Accounting for nonfinancial asset impairment

10/16/2020
Accounting for nonfinancial asset impairment

Get a deeper understanding of triggering events, testing order, and other accounting considerations for nonfinancial assets.

When the economy is strong, nonfinancial asset impairment might seem like a postscript, with limited analysis and documentation required. But when the economy falters, interest in and consideration of asset impairment surges. However, asset impairment can occur at any time, for a number of reasons.

This article focuses on three areas of consideration for the impairment of nonfinancial assets, including inventory, intangible assets, property, plant, and equipment (PP&E), and goodwill:

  • Ordering of impairment testing
  • Testing frequency
  • Triggering events

It also explores specific impairment considerations for the different asset classes of nonfinancial assets.

Ordering of impairments

Under U.S. GAAP, the order of impairment testing is important. If assets are tested out of order, a reporting entity might incorrectly conclude that an impairment loss is (or is not) necessary for a separate class of nonfinancial asset. The following chart displays the correct order of impairment testing for nonfinancial assets (starting from top to bottom): 

Impairment testing for nonfinancial assets 

Impairment testing for nonfinancial assets

Note that even if it is determined that assets are not impaired in a class of nonfinancial assets tested first, the remaining classes of nonfinancial assets must continue to be evaluated for impairment. Lack of impairment in one class does not mean there will not be impairment in a subsequently evaluated class.

Testing frequency

Each asset class has its own requirements for when to test for impairment. While all asset classes must be evaluated for impairment when certain triggering events occur, others also have a requirement to evaluate for impairment at least annually.

Testing frequency

Triggering events

U.S. GAAP requires reporting entities to assess nonfinancial assets for impairment upon the occurrence of certain triggering events. Triggering events can range widely depending on the type of nonfinancial asset being considered. However, the common theme between the triggers is that they all suggest that the asset’s fair value might be below its current carrying amount. The most relevant triggers are those that would have the greatest impact on the asset’s fair value.

Some common triggers include (not all-inclusive):

  • Deteriorating macroeconomic conditions (as with COVID-19)
  • Change in demand for products or services
  • Impact to cost factors (such as raw materials, labor)
  • Industry deterioration 
  • Decline in actual or planned cash flows 
  • Loss of customers
  • A significant adverse change in the extent or manner in which a long-lived asset is being used or in its physical condition 
  • Sustained decrease in share price (as applicable)

Distinct asset class considerations

Each nonfinancial asset class also has unique considerations. 

  • Inventory. Inventory in industries affected by the COVID-19 pandemic might be impaired due to damage (such as spoilage or contamination), decreases in market prices, decreases in demand or sales volumes relative to on-hand inventory, or other factors.  Manufacturers also should consider the degree to which business disruption might impact inventory costing practices, such as overhead absorption. Temporary closures, supply chain disruptions or delays, labor shortages or reductions, and abnormally low sales or production volumes can influence the relationship of production costs and inventory units produced. In this volatile environment, assumptions used in identifying excess and obsolete inventory and in measuring such inventory reserves might need to be more closely scrutinized and more frequently revisited. 
  • Indefinite-lived intangible assets. Indefinite-lived intangible assets are typically evaluated for impairment at the individual asset level by assessing whether it is more likely than not that the asset is impaired (for example, that the fair value of the asset is below its carrying amount). There is no concept of other-than-temporary impairment that can be applied to these assets. If it is more likely than not that the asset is impaired, its carrying amount must be written down to its fair value.
  • Long-lived assets. Long-lived assets are evaluated for impairment at the asset group level when a triggering event occurs. Impairment exists when the carrying amount of the asset group exceeds the undiscounted future cash flows expected to be generated by the asset group. The excess of the carrying amount of the asset group over its fair value is the impairment loss, which is allocated to each long-lived asset on a pro rata basis, subject to certain limitations.
  • Goodwill. Currently, three different models for testing goodwill impairment exist, each with its own requirements:
    • Two-step model (if ASU 2017-04 has not yet been adopted). Testing for impairment at the reporting-unit level must be conducted by first assessing if the fair value of the reporting unit is lower than its carrying value. If it is, the implied fair value of goodwill must be determined by assigning the fair value of a reporting unit to all of its assets and liabilities as if that reporting unit had been acquired in a business combination. An impairment charge, if any, will be recorded for the excess of the carrying amount of goodwill over its implied fair value.
    • One-step model (if ASU 2017-04 has been adopted). The one-step model follows the same initial step as two-step model, except that impairment is recorded for any excess of the carrying value of the reporting unit over its fair value. The second step of determining the implied fair value of goodwill is eliminated.
    • PCC alternative. Goodwill is amortized over a period of 10 years or less, but it must be tested for impairment (at the entity or reporting unit level, based on the company’s accounting policy election) when a triggering event occurs. If determined to be impaired, an impairment charge is recorded for the excess of the carrying amount of the reporting unit (or entity) over its fair value. 

Whatever nonfinancial asset impairments you might be dealing with, Crowe professionals can help you think through accounting and valuation considerations and provide financial reporting insights to help you provide accurate and relevant disclosures to your stakeholders. 

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Mandi Simpson
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