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Impairment of long-lived assets held and used · PwC's accounting podcast

• 0:00
  SPEAKER_00: Thought Leadership from PWC's National Office.
• 0:06
  SPEAKER_01: Welcome to PWC's Accounting Podcast.
• 0:09
  SPEAKER_01: I'm Heather Horn.
• 0:11
  SPEAKER_01: It's March, and for this month of podcasts, we're going to cover topics from our second most popular accounting guide, property, plant, and equipment.
• 0:20
  SPEAKER_01: And in this first episode, we'll focus on one of the most popular sections of this very popular guide, and that would be talking about impairments of long-lived assets.
• 0:30
  SPEAKER_01: I think it's no surprise that it's so popular because even though guidance has not changed much over time, there are many key judgments and complexities.
• 0:39
  SPEAKER_01: So you definitely want to listen carefully.
• 0:41
  SPEAKER_02: You know, companies have to think about the combined effect of all the facts of circumstances when determining if an impairment trigger has occurred, indicating it's more likely than not that the fair value is below the carrying value.
• 0:56
  SPEAKER_01: That was Beth Paul, Deputy Chief Accountant in PWC's national office, and she leads our acquisitions, divesters, and consolidation team.
• 1:05
  SPEAKER_01: Beth has a lot of great insights about all of the considerations for impairment of long-lived assets, so stay tuned.
• 1:12
  SPEAKER_01: So, Beth, welcome to the podcast, and thanks for being back on to talk about one of our PPE topics.
• 1:19
  SPEAKER_01: And I love the fact that PPE is actually our second most popular guide, which, you know, it's not something that I would have necessarily thought, but it's an important topic for a lot of companies, obviously.
• 1:31
  SPEAKER_01: And the topic we're talking about today is one of the most popular topics in the PPE guide.
• 1:37
  SPEAKER_01: Um, and that would be impairment of long-lived assets.
• 1:40
  SPEAKER_01: But before we get into any of the specifics, I was hoping you could kind of set the stage and give your perspective on why this is such an important topic.
• 1:48
  SPEAKER_02: Certainly, and thanks for having me again, Heather.
• 1:50
  SPEAKER_02: It's always glad to be here in the studio.
• 1:52
  SPEAKER_02: A lot of energy here in New York.
• 1:53
  SPEAKER_02: So we're gonna be covering several very interesting and relevant topics today and throughout the month.
• 1:59
  SPEAKER_02: But specifically today, I really want to focus on long-lived assets that are held and used, as opposed to those that are held for sale, which we're gonna cover in the next episode.
• 2:07
  SPEAKER_02: We did cover some of these impairment topics back in our 2022 impairment toolkit series.
• 2:13
  SPEAKER_02: And today I'm gonna use the time to really highlight some of the important things to keep in mind when identifying your asset groups and your impairment triggers.
• 2:21
  SPEAKER_02: And we'll take a deeper dive into the two-step impairment model.
• 2:24
  SPEAKER_01: Yeah, and it's crazy because I was thinking 2022 that just happened, but in fact, that was two years ago.
• 2:30
  SPEAKER_01: So it's a good time to be to be back in the topic.
• 2:33
  SPEAKER_01: So before getting into the model, can you just remind the audience which assets are actually covered by what we're going to be talking about today?
• 2:41
  SPEAKER_02: Yeah, certainly.
• 2:42
  SPEAKER_02: In general, when we discuss assets that are held in use, we're talking about long-lived assets.
• 2:47
  SPEAKER_02: And those are those that are governed by ASC 360 for those that like those types of references.
• 2:52
  SPEAKER_02: But for the average person, let's think about things like PPE.
• 2:55
  SPEAKER_02: So we're talking land, building, machinery, and equipment, and your finite lived intangible assets like your customer lists.
• 3:01
  SPEAKER_02: It's also important to know that in the scope of this are the right of use assets that relate to, you know, leases, which is sort of a newer phenomenon as we've now put those assets on our books.
• 3:13
  SPEAKER_02: We also scope in proved oil and gas properties that use the successful effort method, and long-term prepaid assets.
• 3:21
  SPEAKER_02: A few examples of assets that aren't in scope, goodwill, your indefinite lived intangible assets, sometimes things like trade names, um unproved oil and gas properties, and deferred taxes, just to name a few.
• 3:33
  SPEAKER_02: There are also scope exclusions for the accounting for certain specific industries that there have their own guidance.
• 3:39
  SPEAKER_02: So probably near and dear to you, you know, the regulated entities, we've got music industry, broadcasting software, those have some specific, industry-specific things out there.
• 3:48
  SPEAKER_01: And I guess maybe pausing you there, Beth, for both the things that are out of scope, because you mentioned like goodwill, indefinite lives and tangibles, et cetera, and then these industry-specific ones as well.
