Impairment of Long-Lived Assets: GAAP and Tax Treatment

As restaurant operators well know, things do not always go as planned. For instance, areas where restaurants are operating can become saturated with competition, demographics and target audiences can evolve, or management’s plans may simply change, resulting in a decision to close a location. Under generally accepted accounting principles (GAAP), these situations each represent examples of triggering events which require the performance of an asset impairment test. While the asset impairment test may result in write-downs related to poor performing stores and stores that are expected to be closed, the results may have a different effect on your tax return.

Let’s look at an example: Management of Company A has been watching a group of poorly performing stores and decides further analysis is required. GAAP requires a projection of future cash flows for these stores, which is then compared to the net book value of the related long-lived assets. The calculation of future cash flows involves projecting earnings before interest, taxes, depreciation and amortization for each year through the remaining obligated lease term. However, if any of those locations were owned versus leased, then projected future cash flows should be calculated over the remaining economic life.

In this example, the results of management’s calculations show that the undiscounted cash flows are less than the net book value of the long-lived assets. Company A must then determine the fair value of the long-lived assets, and record an impairment charge for the difference between the fair value and the net book value. If Company A determined that the fair value was less than the carrying value by $600,000, then it would record an impairment charge of $600,000.   

How do you allocate the impairment charge? You must first determine what can be sold or used in other stores. For example, leasehold improvements cannot typically be moved to another location nor sold, therefore the net book value of these assets would be perhaps more significantly impaired, and the remaining impairment charge should be allocated to the remaining equipment. Note, the total impairment charge is typically recorded as a reserve and not a direct write-off against the assets in order to retain historical information for tax and other purposes. However, the reserve is applied against the carrying amount when determining future depreciation. Any depreciable value is the remaining carrying value of the assets and not the original gross value.

The income statement effect of the impairment is part of continuing operations and should not be presented “below the line” or in “other expense.” However, it can be separately presented so that an investor or banker can segregate it from any analysis performed on your company.

Many restaurants are confused about how impairment is treated on the tax return. Under the tax law, a company may not record losses until the asset is actually written off. Therefore, in our example above, if the impairment was recorded in 2016 but management did not physically close the location until 2018, the tax law would not permit Company A to deduct these losses until 2018 when the location physically closes or if the assets were sold.

Under GAAP, since the location closed and will not operate in 2018, the impairment reserve, related assets and accumulated depreciation will be written off and any remaining difference recorded as loss on disposal of assets on the income statement at that time.  

The impairment of goodwill will also impact the financial statements differently than the tax return. Under GAAP, goodwill is tested for impairment at the reporting unit level. A reporting unit is typically a business unit that is one level below the operating segment level. At least annually, or earlier if a triggering event has occurred, much like in the example above, the entity must perform a goodwill impairment test. Note, under the private company alternative, a goodwill impairment test is only required upon a triggering event. Under the guidance, the entity can elect to perform a qualitative test, a likelihood of more than 50 percent that the fair value of the reporting unit is less than the carrying value. If the qualitative test proves there is a likely impairment, then the fair value of the reporting unit must be calculated and compared to its carrying value of the assets and liabilities. Alternatively, the entity can choose to skip the qualitative analysis and move straight to the quantitative test. In either case, if the carrying value is more than fair value, an impairment charge is recorded similar to the above example. For tax purposes, goodwill is not written off until the reporting unit is sold or otherwise closed.

For more information on how to record impairment or disposal of assets, please contact Giselle El Biri at gelbiri@bdo.com. And, be sure to keep up with the Restaurant practice’s latest thoughts by following us on Twitter at @BDORestaurant.

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