Impairment of PPE

Impairment of long-term assets

The impairment evaluation for a held-for-use tangible asset is a two step process:

1. Compare the carrying value (CV) of the asset to undiscounted future cash flows expected from the use and disposal of the asset
2. If applicable, write-down the asset to its fair value.

The process above to determine impairment for held-for-use tangible assets is the same as the process of impairment of finite life intangibles in the next section on intangible assets.

The test is performed when events or changes in circumstances (e.g., a significant drop in market price, adverse change in use, or ongoing operating losses) indicate the carrying value may not be recoverable - it is not performed on a scheduled annual basis. Assets classified as held for sale are treated differently: they’re measured at the lower of carrying amount and fair value less costs to sell, and they are not depreciated while held for sale.

Step 1: Compare carrying value (CV) to undiscounted cash flows

If $\text{CV}>\text{Undiscounted future cash flows}$, this means that the asset is impaired because the carrying value is currently overstated. Proceed to Step 2.

If $\text{CV}\le \text{Undiscounted future cash flows}$, this means that the asset is not impaired because the future benefits are still estimated to be at least as high as the carrying amount in the books. In this case, there is nothing to do and the process ends here.

Step 2: If applicable, write-down the asset to its fair value

Computation of the fair value will not be tested on the CMA exam but it will be provided so you can determine the impairment loss.

Common pitfall: step 1 uses undiscounted cash flows only to test whether the asset is impaired; step 2 measures the loss using fair value, not undiscounted cash flows. This is a U.S. GAAP model - IFRS uses one step, comparing carrying value to recoverable amount. The mechanics of the IFRS recoverable-amount test are covered later, in the chapter on differences between U.S. GAAP and IFRS for long-lived assets and impairment.

Definitions

Fair value

This is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price).

The difference between the carrying amount and the fair value is booked as an impairment loss.

Account	Debit	Credit	Financial statement element
Impairment loss - PPE	XXX		Loss
Accumulated impairment - PPE		XXX	Contra-asset
To record impairment of PPE

The journal entry typically is credited to the contra-asset account because we need to track the cost of the asset.

Under U.S. GAAP (ASC 360), the impairment loss is reported in income from continuing operations (typically within operating income) rather than in other comprehensive income, and it reduces the carrying amount of the asset on the balance sheet.

After impairment, the new carrying amount becomes the asset’s cost basis and is depreciated over its remaining useful life - see the next chapter, Depreciation of PPE. Under U.S. GAAP this loss is never reversed even if fair value recovers, unlike IFRS, which permits reversal.

Example: impairment test

A machine has CV $\$500,000$, undiscounted future cash flows of $\$420,000$, and fair value $\$380,000$.

Step 1: $\$500,000>\$420,000$ → impaired.

Step 2: Loss $=\$500,000-\$380,000=\$120,000$; debit impairment loss - PPE, credit accumulated impairment - PPE.

Answer: Impairment loss $=\$120,000$