• 3:58
  SPEAKER_01: It's not that you don't have to think about impairment.
• 4:00
  SPEAKER_01: I know our listeners know that, but I think it's worth saying.
• 4:02
  SPEAKER_01: It's just that there are other models that are followed, as you reference, like for regulatory assets, which you are right.
• 4:08
  SPEAKER_01: That is very near and dear to me.
• 4:10
  SPEAKER_01: So anyway, I'm sure there's more to think about, but I just wanted to make sure we made that point.
• 4:13
  SPEAKER_02: Yeah, that's right.
• 4:14
  SPEAKER_02: We're gonna address those assets in different models.
• 4:16
  SPEAKER_02: It's also important to remember that there's a separate model for assets held for sale, and you have certain requirements to meet held for sale, and we're gonna cover that actually in our next uh podcast in this series.
• 4:28
  SPEAKER_02: So stay tuned for that.
• 4:29
  SPEAKER_01: Okay, great.
• 4:30
  SPEAKER_01: And then um maybe one other question.
• 4:31
  SPEAKER_01: This is always a good place to have a reminder, the level of the testing, and I know sometimes that has some implications.
• 4:39
  SPEAKER_01: Yeah, I think that's really important.
• 4:40
  SPEAKER_02: So when we're talking about long-lived assets that are held and used, we're gonna be thinking about the asset group level.
• 4:45
  SPEAKER_02: And getting your asset group level correct is gonna be really be your first step in your impairment analysis.
• 4:51
  SPEAKER_02: At its core, an asset group is meant to represent the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets.
• 5:00
  SPEAKER_02: It is possible for an individual long-lived asset to have independent cash flows and therefore be tested individually for impairment.
• 5:07
  SPEAKER_02: In the majority of cases, a long-lived asset generates cash flows alongside with you know other assets, right?
• 5:13
  SPEAKER_02: You think about I've got the building, that's my plant.
• 5:16
  SPEAKER_02: Well, the building itself, you know, you need all the machinery and equipment and all this stuff inside it to make that asset group.
• 5:23
  SPEAKER_02: So oftentimes the groups are comprised not only of those long-lived assets, but also things like inventory and indefinite lived intangibles.
• 5:30
  SPEAKER_02: And depending on the asset group and whether it's also a reporting unit, it could have goodwill.
• 5:35
  SPEAKER_02: The carrying amount of any asset in the asset group that are not long-lived assets, excluding goodwill, should be adjusted for impairment as necessary before we test our long-lived assets for impairment under the held and use model.
• 5:47
  SPEAKER_02: Determining your asset group at the appropriate level is going to be critical because ultimately you wanna make sure that cash flows from one asset group are not inappropriately shielding any shortfalls in cash flows in your asset group.
• 5:59
  SPEAKER_02: Like you're not putting things together and therefore avoiding an impairment inappropriately.
• 6:03
  SPEAKER_02: And I'll talk a little bit more deeply about that recoverability test as we get further into this podcast.
• 6:09
  SPEAKER_01: So then, Beth, I think this can be very difficult to figure out exactly what are your asset groups.
• 6:16
  SPEAKER_01: And I always feel like this is something that we recommend people should not be doing like sort of on the fly when you're trying to look for impairment.
• 6:23
  SPEAKER_01: But anything specific that you would recommend in terms of looking at how to identify the asset group.
• 6:29
  SPEAKER_02: Yeah, so at a high level, you want to really think about the operating characteristics that are entity specific to the company.
• 6:35
  SPEAKER_02: And so you're going to look at are there interdependencies of revenues between asset groups?
• 6:40
  SPEAKER_02: You're going to look at the extent and nature of shared cost structures, you're going to look at the interchangeability of assets that a company is using in their operations, and then how the assets are being managed and used by the company.
• 6:52
  SPEAKER_01: All right.
• 6:52
  SPEAKER_01: So the first one you mentioned, the interdependency of revenues, that is more complicated than it may sound.
• 6:58
  SPEAKER_01: And so what are some of the things that you would look for when you're making that evaluation?
• 7:02
  SPEAKER_01: Yeah, you're right, Heather.
• 7:03
  SPEAKER_02: I mean, this is definitely an area we get questions on.
• 7:05
  SPEAKER_02: And I think it's helpful to walk through a quick example.
• 7:08
  SPEAKER_02: So I'm gonna say, let's pretend we have a company and they provide distribution of a product throughout a portion of the Northeast, since that's where I'm from, under a single contract, and this contract requires a minimum level of service in four states.
• 7:20
  SPEAKER_02: So the delivery vehicles and the related distribution centers that service each state are identifiable, right?
• 7:26
  SPEAKER_02: Immeasurable.
