FAQs: Impairment Considerations in View of COVID-19

The impact on the real estate industry from the unprecedented shutdown of the U.S. economy over the past six months in response to the COVID-19 pandemic is yet to be fully appreciated. What we know is that uncertainty around the nature of reopening steps taken by various jurisdictions, along with the still-present threat of the virus, continue to affect consumers and businesses. Government has responded by providing record stimulus packages and incentives, with more possibly on the way.

Since the end of the Great Recession, the U.S. real estate market generally has enjoyed an almost unbroken streak of price appreciation. During this time, entities paid scant attention to the issue of assessing impairment for financial reporting purposes. However, from a financial reporting perspective, the sudden turn of events this year has forced all real estate entities to reassess the carrying value of their properties. Accordingly, management will need to reacquaint themselves with the unique requirements of accounting for the impairment of long-lived assets, including real estate, in accounting principles generally accepted in the U.S. (“U.S. GAAP”). We have prepared the following FAQs, based on conversations with clients and colleagues, to assist entities in staying abreast of impairment considerations when accounting and reporting in conformity with U.S. GAAP.

Q: What do you mean by impairment?

A: U.S. GAAP defines impairment as the condition that exists when the carrying amount of a long-lived asset (or asset group) exceeds its fair value.

Q: Do we need to recognize a loss when an asset meets the definition of impairment?

A. Not necessarily. U.S. GAAP specifies that an entity recognize an impairment loss only upon meeting both of the following conditions:

1. The carrying amount of an asset exceeds its fair value (i.e., meets the definition of impairment); and
2. The carrying amount of the asset is not recoverable.

   Considering the fact that the volume of real estate transaction has been limited during this period, management and its valuation team might face difficulty in deriving the fair value using the typical alternate valuation methodologies. 

Q. What do you mean by recoverable?

A. U.S. GAAP explains that the carrying amount of an asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset.

Q. What happens if we determine that an asset meets both conditions for recognition of an impairment loss?

A. When both conditions are met, recognize a loss measured as the amount by which the carrying amount of the asset exceeds its fair value. 

Q. What do we do if we determine that an asset meets the first condition (i.e., meets the definition of impairment), but in our assessment of recoverability, we conclude that the asset is recoverable?

A. When an asset is determined to be impaired but the carrying value is recoverable, no loss is recognized. In such an instance, management should monitor and update its assessment of impairment and recoverability as events and conditions warrant. In many cases management has provided tenants with temporary rent relief through concessions and payment deferrals; the longer term impact of these arrangements would be an important factor to consider when determining future recoverability.

Q. When should management test a long-lived asset for recoverability?

A. U.S. GAAP requires that management test a long-lived asset for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. Examples of such events or changes in circumstances include:

1. significant decrease in the market price of a long-lived asset (asset group),
2. significant adverse change in the extent or manner in which a long-lived asset (asset group) is being used or in its physical condition,
3. a significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset (asset group), including an adverse action or assessment by a regulator,
4. accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of a long-lived asset (asset group),
5. current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of a long-lived asset (asset group), and
6. A current expectation that, more likely than not, a long-lived asset (asset group) will be sold or otherwise disposed of significantly before the end of its previously estimated useful life.

Q: What are the financial statement disclosures required for an impairment loss?

A. U.S. GAAP requires disclosure of the following information when an impairment loss has been recognized:

1. a description of the impaired long-lived asset (asset group), and the facts and circumstances leading to the impairment;
2. if not separately presented on the face of the statement, the amount of the impairment loss and the caption in the income statement or the statement of activities that includes the loss;
3. the method or methods used to determine the fair value (whether based on a quoted market price, prices for similar assets, or another valuation technique); and
4. if applicable, the segment in which the impaired long-lived asset (asset group) is reported under ASC 280.

As in many aspects of accounting and reporting in U.S. GAAP, management’s evaluation of impairment requires considerable judgment. It is important to keep in mind that an asset that meets the definition of impairment does not necessarily equate to recognizing an impairment loss. An impairment loss is recognized only if the carrying amount is determined not to be recoverable. With all the uncertainties associated with the COVID-19 pandemic, communication is key – both internally, including those involved in asset and property management, and externally, including valuation specialists and auditors.