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									Lecture Notes for Acct 592                                      Professor Teresa Gordon



         FASB 144 Impairment of Assets
Assets held for use
         Includes land, building, equipment, natural resources, and
         intangible assets
         FASB 147 specifies that intangibles from the banking
         industry are covered by FASB 144 rules:
                   Long-term customer relationship assets such as
                         Depositor-relationships intangible assets
                         Borrower-relationships intangible assets
                         Credit card holder Intangible assets


When should impairment be recognized?
                   Testing each asset each period would be too costly
                   Events or changes in circumstances indicate that its carrying
                   amount may not be recoverable


                            TRIGGERING EVENTS:
                            Decline in market value
                            Change in way asset is used or physical change in
                            asset
                            Adverse changes in legal factors or business climate
                            Accumulated costs in excess of amounts originally
                            expected to construct or acquire asset
                            Current expectation that, more likely than not, a long-
                            lived asset will be sold or disposed of significantly
                            before the end of its previously estimated useful life
                            Current period losses with history of operating or cash
                            flow losses associated with asset




4d60bf01-8a58-411a-8b70-600014cbd6be.doc                                        Page 1
Lecture Notes for Acct 592                                     Professor Teresa Gordon


To apply impairment tests
         A long-lived asset shall be grouped with other assets and
         liabilities at the lowest level for which identifiable cash
         flows are largely independent of the cash flows of other
         assets and liabilities.
         Primary asset approach
                   FASB 144 establishes a "primary-asset" approach to
                   determine the cash flow estimation period for a group of
                   assets and liabilities that represents the unit of accounting for
                   a long-lived asset to be held and used
                   Goodwill is included in the asset group only if the asset group
                   is a reporting unit (defined in FASB 142)
                   Other assets and liabilities (inventory, accounts payable, long-
                   term debt, etc) are to be properly valued in accordance with
                   GAAP prior to testing the asset group for recoverability

An impairment loss is recognized if . . .
         Carrying amount of asset (book value) is greater than undiscounted
         future cash flows related to use and disposal of asset
                            In other words, the carrying value is not recoverable
                            Note that an impairment can exist (that is, carrying
                            value can be less than fair value) but it is not
                            recognized as long as the future cash flows
                            (undiscounted) are greater than the carrying value.
         The asset is written down to fair value
         The fair value becomes the new carrying value (book value) and
         depreciation is recorded over remaining useful life
                   Restoration of a previously recognized impairment loss is
                   prohibited.




4d60bf01-8a58-411a-8b70-600014cbd6be.doc                                       Page 2
Lecture Notes for Acct 592                                                  Professor Teresa Gordon


Determining fair value
         FASB 144 describes a probability-weighted cash flow
         estimation approach to deal with situations in which
                   alternative courses of action to recover the carrying amount of
                   a long-lived asset are under consideration, or
                   a range is estimated for the amount of possible future cash
                   flows


Assets to be Sold vs. Abandoned
         New rules in FASB 144 distinguish between assets to be sold and
         those to be abandoned, exchanged or spun-off
         Problems with FASB 121
                   Under the old rules, there were two possible valuation
                   procedures
                            Net realizable value
                            Fair value less cost to sell
                   The effect was to recognize future operating losses
                            FASB decided that this violated the definition of a
                            liability


Long-lived assets to be disposed of by sale
         Classified as “held for sale” in period in which all of the
         following criteria are met:
                            1.        Management commits to a plan to sell the asset
                            2.        Asset is available for immediate sale in its present condition
                            3.        Active program to locate a buyer has been initiated
                            4.        Sale is probable within one year
                            5.        Asset is being actively marketed for a reasonable price
                            6.        It is unlikely that the plan to sell will be changed




4d60bf01-8a58-411a-8b70-600014cbd6be.doc                                                     Page 3
Lecture Notes for Acct 592                                               Professor Teresa Gordon


         Measurement
                   Write asset down to the LOWER of
                            Carrying amount
                            Fair value less cost to sell (see definitions below)
                                             Stop depreciating the asset


                            Costs to sell
                                      Includes incremental direct costs to transact the sale
                                           Broker commissions
                                           Legal & title transfer fees
                                           Closing costs
                                      Generally does not include costs to protect or
                                      maintain asset
                                           Insurance
                                           Security services
                                           Utility expenses
                                      The cost to sell are discounted to present in special
                                      circumstances when the sale is more than one year in the
                                      future




4d60bf01-8a58-411a-8b70-600014cbd6be.doc                                                 Page 4
Lecture Notes for Acct 592                                                         Professor Teresa Gordon




             Do events and
                                                          Is carrying value >
        circumstances indicate a
                                            Yes          anticipated cash flows           Yes
             need to assess
                                                            (undiscounted)?
              impairment?