• 7:26
  SPEAKER_02: We can figure that out on our own.
• 7:28
  SPEAKER_02: But let's also assume, my example, I've got one state that's really kind of operating, you know, inefficiently, it's at a deficit.
• 7:35
  SPEAKER_02: This deficit is going to cause that to be sort of unrecoverable on its own.
• 7:39
  SPEAKER_02: So now the question is, but am I looking at it on its own or as a group?
• 7:43
  SPEAKER_02: And since in my example, I said that the contract includes a minimum level of service in four states, the distribution in the other three states is dependent on the company continuing to operate in that unprofitable state.
• 7:56
  SPEAKER_02: This would lead us to believe the revenue streams associated with each state are dependent on each other, and the contract encompassing all four distribution areas would be the right level to group your assets at.
• 8:06
  SPEAKER_02: Let's contrast that to a situation in which the distributor could choose to exit any of the individual states.
• 8:10
  SPEAKER_02: In that instance, it's likely we're looking at those as four distinct asset groups.
• 8:14
  SPEAKER_02: And, you know, I could tweak this example a bunch of different ways, but let's just say I tweak it such that there's only one distribution center.
• 8:21
  SPEAKER_02: It is used for all four states, and my customers, you know, they are operating in the different states as well.
• 8:26
  SPEAKER_02: So it's really hard for me to figure out which states relate to which revenues because the customers are kind of across it, and I kind of have the shared asset.
• 8:35
  SPEAKER_02: In that case, the recoverability test might be sort of in my example at that NT-wide basis, because I'm just off operating in that one region.
• 8:41
  SPEAKER_02: And that would be a situation where we would estimate whether the NT as a whole would generate sufficient cash flows to recover the carrying amount of all the assets.
• 8:50
  SPEAKER_01: So you definitely anticipated my question because I was going to ask about a single distribution center.
• 8:55
  SPEAKER_01: And so what I take away from this though is it's really important to make sure you fully understand the contractual arrangements and the operations before you decide where your asset group should be defined.
• 9:07
  SPEAKER_02: Yeah, that's right.
• 9:08
  SPEAKER_01: All right.
• 9:08
  SPEAKER_01: And definitely the example I think helps a lot in terms of illustrating that.
• 9:12
  SPEAKER_01: So then we talked about the shared distribution center.
• 9:15
  SPEAKER_01: But what if we have a case then where there's assets shared across the entire company?
• 9:20
  SPEAKER_01: So again, if I take your example with my, you know, I have distributions in the Northeast, but let's say also I'm in California and there's one corporate center.
• 9:28
  SPEAKER_01: How do you think about that?
• 9:30
  SPEAKER_01: Yeah, I think that's a great question.
• 9:31
  SPEAKER_02: You might hear, you know, a corporate asset referred to as sort of an enterprise or entity-wide asset.
• 9:37
  SPEAKER_02: And they don't really have separate identifiable cash flows on their own.
• 9:41
  SPEAKER_02: So how do we think about them?
• 9:42
  SPEAKER_02: Well, what we usually do is we evaluate the recoverability of an entity-wide asset based on the entire company, which would be dependent on the net cash flows of the lower level asset groups.
• 9:53
  SPEAKER_02: So operationally, this would happen after you test the recoverability of the lower level groups.
• 9:59
  SPEAKER_02: While the standard doesn't provide explicit guidance on how to perform the impairment tests for entity-wide assets, one common approach we see in practice is referred to as the residual approach.
• 10:08
  SPEAKER_02: And when applying the residual approach, a company first tests the lower level and based on its undiscounted cash flows, and then those undiscounted cash flows would include an imputed charge for the use of the shared asset as appropriate.
• 10:20
  SPEAKER_02: Next, the company would accumulate the excess undiscounted cash flows from all the recoverability tests for all those lower level asset groups, add back any imputed charge for the lower level asset groups for the use of the enterprise asset, and subtract cash flows for any expenses directly attributable to the enterprise asset.
• 10:37
  SPEAKER_02: And if the carrying amount of the entity-wide assets is greater than the amount we just calculated, then an impairment loss should be recognized based on the fair value of the asset compared to the carrying value.
• 10:48
  SPEAKER_01: So, Beth, if we have our scenario where we're we're distributing in the Northeast and then also California, and we have this issue in the Northeast, does that automatically mean that we have to test these enterprise-wide assets or you could trigger a test for the enterprise-wide assets on its own?
• 11:06
  SPEAKER_02: Like all things, it probably depends.
• 11:08
  SPEAKER_02: I mean, if you had a trigger in the Northeast and that was pretty significant, right?
