management has determined that an impairment triggering event has occurred for the asset group. In performing the recoverability test, the cash flows would include (1) the undiscounted cash flows over years two through five of the lease, and (2) the residual value determined based on the cash flows expected during the renewal period, discounted to year five of the lease (i.e., the end of the undiscounted cash flow period). The sum of the cash flows would then be compared to the carrying amount of the asset group. Other approaches may also be acceptable when determining the residual value of the asset group (see PPE 5.2.4.2).

5.2.7.2 Measuring impairment of a right-of-use asset

When measuring the asset group’s fair value in the impairment test, the lessee can elect to either include or exclude the operating lease liabilities in the asset group, consistent with the recoverability test (see PPE 5.2.7.1). We generally do not expect significant differences in the measurement of an impairment loss because a lessee’s estimate of the fair value of the asset group would reflect whether the asset group includes or excludes operating lease liabilities. See FV 8 for a detailed discussion of the incorporation of credit risk in the fair value measurement of assets and liabilities.

Variable lease payments should be included when determining the fair value of the asset group using the discounted cash flow approach. Consistent with ASC 820, a market participant would consider expected lease cash outflows in determining the fair value of the asset group.

When determining the fair value of a right-of-use asset, market participant assumptions should be used. For example, when determining the appropriate discount rate to use when calculating the fair value of a right-of-use asset using the income approach, the discount rate applied should be based on a market participant’s assessment of the risk in the cash flow forecast related to the asset group. This would not necessarily be the same as the lessee's incremental borrowing rate. To determine an appropriate rate, a lessee should consider the highest and best use of the right-of-use asset (e.g., is the space more profitable as retail versus office space, which would likely result in different market discount rates). This use may be different than how the lessee is currently using the right-of-use asset. For discussion on the considerations of the highest and best use of nonfinancial assets, see FV 4.2.5. For discussion of the considerations when determining the fair value of the lease liability, see FV 4.2.6.

The inclusion of operating lease liabilities in a lessee’s asset group may result in the carrying amount of the asset group being zero or negative. While the fair value of a legal entity is generally not negative as the equity holders can choose not to fund future losses, asset groups are often not legal entities, thus an asset group can have a negative fair value. This contrasts with calculating the fair value of a reporting unit for purposes of a goodwill impairment test. The fair value for a reporting unit typically would not be negative because a reporting unit often consists of one or more legal entities and is typically a business.

A negative asset group fair value (i.e., the need to pay a market participant to step into the current owner’s shoes) may result when there are costs to exit an activity that is within a larger entity. Although the fair value of the asset group can be negative, the fair value of an individual asset cannot be less than zero.

As discussed in PPE 5.2.5, an impairment loss should be allocated among the long-lived assets in the asset group on a pro rata basis using their relative carrying amounts, except that the loss allocated to an individual long-lived asset should not reduce the carrying amount of that asset below its fair value whenever that fair value is determinable without undue cost and effort.

5.2.7.3 Accounting for a lease after impairment testing (ASC 842)

If a right-of-use asset is impaired, the impairment will be allocated to the asset group, including the right-of-use asset, as discussed in PPE 5.2.5. For operating leases, as a result of recognizing an impairment for a right-of-use asset, the right-of-use asset amortization becomes delinked from the lease liability. Prior to impairment, the amortization of the right-of-use asset is the difference between the straight-line lease expense and the effective interest calculated on the lease liability. This results in straight-line lease expense. However, in accordance with ASC 842-20-35-10, once the right-of-use asset is impaired, the lessee will continue to amortize the lease liability using the same effective interest method but the right-of-use asset will be amortized generally on a straight-line basis over the shorter of its remaining useful life or remaining lease term. If the impaired asset is a finance lease, the lessee will amortize the right-of-use asset in the same manner as before the impairment (i.e., over the shorter of its remaining useful life or remaining lease term). However, if title transfers automatically to the lessee or the lessee is reasonably certain to exercise a purchase option, the amortization period is the remaining useful life of the right-of-use asset.

As discussed in PPE 5.2.4, the useful lives of long-lived assets should be reassessed whenever events or circumstances indicate that a revision to the useful life is warranted. It may be necessary to reassess the useful life of a right-of-use asset even when the asset is not impaired based on the outcome of the recoverability test. For further details regarding the remaining useful life of a right-of-use asset, see PPE 4.2.4.

