Asset Group: Accounting and Impairment Testing

An asset group is a collection of assets and liabilities that work together to generate income, as the individual assets cannot produce significant cash flows on their own. The primary function of establishing an asset group is for impairment testing, a process used to determine if the value of long-lived assets, like buildings or machinery, has fallen below the value recorded on the company’s books.

Rather than evaluating a single piece of equipment in isolation, the company evaluates the entire production line that it is part of. This approach provides a more accurate picture of value, as the production line’s ability to generate revenue is what truly supports the carrying value of its components on the balance sheet.

Identifying an Asset Group

The process of identifying an asset group is guided by a core principle found in U.S. Generally Accepted Accounting Principles (GAAP), specifically under Accounting Standards Codification (ASC) 360. An asset group is defined as the lowest level for which identifiable cash flows are largely independent of the cash flows from other assets and liabilities. For these cash flows to be “largely independent,” it means the group must generate revenue and incur costs without significant reliance on other parts of the business.

For example, a coffee shop chain might identify each store as a separate asset group. Each store has its own building, equipment, and employees that work together to generate revenue from selling coffee, and its financial performance can be tracked separately from other stores.

In some cases, assets do not have their own independent cash flows. A corporate headquarters building, for instance, does not generate revenue on its own; it supports the entire organization. In such situations, these shared corporate assets must be tested for impairment as part of a larger group, which could potentially include all assets and liabilities of the entire company.

The Impairment Test for an Asset Group Held for Use

When a company intends to continue using an asset group, it must test for impairment whenever events or circumstances suggest that its carrying amount may not be recoverable. This is not an annual requirement but is triggered by indicators like a significant drop in market price or an adverse change in the business climate. The evaluation for assets held for use is a two-step process.

The first step is the recoverability test. Here, the company compares the asset group’s carrying amount—its value on the balance sheet net of accumulated depreciation—to the sum of the future net cash flows expected from its use and eventual sale, calculated on an undiscounted basis. If the total of these undiscounted cash flows is greater than the carrying amount, the asset group is considered recoverable, and the process ends.

If the asset group fails the recoverability test, the company proceeds to the second step: measuring the impairment loss. The loss is calculated as the amount by which the asset group’s carrying amount exceeds its fair value. Fair value is the price that would be received to sell the asset group in an orderly transaction between market participants. This can be determined by looking at market prices for similar asset groups or by calculating the present value of the expected future cash flows.

Once the total impairment loss is calculated, it must be allocated to the long-lived assets within the group, such as property and equipment. The allocation is done on a pro-rata basis using the relative carrying amounts of those assets. However, an important constraint applies: the loss allocated to an individual asset cannot reduce its carrying amount below its own determinable fair value.

Accounting for an Asset Group Held for Sale

The accounting treatment changes when management commits to a plan to sell an asset group. To be classified as “held for sale,” a specific set of criteria must be met. These include:

• Management, with the proper authority, committing to a sales plan.
• The asset group being available for immediate sale in its present condition.
• An active program to find a buyer having been initiated.
• The sale must be probable, with an expectation of completion within one year.
• The marketing price must be reasonable relative to the group’s current fair value.

Once an asset group is classified as held for sale, it is measured differently. Instead of the two-step process for assets held for use, these groups are immediately measured at the lower of their carrying amount or their fair value less costs to sell. Costs to sell are the direct incremental costs to transact the sale, such as broker commissions. Any loss resulting from this initial measurement is recognized in the financial statements.

This single-step test is performed upon classification and is re-evaluated in subsequent periods until the asset group is sold. A defining feature of the held-for-sale classification is that depreciation and amortization on the long-lived assets within the group cease immediately. On the balance sheet, assets and liabilities of the disposal group are presented separately from other company assets.