• 11:12
  SPEAKER_02: And so you know you're not gonna have a lot of excess or any excess cash flows there, I guess depending on how significant that was to the, in your scenario, the West Coast, it could say, oh, I might have problems elsewhere because I don't think I'm going to have enough excess to cover at the top.
• 11:27
  SPEAKER_01: Yeah.
• 11:27
  SPEAKER_01: So basically, if I'm a company with lots of asset groups, if I have a problem in one, it's not necessarily isolated because it could also impact some of these enterprise-wide assets.
• 11:37
  SPEAKER_01: Is that a fair That's fair?
• 11:38
  SPEAKER_01: Okay.
• 11:39
  SPEAKER_01: That's helpful to think about.
• 11:40
  SPEAKER_01: And then I think the other question that I know we often get is okay, now I've set my asset groups.
• 11:45
  SPEAKER_01: Can I change them?
• 11:46
  SPEAKER_02: You you can change them if facts and circumstances change.
• 11:49
  SPEAKER_02: And not only can you can, but in certain situations you have to, right?
• 11:52
  SPEAKER_02: Like it's not a set it and forget it.
• 11:54
  SPEAKER_02: You know, if the company has a significant change in how it operates or the way the long-lived assets are being used in the day-to-day, we could see a change in the interdependency of the cash flows, in which case, a change in your asset group may be appropriate.
• 12:07
  SPEAKER_02: When a change in your asset group occurs, this is going to be accounted for prospectively, similar to a change in estimate.
• 12:13
  SPEAKER_02: We have seen this more recently as companies consider what they may do with excess office space and whether those resources might be redeployed in the sublease market as opposed to be using, I'll say, in their core operations.
• 12:25
  SPEAKER_02: In those situations, the asset group might switch from being part of that operational asset group, whatever it was, your distribution, however it was, to sort of a separate now asset group of your sublease activity.
• 12:36
  SPEAKER_02: Companies should also think about whether the changes in facts and circumstances that brought about the change in the asset group could be an impairment indicator.
• 12:43
  SPEAKER_02: And when there are changes in how an asset group is going to be used, this could also result in a change in the useful lives.
• 12:49
  SPEAKER_02: So you've got to kind of think through all of the pieces.
• 12:51
  SPEAKER_01: All right.
• 12:52
  SPEAKER_01: So to your point then, even maybe I test, I don't have an impairment, but I still may need to change the useful life of my asset.
• 12:58
  SPEAKER_01: Or if I have an impairment also.
• 13:00
  SPEAKER_01: So and then, Beth, with all that background, then you started touching on this earlier.
• 13:05
  SPEAKER_01: But now that we have our asset groups, then how does what does the company need to do to determine if it's time, if you have this trigger you referenced to test for impairment?
• 13:16
  SPEAKER_02: Yeah, that's right.
• 13:17
  SPEAKER_02: So long-lived assets don't require an annual test like we see for Goodwill and Indefinite Lived.
• 13:22
  SPEAKER_02: So you really are looking at whether there is an event or a circumstance change that's a trigger event.
• 13:29
  SPEAKER_02: And these trigger events are circumstances that indicate it's sort of more likely than not that the carrying amount of the asset may not be recoverable.
• 13:37
  SPEAKER_01: All right.
• 13:38
  SPEAKER_01: And so this is another place where I know there's some examples in the guidance, and it's helpful to talk through them.
• 13:43
  SPEAKER_02: Yeah, I mean, the guidance provides a list.
• 13:45
  SPEAKER_02: It's certainly important to remember the list is not all inclusive, and there could be other company-specific facts or circumstances, such as a decline in stock price, or maybe your goodwill was impaired, so you had a trigger there.
• 13:56
  SPEAKER_02: That might suggest you have a trigger in your um 360 assets.
• 14:00
  SPEAKER_02: But a few things to consider that are in the standard are you know, has there been adverse change in the way the assets are being used or the extent of their usage?
• 14:08
  SPEAKER_02: This could be due to a change in laws or regulations.
• 14:10
  SPEAKER_02: For example, will the company need to switch to a more eco-friendly production?
• 14:14
  SPEAKER_02: Or is just consumer preferences changing?
• 14:17
  SPEAKER_02: Or is there that kind of change that will drive an impact?
• 14:20
  SPEAKER_02: Has there been a change in the physical condition of the assets?
• 14:23
  SPEAKER_02: Is the asset group producing operating losses or negative cash flows?
• 14:27
  SPEAKER_02: Um, are there instances where a long-lived asset group is being constructed?
• 14:30
  SPEAKER_02: If that's the case and we're starting to see accumulation of costs that are exceeding the amount initially budgeted for, this could be an indicator it's time to look at impairment.
• 14:38
  SPEAKER_02: We also see instances when a company may determine it's more likely than not that the long-lived asset will be sold or disposed of before the end of its useful life.