If a right-of-use asset has not been impaired, but its useful life has been shortened, different approaches can be applied to subsequently amortize the right-of-use asset. See PPE 6.3.1.1 for examples of two acceptable approaches, including “delinked” and “linked” recognition methods.

5.2.8 Presentation and disclosure–held and used impairments

See FSP 8.6.1 for information on the presentation and disclosure of held and used impairment losses.

¹ Although cash flows upon sale are the same in this example, they may vary in other scenarios

PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.

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5.2 Impairment of long-lived assets to be held and used

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5.2 Impairment of long-lived assets to be held and used

5.2.1 Determining the asset group for long-lived assets

5.2.1.1 Entity-wide asset groups for long-lived assets

5.2.1.2 Changes to asset groups for long-lived assets

5.2.2 Order of impairment testing for long-lived assets held and used

5.2.3 When to test long-lived assets for impairment

5.2.3.1 Impairment indicators for individual assets in an asset group

5.2.4 Determining whether long-lived assets are recoverable

5.2.4.1 Estimates of future cash flows used in the recoverability test

5.2.4.2 Cash flow estimation period used in the recoverability test

5.2.4.3 Probability-weighted cash flow estimates in the recoverability test

5.2.4.4 Assets under development in the recoverability test

5.2.4.5 Debt and other obligations in the recoverability test

5.2.4.6 Long-term operating obligations in the recoverability test

5.2.4.7 Contingent obligations in the recoverability test

5.2.4.8 Consideration of income tax effects in the recoverability test

5.2.4.9 Customer relationships in the recoverability test

5.2.4.10 Leasehold improvements in the recoverability test

5.2.4.11 Impact of bankruptcy filing on the recoverability test

5.2.4.12 Impact of going concern considerations on the recoverability test

5.2.4.13 Environmental contingencies in the recoverability test

5.2.4.14 Asset retirement obligations in the recoverability test

5.2.4.15 Consideration of AOCI in the recoverability test

5.2.5 Measuring and allocating an impairment loss—held and used

5.2.6 Fair value considerations – long-lived assets held and used

5.2.7 Right-of-use asset impairment considerations

5.2.7.1 Right-of-use asset recoverability test

5.2.7.2 Measuring impairment of a right-of-use asset

5.2.7.3 Accounting for a lease after impairment testing (ASC 842)

5.2.8 Presentation and disclosure–held and used impairments

Search within this section

Suggested terms

Suggested guidance

5.2 Impairment of long-lived assets to be held and used

5.2.1 Determining the asset group for long-lived assets

5.2.1.1 Entity-wide asset groups for long-lived assets

5.2.1.2 Changes to asset groups for long-lived assets

5.2.2 Order of impairment testing for long-lived assets held and used

5.2.3 When to test long-lived assets for impairment

5.2.3.1 Impairment indicators for individual assets in an asset group

5.2.4 Determining whether long-lived assets are recoverable

5.2.4.1 Estimates of future cash flows used in the recoverability test

5.2.4.2 Cash flow estimation period used in the recoverability test

5.2.4.3 Probability-weighted cash flow estimates in the recoverability test

5.2.4.4 Assets under development in the recoverability test

5.2.4.5 Debt and other obligations in the recoverability test

5.2.4.6 Long-term operating obligations in the recoverability test

5.2.4.7 Contingent obligations in the recoverability test

5.2.4.8 Consideration of income tax effects in the recoverability test

5.2.4.9 Customer relationships in the recoverability test

5.2.4.10 Leasehold improvements in the recoverability test

5.2.4.11 Impact of bankruptcy filing on the recoverability test

5.2.4.12 Impact of going concern considerations on the recoverability test

5.2.4.13 Environmental contingencies in the recoverability test

5.2.4.14 Asset retirement obligations in the recoverability test

5.2.4.15 Consideration of AOCI in the recoverability test

5.2.5 Measuring and allocating an impairment loss—held and used

5.2.6 Fair value considerations – long-lived assets held and used

5.2.7 Right-of-use asset impairment considerations

5.2.7.1 Right-of-use asset recoverability test

5.2.7.2 Measuring impairment of a right-of-use asset

5.2.7.3 Accounting for a lease after impairment testing (ASC 842)

5.2.8 Presentation and disclosure–held and used impairments

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