FAS 144: Impairment and Disposal of Long-Lived Assets

The accounting standard FAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” established guidance for handling assets that have lost value or are slated for sale. This guidance is now part of the Financial Accounting Standards Board’s (FASB) Accounting Standards Codification (ASC) 360, “Property, Plant, and Equipment,” which is the current authoritative source for these rules.

ASC 360 provides a framework for recognizing impairment losses for long-lived assets a company continues to use. It also establishes the accounting model for long-lived assets reclassified as “held for sale.” This distinction ensures that assets intended for disposal are accounted for differently than those still generating operational value.

Scope of the Standard

ASC 360 applies to a company’s operational long-lived assets. This includes tangible assets like property, plant, and equipment (PP&E) and finite-lived intangible assets, such as patents and copyrights.

Several asset types are excluded because they are covered by other accounting rules, including:

• Goodwill and other indefinite-lived intangible assets (ASC 350)
• Financial instruments, such as stocks and bonds (ASC 321 and ASC 825)
• Deferred tax assets (ASC 740)
• Assets related to pension and other postretirement benefit plans (ASC 715)

This delineation ensures that assets are evaluated for impairment using the most appropriate framework.

Impairment of Assets Held and Used

An impairment test is not a routine event but is triggered by specific circumstances. A company must assess an asset for impairment when events or changes in the business environment suggest its carrying amount may not be recoverable. Triggering events include a significant drop in market price, a negative change in the asset’s use, an adverse shift in the business climate, or a projection of losses from the asset.

When a triggering event occurs, the company performs a two-step analysis. The first step is the recoverability test, which compares the asset’s carrying amount to the total future undiscounted net cash flows it is expected to generate. If the undiscounted cash flows are greater than the asset’s book value, the asset is recoverable, and no impairment loss is recognized.

For example, if a machine with a carrying amount of $100,000 is expected to generate $120,000 in future net cash flows, it passes the test and no action is needed.

If the asset fails the recoverability test, the second step is to measure the impairment loss. The loss is the amount by which the asset’s carrying amount exceeds its fair value. Fair value is the price that would be received for the asset in an orderly transaction, determined by a quoted market price or other valuation techniques.

If that same machine is expected to generate only $80,000 in cash flows, it fails the test. If its fair value is determined to be $70,000, the company must recognize an impairment loss of $30,000, which is the difference between the $100,000 carrying amount and its fair value.

This loss is reported on the income statement, and the asset’s carrying amount is written down to its new fair value of $70,000. This value becomes its new depreciable basis. An impairment loss recognized for an asset held and used cannot be reversed in a future period, even if its fair value recovers.

Accounting for Assets Held for Sale

When a company decides to sell a long-lived asset, the accounting treatment changes. To be classified as “held for sale,” an asset must meet several criteria:

• Management must be committed to a plan to sell the asset.
• The asset must be available for immediate sale in its present condition.
• The company has initiated an active program to locate a buyer.
• The asset is being marketed at a reasonable price relative to its current fair value.
• The sale is probable and expected to be completed within one year.

Once classified as held for sale, an asset is recorded at the lower of its carrying amount or its fair value less costs to sell. Costs to sell are the direct costs of the transaction, such as broker commissions and legal fees.

Depreciation also ceases once an asset is classified as held for sale. This reflects that the asset’s value is now tied to its sale price rather than its productive use. Subsequent declines in fair value less costs to sell are recognized as a loss, while subsequent increases can be recognized as a gain, but only up to the amount of cumulative losses previously recorded.

Reporting Discontinued Operations

The disposal of an asset group may be reported as a discontinued operation if it represents a strategic shift that will have a major effect on the company’s operations and financial results. To qualify, the disposal must involve a “component of an entity.”

A component is a part of an organization whose operations and cash flows can be clearly distinguished from the rest of the company, such as a subsidiary or a specific product line. The main consideration is whether the disposal fundamentally alters the nature of the company’s ongoing business.

When a disposal qualifies, its financial results are segregated from continuing operations on the income statement. This gives investors a clearer view of the company’s ongoing performance. The results are reported in a separate section after income from continuing operations.

This section presents two figures, net of tax: the operating income or loss of the component, and the gain or loss recognized on the sale of the component’s net assets. This presentation prevents the results of a major disposal from distorting the profitability trends of the continuing business.

Financial Statement Presentation and Disclosure

Disclosures for Impairment Losses

When a company recognizes an impairment loss, it must provide disclosures in its financial statement notes. The company must describe the impaired asset and the circumstances that led to the loss.

The amount of the loss must be disclosed, along with the income statement line item where it is included if not presented separately. The method used to determine the asset’s fair value must also be disclosed, specifying if it was based on market prices or a discounted cash flow analysis.

Disclosures for Assets Held for Sale/Discontinued Operations

For assets classified as held for sale, disclosures must describe the facts and circumstances of the expected disposal, including its manner and timing. The major classes of assets and liabilities in the disposal group must also be presented on the balance sheet or in the notes.

If the disposal qualifies as a discontinued operation, the company must also detail the carrying amounts of the major classes of assets and liabilities of the operation in the notes.