• 14:45
  SPEAKER_02: So it's important to remember that when a company identifies one of these events, it's not automatically conclusive that the asset group may not be recoverable.
• 14:52
  SPEAKER_02: You know, companies have to think about the combined effect of all the facts and circumstances when determining if an impairment trigger has occurred, indicating it's more likely than not that the fair value is below the carrying value.
• 15:02
  SPEAKER_01: Yeah, and it's interesting, Beth, to your point about assets being constructed, because when you think about held and used, then you think, oh, well, an asset under construction is not in use yet.
• 15:11
  SPEAKER_01: But to your point, those often can be an area depending on you know facts and circumstances where you could have an impairment.
• 15:18
  SPEAKER_01: So then, Beth, what if you identify this indicator, but it's only for like one asset in the group?
• 15:24
  SPEAKER_01: And you gave some good examples earlier where you have multiple assets.
• 15:28
  SPEAKER_01: Um, what how do you think about that?
• 15:30
  SPEAKER_01: Yeah, another great question.
• 15:31
  SPEAKER_02: I mean, because we get it a lot, right?
• 15:32
  SPEAKER_02: Like, for example, a company might come in and say, look, we're aware our lease payments for a piece of equipment used in a manufacturing facility are above market.
• 15:40
  SPEAKER_02: So that indicates that the fair value of the related right of use asset may be below its carrying value.
• 15:45
  SPEAKER_02: And so they're saying, you know, can we sort of test that by itself?
• 15:48
  SPEAKER_02: And in those cases, you know, if it's part of a larger asset group, no, you're testing the asset group.
• 15:52
  SPEAKER_02: And so then you have to think about how significant the asset is to the overall asset group.
• 15:57
  SPEAKER_02: If it's insignificant to the broader asset group, the presence of the indicator may not trigger the need to test that whole asset group.
• 16:03
  SPEAKER_02: On the other hand, right, if it is significant to the asset group, then we might need to move on to that recoverability test.
• 16:09
  SPEAKER_01: All right, so then let's assume we do have a trigger and it is for our whole asset group.
• 16:14
  SPEAKER_01: Then what should you think about?
• 16:16
  SPEAKER_02: Yeah, so this is where we got to think about the sort of ordering of the test.
• 16:20
  SPEAKER_02: So first thing you need to do is you have to test other assets such as receivables, inventory, and indefinite lived intangibles in the asset group before you test your long-lived assets.
• 16:30
  SPEAKER_02: When it comes time for the long-lived asset impairment test, the first step is going to be focused on their recoverability.
• 16:35
  SPEAKER_02: And this is done by comparing the carrying value of the asset group to the entity-specific undiscounted net cash flows that will be generated by the use and eventual disposition of the asset group.
• 16:46
  SPEAKER_02: And in practice and throughout this podcast, I call that the recoverability test.
• 16:49
  SPEAKER_02: Right.
• 16:49
  SPEAKER_02: Right.
• 16:50
  SPEAKER_02: And so if your asset group is determined to be recoverable, this means that the undiscounted cash flows are greater than the carrying value, and you're done.
• 16:57
  SPEAKER_02: That is, even if you know that if you went to the next test part and looked at carrying value versus fair value, there'd be an impairment, you you don't move on because if you don't fail a recoverability test, you can't kind of go to step two.
• 17:09
  SPEAKER_02: On the flip side, if the asset group is not recoverable, an impairment loss will be recorded when the amount of the carrying value exceeds the fair value.
• 17:16
  SPEAKER_01: So about this whole um undiscounted cash flows test, I know sometimes for companies almost can cause a frustration because to your point, they they quote, know that the underlying asset is, in their view, impaired, but yet they've passed this test.
• 17:32
  SPEAKER_01: And so this may be um testing your long-term memory.
• 17:36
  SPEAKER_01: But do you know why the FASB took this approach, like this two-step approach or sort of the theory behind it?
• 17:44
  SPEAKER_02: I do think it's going to, right, like you're not planning on disposing of that asset currently.
• 17:49
  SPEAKER_02: You are holding and use and using the asset.
• 17:52
  SPEAKER_02: And so you're trying to look at, okay, in that model, looking at the group as a whole, am I going to still receive the benefit, right?
• 18:00
  SPEAKER_02: Because if you record, I'll say too many impairments or we break everything down too soon, you you're not going to have assets to depreciate.
• 18:07
  SPEAKER_02: And one might say inadvertently, you know, increase your margins and things like that.
• 18:12
  SPEAKER_02: Yeah.
• 18:12
  SPEAKER_01: Or like mismatchings.
• 18:14
  SPEAKER_01: Because I guess basically to your point, and I hadn't thought about it this way, you actually are going to make, quote, make money over the life of the asset if the undiscounted cash flows demonstrate that.