                No
                                                                No




                                                                                   Are quotes prices in active
                                                               Yes                markets available as basis for
                                                                                    fair value determination?




          No impairment is                                                                      No
         recorded. Asset is
       reported at its carrying
               value


                                                                                      Can fair value be
                                                               Yes                estimated based on Mkt
                                                                                  Value of similar assets?




                                                                                                No

   FASB 144 -
  Impairment of                                                                       Determine FV by
  Assets To Be                                                                     discounting anticipated
                                                                                      future cash flows
  Held and Used
                                           Record impairment loss =
                                             to excess of carrying
                                             value over fair value




4d60bf01-8a58-411a-8b70-600014cbd6be.doc                                                                    Page 5
Lecture Notes for Acct 592                                  Professor Teresa Gordon



Assets to be disposed of other means
         •Situations include:
                   –Abandonment
                   –Exchange for similar productive asset
                   –Distribution to owners in a spinoff
         •The asset shall continue to be classified as “held and
         used” until it is disposed of

Assets to be disposed of other means
         •Asset stays in PP&E
                   –Depreciation estimates should be revised to reflect shortened
                   life


         •Depreciation ends and a gain or loss is recorded when
         the property is “disposed of”

The “disposed of” date:
         •Abandoned
                   –The date it ceases to be used
         •Exchanged or distributed to owners through a spinoff
                   –The date when it is exchanged or distributed




4d60bf01-8a58-411a-8b70-600014cbd6be.doc                                    Page 6
Lecture Notes for Acct 592                                        Professor Teresa Gordon



Impairment Example 1
         Johnson Company purchased equipment 8 years ago for $1,000,000. The
         equipment has been depreciated using the straight-line method with a 20-year
         useful life and 10% residual value. Johnson's operations have experienced
         significant losses for the past 2 years and, as a result, the company has decided
         that the equipment should be evaluated for possible impairment. The management
         of Johnson Company estimates that the equipment has a remaining useful life of 7
         years. Net cash inflow from the equipment will be $80,000 per year. The fair
         value of the equipment is $240,000. No goodwill was associated with the
         purchase of the equipment.

(a)    Determine if an impairment loss should be recognized.

What is the book value of the asset?
       (We need to first figure out how much is in accumulated depreciation.)




What are the projected cash flows from asset?



(b)    Determine the amount of the loss and prepare the journal entry to record the
       loss.

                                                                     Debit            Credit




(c)    What journal entry should Johnson Company make if future cash flows
       related to the equipment were $980,000 in total?

                                                                     Debit            Credit




4d60bf01-8a58-411a-8b70-600014cbd6be.doc                                              Page 7
Lecture Notes for Acct 592                                         Professor Teresa Gordon


                               Impairment Example/Homework 2
         Howard Company purchased a manufacturing facility 8 years ago on January 8,
         1994 for $10,000,000. The facility has been depreciated using the straight-line
         method with a 20-year useful life and 10% residual value. Howard’s operations
         have experienced significant losses for the past 2 years and, as a result, the
         company has decided that the facility should be evaluated for possible impairment
         at December 31, 2001. The management of Howard Company estimates that the
         facility has a remaining useful life of 7 years. Net cash inflow from the facility
         will be $800,000 per year. The fair value of the facility (using present value
         techniques) is estimated to be $3,400,000. No goodwill was associated with the
         purchase of the equipment.

(a)    Determine if an impairment loss should be recognized.




(b)    If appropriate, determine the amount of the loss and prepare the journal entry to
       record the loss.




4d60bf01-8a58-411a-8b70-600014cbd6be.doc                                              Page 8
Lecture Notes for Acct 592                                      Professor Teresa Gordon


         Johnson Co. - Impairment of Assets Example 1 – solution

(a) Annual depreciation for the equipment has been $45,000 ($1,000,000 - $100,000)/20
years. Current book value of the equipment is:
              Original cost ........................................      $1,000,000
                                                                             360,000
              Book value ...........................................       $ 640,000

According to FASB 144, the existence of impairment is determined by comparing book
value of $640,000 to the undiscounted future cash flows of $560,000. The fair value is
lower, so an impairment loss should be recognized.

(b) The impairment loss is equal to the $400,000 ($640,000 - $240,000) difference
between the book value of the equipment and its fair value. The impairment loss would
be recorded as follows:
                                                                   Debit          Credit
Accumulated Depreciation--Equipment ........                     360,000
Loss on Impairment of Equipment ............                     400,000
    Equipment ($1,000,000 - $240,000) ........                                  760,000

(c) Since the future cash flows (undiscounted) equal $980,000 and this amount is greater
than the book value of $640,000, Johnson Company will not do anything. No
impairment is recognized and no upward revaluation is recorded.




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