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Article Author:

Review Your Capital Assets for Possible Impairments

As we put the recent recession in our rearview mirror and look ahead to the anticipated greener pastures of 2010 and beyond, it may be appropriate to review your company’s capital assets (land, buildings, machinery, and equipment) for potential impairments.

U.S. Generally Accepted Accounting Principles (U.S. GAAP)  require us to evaluate intangible assets such as goodwill each year to determine if a potential impairment exists. However, the rules regarding capital assets do not require a similar systematic approach to impairment testing.

The accounting rules for capital assets to be held and used, such as land, buildings, machinery, and equipment, require these assets be tested for impairment whenever events or changes in circumstances indicate the asset or assets carrying amount (in the case of capital assets this would be the net book value) may not be recoverable. 

Events or changes in circumstances that indicate a potential impairment may include the following:

• A significant decrease in the market price of similar new or used equipment
• A significant adverse change in the manner in or extent to which the capital asset is being utilized. This could potentially include underutilized equipment or not utilizing equipment as originally intended.
• A change in the physical condition of equipment. This would include equipment that is damaged or potentially obsolete.
• Current period operating cash flow losses combined with a history of similar losses associated with the equipment 
• A projection or forecast of continued losses associated with the equipment 
• Greater than 50% likelihood that the equipment will be sold or disposed of prior to the end of its previously determined useful life

During times of economic expansion, the above factors may not be present. However, based upon the economic environment of the recent past and the fact that most manufacturers have realized significant decreases in volume and operating cash flows, the likelihood of the existence of one or more of these impairment indicators increases, potentially requiring the company to perform impairment testing of capital assets under U.S. GAAP.

Once it has been determined impairment testing is required, the test generally requires comparing the computed fair value of the asset or assets to the carrying amount (net book value) as of the date the asset is being tested. In many circumstances the fair value is computed as the sum of the undiscounted future cash flows expected to result directly from the use and eventual disposition of the asset being evaluated. An impairment loss is recognized as the amount by which the carrying amount of the asset exceeds its computed fair value.

However, be aware that the previous paragraph is a simplistic summary of the rules regarding capital asset impairments. In many cases the rules can be much more complex and may vary under different circumstances such as:

• Multiple assets are being evaluated as a group vs. the evaluation of the same assets individually. 
• The capital asset is no longer in use and is anticipated to be sold (held for sale)
• The capital asset is anticipated to be abandoned prior to its originally estimated useful life or has been temporarily idled

When performing the impairment analysis, make sure you review the rules under U.S. GAAP, and if necessary consult with your auditors. 

Finally, in addition to any initial impairment charge resulting from the write-down of a capital asset, it is important to understand all of the ways an impairment charge could impact your company’s financial reporting. For example, impairment charges could impact the following:

• Available borrowings under bank lines of credit secured by equipment 
• Compliance with bank covenants
• Amendments to inventory overhead rates resulting from reductions in prospective depreciation/amortization
• Revisions to future budgets and/or projections
• Changes to certain ratios being reported to shareholders and others
• Additional non-recurring financial statement disclosures

So, before you say your final farewell to 2009 and look optimistically to 2010 (and beyond), a timely comprehensive review of capital assets should be performed. The review should be designed to identify events or changes in circumstances that indicate a potential impairment and the need for additional impairment testing. The comprehensive review will help to avoid unexpected audit adjustments, will ensure impairment charges are properly recorded, and will allow company management to focus on the future with accurate financial reports and a clear focus.

For more information, please contact Ken McCreadie, Partner, at 312-980-2984 or your Blackman Kallick representative.


 

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.