• 18:24
  SPEAKER_01: So it's an interesting point.
• 18:26
  SPEAKER_01: And again, I had this debate a few times.
• 18:28
  SPEAKER_01: So I was just curious the thinking there.
• 18:31
  SPEAKER_01: And then so let's we're still talking about this recoverability test, and I know there are a lot of considerations.
• 18:38
  SPEAKER_01: So what are some of the key ones that you would highlight?
• 18:41
  SPEAKER_02: Yeah.
• 18:41
  SPEAKER_02: So the recoverability test is a company specific test.
• 18:46
  SPEAKER_02: And it's an undiscounted cash flow test based on the expected use of the asset and its eventual disposition by the company.
• 18:54
  SPEAKER_02: This is different than market participant assumptions that would be used to measure the asset group fair value.
• 18:59
  SPEAKER_02: These cash flow estimates will include current conditions and assumptions, all that exist as in the measurement date, which is your triggering event date, and it doesn't consider subsequent events.
• 19:09
  SPEAKER_02: This is another subjective area to the overall impairment assessment and requires judgment by the company.
• 19:14
  SPEAKER_02: Because all of your inputs to the estimates of future cash flows should generally be consistent with assumptions you're using, you know, in your internal budgets and projections, unless those include capital expenditures to expand operations versus existing sort of maintaining service levels you have today.
• 19:30
  SPEAKER_02: The projections of the expected cash flows will include all cash inflows expected from the use of the asset over the remaining useful life of the primary asset, and any cash outflows necessary to obtain those projected cash inflows and cash flows associated with the eventual disposition of the asset.
• 19:47
  SPEAKER_02: It's important to remember your inflows will be based on existing service potential.
• 19:51
  SPEAKER_02: And I know I just said that, but it's really important to make sure because sometimes those capital improvements are in those numbers, and we have to remember to deal with that.
• 19:58
  SPEAKER_02: Cash outflows would also include all costs directly attributable to the asset, regardless of which legal entity incurs the cost.
• 20:06
  SPEAKER_02: So for example, sometimes expenses directly attributable to an asset group are incurred at the corporate level.
• 20:11
  SPEAKER_02: But we need to include those in our cash flows.
• 20:14
  SPEAKER_02: So this could come into play when we have those shared assets that I mentioned earlier, and you got to think about imputed charge, or sometimes it's just things like employee comp.
• 20:21
  SPEAKER_02: You know, sometimes those are just recorded at the corporate level, but those are the employees running the machines, and so we got to make sure we're putting those costs down there and that we allocate those on a reasonable and rational basis.
• 20:32
  SPEAKER_02: In developing your cash flow estimates for the recoverability test, it's important to consider whether to use a single set of cash flows that represents management's best estimate of the most likely outcome within a range of possible estimates, or the use of an expected cash flow approach, which includes a set of cash flows that in theory represent the probability weighted average of all possible cash outflows.
• 20:53
  SPEAKER_02: So something for a company to consider as well.
• 20:55
  SPEAKER_01: And Beth, do you normally see one approach versus the other, or it really just depends on facts and circumstances?
• 21:03
  SPEAKER_02: It depends.
• 21:03
  SPEAKER_02: I think we see sort of the use of um the probability weighted when companies might be thinking about strategic alternatives.
• 21:11
  SPEAKER_02: So we're not yet to held for sale or but companies are thinking about maybe different ways to monetize.
• 21:17
  SPEAKER_02: And so they'll think about a probability-weighted average.
• 21:19
  SPEAKER_01: All right, that's helpful.
• 21:20
  SPEAKER_01: And then Beth, one of the points you made there, you were talking about um employee costs or maybe shared costs or other costs.
• 21:27
  SPEAKER_01: And often, as you pointed out, it's not so tidy as to have like separate books for this asset group to identify what should be included.
• 21:35
  SPEAKER_01: So, how what are the types of things companies should be thinking about in terms of which cash flows should be included in which asset group?
• 21:43
  SPEAKER_01: Yeah, that's correct.
• 21:44
  SPEAKER_02: I mean, determining whether certain cash flows should be included or excluded also requires judgment.
• 21:50
  SPEAKER_02: And one example is principal and interest payments on debt.
• 21:53
  SPEAKER_02: Those are generally excluded because they usually don't represent the lowest level of identifiable cash flows.
• 21:59
  SPEAKER_02: You know, a lot.
• 22:00
  SPEAKER_02: Times it's corporate level debt.
• 22:01
  SPEAKER_02: However, there are instances where it might be appropriate to include the debt in the funding of the asset group if it sort of directly relates to it.
• 22:09
  SPEAKER_02: And then you include the principal payments, but not the interest of payments, because interest is really more about capitalization of an entity, not its operations.
