5 Questions to Ask When Assessing ROU Assets for Impairment

Most economists see steady improvement in the U.S. economy, underscored by the Fed’s recent 25 basis point rate cut and the expected soft landing. Even so, the general public is skeptical about this improvement, backed by price concerns and political uncertainty.

While the Fed cuts are viewed favorably, lower interest rates may lead to larger initial or modified lease liabilities and the resulting right-of-use (ROU) assets for private companies that use the risk-free interest rate. Those larger ROU asset balances may stress future impairment assessments.

In this article, we will walk you through the key questions to ask to make informed decisions when assessing ROU assets for impairment.

What is the Appropriate Accounting Framework?

Lessees apply the impairment guidance in ASC 360, Property, Plant, and Equipment, ROU assets.

What is the Unit of Account?

Long-lived assets (e.g., property, plant, equipment, and ROU assets) are tested for impairment at the asset group level, the lowest level at which the entity tracks financial information for a set of long-lived assets generating cash flows largely independent of other assets and liabilities.

When determining asset groups, entities should consider factors such as interdependent revenues, shared cost structures (e.g., a common sales force or manufacturing), interchangeable operational uses and how the assets are managed and utilized. Alternatively, some long-lived assets may individually have largely independent cash flows. This means the ROU asset is typically tested for impairment as part of an asset group unless it generates cash flows independently from other assets.

How do I Navigate the Impairment Model?

The asset group is tested for recoverability only when triggering events indicate that the asset group’s carrying value is not recoverable. The recoverability assessment compares the asset group’s future undiscounted cash flows expected to be generated over the remaining useful life of the primary asset within the asset group to its carrying value. Suppose the carrying value is more than the total undiscounted cash flows. In that case, the entity is required to determine the fair value of the asset or asset group and recognize an impairment measured as the difference between the carrying value and the fair value of the asset or asset group.

Lessees can elect an accounting policy to include or exclude operating lease liabilities from the asset group’s carrying amount, future undiscounted cash flows and any impairment loss calculation.

What is the Impact of Subleasing?

Executing a sublease on a property or a portion of a property may create a separate asset group for impairment testing since the sublease’s third-party rental income may be largely independent of the original asset group’s cash flows.

Additionally, subleasing part of a larger property (e.g., one floor or a suite in a multi-floor lease) may indicate that this portion should be accounted for as a separate lease component under the head lease. For example, assume that the head lessee (acting as the intermediate lessor) initially accounted for a 10-floor building lease as a single lease component and recorded one ROU asset and one lease liability. After executing a sublease for part of the building, the head lessee should reassess whether that subleased portion is a separate lease component under the head lease. This may require splitting the original ROU asset and lease liability into separate amounts for the subleased and remaining portions.

If the subleased asset represents a separate asset group, it may be subject to an ASC 360 impairment assessment since such a change could represent a “significant adverse change in the extent or manner in which a long-lived asset (asset group) is being used.” In this scenario, an impairment analysis would be performed at the subleased asset level.

Haven’t I Abandoned the ROU Asset?

All ROU assets are considered held and used, similar to property and equipment, until the lessee ceases using the asset. This occurs when the asset is no longer utilized for any purpose, and the lessee determines there is no future economic benefit to be gained. Plans to vacate a property under a real estate lease or to cease using an asset under an equipment lease does not mean the asset is abandoned. Abandonment only occurs at the cease-use date. That is when the property is vacated or the leased equipment is permanently not being operated. Determining if and when ROU assets have been abandoned may require significant judgment. Consider an entity that has temporarily idled a leased property but uses the location for storage or minor operations. This scenario does not result in abandonment because the lessee still receives an economic benefit from the leased property.Similarly, the intent and ability to sublease the asset also provide an economic benefit.

Unlike impairment accounting at the asset group level discussed above, abandonment accounting is applied to the individual asset or lease component. Under ASC 360, a plan to abandon an asset is generally an impairment-triggering event and may result in the need to adjust the asset’s estimated useful life.

For More Information

If you have any questions about applying impairment accounting guidance to your ROU assets, please connect with a member of our team.