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16/01/2021 08:00:33 AM

Impairment of fixed aset in international accounting

IMPAIRMENT OF FIXED ASET IN INTERNATIONAL ACCOUNTING

Nguyễn Thị Kim Hương

The general accounting standard of lower-of-cost-or-market for inventories does not apply to property, plant, and equipment. Even when property, plant, and equipment has suffered partial obsolescence, accountants have been reluctant to reduce the asset’s carrying amount. Why? Because, unlike inventories, it is difficult to arrive at a fair value for property, plant, and equipment that is not subjective and arbitrary.

For example, Falconbridge Ltd. Nickel Mines had to decide whether to write off all or a part of its property, plant, and equipment in a nickel-mining operation in the Dominican Republic. The project had been incurring losses because nickel prices were low and operating costs were high. Only if nickel prices increased by approximately 33 percent would the project be reasonably profitable.

Whether a write-off was appropriate depended on the future price of nickel. Even if the company decided to write off the asset, how much should be written off?

1. Recognizing Impairments

As discussed in the opening story, the FASB and international accounting standardsetters have developed rules for recognizing impairments on long-lived assets.

According to these standards, when the carrying amount of an asset is not recoverable, a company records a write-off. This write-off is referred to as an impairment. Various events and changes in circumstances might lead to an impairment.

Examples are:

a. A significant decrease in the market value of an asset.

b. A significant change in the extent or manner in which an asset is used.

c. A significant adverse change in legal factors or in the business climate that affects

the value of an asset.

d. An accumulation of costs significantly in excess of the amount originally expected to acquire or construct an asset.

e. A projection or forecast that demonstrates continuing losses associated with an asset.

These events or changes in circumstances indicate that the company may not be able to recover the carrying amount of the asset. In that case, a recoverability test is used to determine whether an impairment has occurred.

To apply the first step of the recoverability test, a company like UPS estimates the future net cash flows expected from the use of that asset and its eventual disposition.

If the sum of the expected future net cash flows (undiscounted) is less than the carrying amount of the asset, UPS considers the asset impaired. Conversely, if the sum of the expected future net cash flows (undiscounted) is equal to or greater than the carrying amount of the asset, no impairment has occurred.

The recoverability test therefore screens for asset impairment. For example, if the expected future net cash flows from an asset are $400,000 and its carrying amount is $350,000, no impairment has occurred. However, if the expected future net cash flows are $300,000, an impairment has occurred

2. Impairment—Example

M. Alou Inc. has an asset that, due to changes in its use, it reviews for possible impairment. The asset’s carrying amount is $600,000 ($800,000 cost less $200,000 accumulated depreciation). Alou determines the expected future net cash flows (undiscounted) from the use of the asset and its eventual disposal to be $650,000.

The recoverability test indicates that the $650,000 of expected future net cash flows from the asset’s use exceed the carrying amount of $600,000. As a result, no impairment occurred. (Recall that the undiscounted future net cash flows must be less than the carrying amount for Alou to deem an asset to be impaired and to measure the impairment loss.) Therefore, M. Alou Inc. does not recognize an impairment loss in this case.

3. Reversal of Impairment Loss

After recording an impairment loss, the reduced carrying amount of an asset held for use becomes its new cost basis. A company does not change the new cost basis except for depreciation or amortization in future periods or for additional impairments.

To illustrate, assume that Damon Company at December 31, 2009, has equipment with a carrying amount of $500,000. Damon determines this asset is impaired and writes it down to its fair value of $400,000. At the end of 2010, Damon determines that the fair value of the asset is $480,000. The carrying amount of the equipment should not change in 2010 except for the depreciation taken in 2010. Damon may not restore an impairment loss for an asset held for use. The rationale for not writing the asset up in value is that the new cost basis puts the impaired asset on an equal basis with other assets that are unimpaired.

4. Impairment of Assets to Be Disposed Of

What happens if a company intends to dispose of the impaired asset, instead of holding it for use? Recently Kroger recorded an impairment loss of $54 million on property, plant, and equipment it no longer needed due to store closures. In this case, Kroger reports the impaired asset at the lower of cost or net realizable value (fair value less cost to sell). Because Kroger intends to dispose of the assets in a short period of time, it uses net realizable value in order to provide a better measure of the net cash flows that it will receive from these assets.

Kroger does not depreciate or amortize assets held for disposal during the period it holds them. The rationale is that depreciation is inconsistent with the notion of assets to be disposed of and with the use of the lower of cost or net realizable value. In other words, assets held for disposal are like inventory; companies should report them at the lower of cost or net realizable value. Because Kroger will recover assets held for disposal through sale rather than through operations, it continually revalues them. Each period, the assets are reported at the lower of cost or net realizable value. Thus Kroger can write up or down an asset held for disposal in future periods, as long as the carrying value after the write-up never exceeds the carrying amount of the asset before the impairment. Companies should report losses or gains related to these impaired assets as part of income from continuing operations