• 22:18
  SPEAKER_02: And the principal guidance is that similar asset groups should not yield different results because of how they were capitalized, the structure, right?
• 22:27
  SPEAKER_02: Debt versus equity.
• 22:28
  SPEAKER_02: Another area that requires judgment is contingent obligations.
• 22:32
  SPEAKER_02: So the standard is very specific on AROs, asset retirement obligations.
• 22:37
  SPEAKER_02: And in those situations, it's clear that an estimated future cash outflows related to these are excluded from the recoverability test and the fair value based on the standard.
• 22:48
  SPEAKER_02: One important reminder is that since you exclude these costs from the undiscounted cash flows used in the recoverability test, you also need to exclude any obligation from the carrying amount so that you're kind of doing an apples to apples comparison.
• 23:00
  SPEAKER_02: Environmental liabilities, there's some very specific guidance in the standard.
• 23:05
  SPEAKER_02: And so I would really encourage anyone that has those related to an asset group to either look at our PPE guide or read the standard.
• 23:10
  SPEAKER_02: It's a little bit uh tricky there.
• 23:12
  SPEAKER_02: And then finally, for other contingent payments, something we see, you know, under GAP, when you have contingent liabilities, you don't record those to the probable and reasonably estimable.
• 23:22
  SPEAKER_02: But from a cash flow perspective, such potential cash outflows may need to be considered if they relate to the asset group and the losses sort of possible, right?
• 23:31
  SPEAKER_02: Because that would be in there.
• 23:32
  SPEAKER_02: So that's something to consider.
• 23:33
  SPEAKER_02: And then another question I get a lot is you know, Beth, should I do this pre-tax or post-tax?
• 23:37
  SPEAKER_02: And I would say the guidance doesn't answer that question.
• 23:40
  SPEAKER_02: It doesn't specifically address it.
• 23:41
  SPEAKER_02: But in practice, what I'm seeing is most people do this on a pre-tax basis.
• 23:45
  SPEAKER_02: All right.
• 23:45
  SPEAKER_01: So then, Beth, as the company is calculating this projected cash flow estimate, how should they think about the period?
• 23:51
  SPEAKER_01: And again, this is a question that I know is probably top of mind for companies as they're going through this process.
• 23:59
  SPEAKER_02: Yeah, I mean, to determine the appropriate time period used to estimate the future cash flows, the company first needs to identify what's known as the primary asset.
• 24:06
  SPEAKER_02: Um, and that's the life once you identify it that you're going to use for the cash flows.
• 24:11
  SPEAKER_02: So the primary asset of the group is going to be the principal asset used that is the most significant driver of the cash flows of the asset group.
• 24:18
  SPEAKER_02: And it has to be an asset that is depreciated.
• 24:21
  SPEAKER_02: So it can't be something like an indefinite lived intangible, or it can't be land.
• 24:25
  SPEAKER_02: So it's generally the asset in the group that has the longest remaining useful life, the one that generally requires the greatest level of investment to replace, and it's the one that without the other asset groups or the other assets in the asset group may not have been acquired.
• 24:39
  SPEAKER_02: So in our early example of the distributor, um, you know, you might think about the distribution facility.
• 24:44
  SPEAKER_02: That might be the primary asset.
• 24:46
  SPEAKER_02: It likely has the longest life, it likely requires the greatest investment, and so it probably meets that criteria.
• 24:52
  SPEAKER_02: But again, everything is really facts and circumstances, so you do want to get into it.
• 24:56
  SPEAKER_02: If the primary asset in your asset group is not the asset with the longest life, then the estimated future cash flow should be based on the assumption that the asset group will be sold at the end of the useful life of the primary asset.
• 25:08
  SPEAKER_02: This will commonly be referred to as the residual value of the asset group.
• 25:11
  SPEAKER_02: And in measuring the residual value, you consider how to maximize the value of the asset group upon the assumed sale.
• 25:17
  SPEAKER_02: And in doing so, you take into account cash outflows associated with any future expenditures needed to maintain that level of service I talked about before.
• 25:25
  SPEAKER_02: So we're thinking about repairs and maintenance, but not contemplating like capital expansions and those types of things.
• 25:30
  SPEAKER_01: All right, that's helpful.
• 25:31
  SPEAKER_01: So then, Beth, all of this, and we're actually still on step one.
• 25:35
  SPEAKER_01: That's right.
• 25:36
  SPEAKER_01: But let's say now I've gone through all this process and I've estimated my cash flows and I fail.
• 25:43
  SPEAKER_01: So we used to say you fell off the cliff.
• 25:45
  SPEAKER_01: I don't know if you still use that terminology, but at least in the power and utilities industry.
• 25:49
  SPEAKER_01: But in any event, if you fail your recoverability test, what should a company or engagement team be thinking about next?
• 25:55
  SPEAKER_01: Right.
• 25:56
  SPEAKER_02: So now we're finally moving on to that step two.
• 25:58
  SPEAKER_02: We're trying to figure out the amount of an impairment loss, if any.
• 26:01
  SPEAKER_02: So the impairment loss is based on the excess of the carrying value of the asset group compared to the fair value.
• 26:06
  SPEAKER_02: It's important to remember here now that fair value considers highest and best use from a market participant perspective.
• 26:12
  SPEAKER_02: So often this is the same as how management was using the asset group.
• 26:16
  SPEAKER_02: And the standard does sort of say that a reporting entity's current use of the asset is presumed to be its highest and best use unless market or other factors suggest that a different use by market participants would maximize the value.
• 26:29
  SPEAKER_02: So once the impairment has been calculated, it's important to remember that the impairment reduces only the carrying amount of the long-lived assets in the asset group.
• 26:37
  SPEAKER_02: The impairment loss is allocated among the long-lived assets in the asset group on a pro rata basis using a relative carrying amount.
• 26:43
  SPEAKER_02: However, keep in mind the loss allocated to an individual asset cannot reduce the carrying amount below its fair value, assuming fair value is determinable without undue cost or effort.
• 26:54
  SPEAKER_02: It's also important to note that you can have situations in which the fair value of the asset group in total exceeds the carrying value of the asset group.
• 27:01
  SPEAKER_02: And therefore an impairment cannot be taken, even if the individual assets have fair value below their caring value.
• 27:06
  SPEAKER_01: So wait, Beth, let me talk through this.
• 27:08
  SPEAKER_01: So this means you failed the recoverability test, but then when you actually go through and do the fair value testing, that you see the fair value actually is higher than the carrying value.
• 27:18
  SPEAKER_01: And so then there's you don't need to make that's right.
• 27:21
  SPEAKER_02: Then you can't take an impairment.
• 27:22
  SPEAKER_01: All right.
• 27:22
  SPEAKER_01: That's helpful and interesting outcome.
• 27:25
  SPEAKER_01: Because I guess in your scenario, you're saying some are below, but there's others that are are actually higher.
• 27:31
  SPEAKER_01: All right.
• 27:31
  SPEAKER_01: And then Beth, when we're thinking about fair value, any in in measuring this loss, um, obviously we also have an entire guide on fair value, but any other specific things that you would highlight?
• 27:41
  SPEAKER_02: Yeah, I guess maybe just reiterating that if you're going to use that income approach to determine the fair value of the asset group, the cash flows are based on the market participant assumptions rather than the company's own entity specific assumptions.
• 27:54
  SPEAKER_02: And this could cause a difference between the cash flows used to measure the fair value when calculating your impairment and those that were used in the undiscounted cash flows for the recoverability test.
• 28:04
  SPEAKER_02: Often in practice, what we see people do though is we see companies start with those cash flows using the recoverability test and then think about do they need to layer on any adjustments to get to what a market participant measure of fair value would be?
• 28:16
  SPEAKER_01: All right.
• 28:16
  SPEAKER_01: So, Beth, definitely a lot to think about here.
• 28:19
  SPEAKER_01: And I think for companies who likely are not doing too many of these tests, or hopefully are not doing too many of these tests, it can be challenging to go through this process.
• 28:29
  SPEAKER_01: So, from your perspective, having answered many, many questions, what are some of the things you would recommend to either companies or auditors as they're thinking about this?
• 28:38
  SPEAKER_02: Yeah, I mean, as you said, right?
• 28:39
  SPEAKER_02: Hopefully companies aren't doing this frequently.
• 28:41
  SPEAKER_02: And so that makes it sort of a non-routine, unusual transaction.
• 28:44
  SPEAKER_02: So it's important for companies really to focus on it when it occurs, but also to think about whether they need to engage with valuation specialists if they're going down this path.
• 28:53
  SPEAKER_02: And if they do, invite them into the discussion early so you can have that kind of wholesome discussion, you know, as part of the process, not at the end.
• 29:01
  SPEAKER_01: Yes, that's definitely good advice.
• 29:02
  SPEAKER_01: So, Beth, um, very helpful, definitely an interesting topic.
• 29:05
  SPEAKER_01: Again, hopefully one people will not need to refer to too often, but great resources if they do.
• 29:11
  SPEAKER_01: So thanks for joining me.
• 29:12
  SPEAKER_01: Thanks for having me.
• 29:15
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• 29:17
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• 29:20
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• 29:37
  SPEAKER_01: From Thought Leadership at PWC, I'm Heather Horn.
• 29:41
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