9.3 Impairment of intangible assets

Identifying Intangible Assets for Impairment

Intangible assets like patents, trademarks, and goodwill can lose value over time. Impairment occurs when the carrying amount of an intangible asset exceeds its fair value, signaling that the asset is overstated on the balance sheet. Companies need to watch for specific warning signs, both inside and outside the organization, that trigger the need for impairment testing.

Internal Indicators of Impairment

These are changes within the company that suggest an intangible asset may have lost value:

• Significant changes in how the asset is used or expected to be used (e.g., a patent that the company no longer plans to commercialize)
• Deterioration in cash flows generated by the asset compared to original projections
• Plans to discontinue or restructure the operation tied to the intangible asset
• Evidence of obsolescence, such as a technology patent being replaced by a newer internal development

External Indicators of Impairment

These come from outside the company:

• A decline in market value driven by technological advances, shifting market conditions, or new legal restrictions
• Adverse changes in the business environment, like increased competition or unfavorable regulatory changes
• Rising market interest rates, which increase the discount rate used to value future cash flows and thereby reduce the asset's present value
• Weaker-than-expected market performance of products or services tied to the asset

Impairment Testing for Intangible Assets

Impairment testing determines whether an intangible asset's carrying amount has fallen below its fair value. The key distinction here is between finite-lived and indefinite-lived intangibles, because each follows a different testing process.

Impairment Testing for Finite-Lived Intangibles

Finite-lived intangible assets are amortized over their useful lives and only tested for impairment when triggering events or indicators are present. Under U.S. GAAP (ASC 360), the process follows a two-step approach:

1. Recoverability test: Compare the asset's carrying amount to the undiscounted future cash flows expected from using and eventually disposing of the asset.
2. If the carrying amount exceeds the undiscounted cash flows, the asset fails the recoverability test and you move to step two.
3. Measure the impairment loss: Calculate the difference between the asset's fair value and its carrying amount. That difference is the impairment loss.

Example: A patent has a carrying amount of $120{,}000$. Expected undiscounted future cash flows are $100{,}000$, and the patent's fair value is $85{,}000$. The patent fails the recoverability test ($120{,}000 > 100{,}000$), so the impairment loss is $120{,}000 - 85{,}000 = 35{,}000$.

Impairment Testing for Indefinite-Lived Intangibles

Indefinite-lived intangible assets (like certain trademarks or goodwill) are not amortized. Instead, they must be tested for impairment at least annually, or more frequently if indicators of impairment arise. The test is simpler than for finite-lived assets:

1. Compare the asset's fair value directly to its carrying amount.
2. If the carrying amount exceeds fair value, recognize an impairment loss equal to the difference.

There is no undiscounted cash flow screening step for indefinite-lived intangibles. You go straight to the fair value comparison.

Measuring Impairment Loss for Intangible Assets

The impairment loss equals the amount by which an asset's carrying amount exceeds its fair value.

Fair Value vs. Carrying Amount

• Fair value is the price that would be received to sell the asset in an orderly transaction between market participants at the measurement date (ASC 820 definition).
• Carrying amount is the asset's original cost minus accumulated amortization and any previously recognized impairment losses.
• An impairment loss is recognized whenever fair value drops below carrying amount (after passing the applicable test for the asset type).

Allocating Impairment Loss to Asset Groups

When an intangible asset is tested as part of a larger asset group (a group of assets whose cash flows are largely independent of other assets), the impairment loss must be allocated:

• Allocate the loss pro rata based on the relative carrying amounts of the assets in the group.
• No individual asset's carrying amount can be reduced below its fair value through this allocation. Any excess loss that would push an asset below fair value gets redistributed to the remaining assets in the group.

Recognizing and Reporting Impairment Losses

Impairment losses are recognized in the period when the impairment is identified.

Timing of Impairment Loss Recognition

• Finite-lived intangibles: Recognize the loss when indicators are present and the undiscounted cash flows fall below the carrying amount.
• Indefinite-lived intangibles: Recognize the loss during the annual impairment test, or earlier if triggering events occur between annual tests.

Financial Statement Presentation of Impairment Losses

• Report impairment losses on the income statement, typically as a separate line item within operating expenses or as part of a broader line item depending on materiality.
• The carrying amount of the asset on the balance sheet is reduced by the impairment loss.
• Notes to the financial statements should disclose the amount, nature, and circumstances that led to the impairment.

After recognizing an impairment loss on a finite-lived intangible, the new (lower) carrying amount becomes the basis for calculating amortization over the asset's remaining useful life.

Reversing Impairment Losses for Intangible Assets

This is where U.S. GAAP and IFRS diverge significantly.

U.S. GAAP (ASC 350 / ASC 360)

Under U.S. GAAP, reversal of impairment losses is prohibited for intangible assets (and for goodwill). Once you write down an intangible asset, that reduced carrying amount is permanent. This is a critical rule to remember.

IFRS (IAS 36)

Under IFRS, impairment losses on intangible assets other than goodwill may be reversed if conditions change:

• A reversal is permitted only when there has been a change in the estimates used to determine the asset's recoverable amount since the last impairment was recognized.
• The reversal cannot exceed the carrying amount that would have been determined (net of amortization) had no impairment loss ever been recognized.
• The reversal is recognized as a gain in profit or loss for the period.
• Future amortization is adjusted to allocate the revised carrying amount over the asset's remaining useful life.

Tax Considerations for Intangible Asset Impairment

Impairment losses on intangible assets can create differences between book income and taxable income.

Deductibility of Impairment Losses

• Tax deductibility of impairment losses depends on the jurisdiction's specific tax laws. In many cases, impairment write-downs for financial reporting purposes are not immediately deductible for tax purposes.
• Tax deductions for intangible assets often follow their own amortization schedules (e.g., Section 197 amortization in the U.S. for certain intangibles over 15 years), regardless of impairment recognized on the books.

Deferred Tax Assets and Valuation Allowances

When an impairment loss is recognized for book purposes but not for tax purposes, a temporary difference arises:

• This creates a deferred tax asset (DTA), because the future tax deduction will exceed the future book expense.
• You must assess whether the DTA is recoverable. If it is more likely than not (greater than 50% probability) that some or all of the DTA will not be realized, record a valuation allowance to reduce the DTA to its expected realizable amount.

Disclosure Requirements for Intangible Asset Impairment

Transparent disclosure helps financial statement users understand the judgments behind impairment decisions.

Required Disclosures for Impairment Testing

• The methods and key assumptions used to determine fair value (e.g., discount rates, growth rates, market comparables)
• For indefinite-lived intangibles, the date of the most recent impairment test and, if tested outside the regular annual cycle, the reasons for doing so

Disclosures for Recognized Impairment Losses

• The amount of impairment loss recognized during the period, broken out by major class of intangible asset
• A description of the events and circumstances that led to the impairment
• The valuation method used to determine fair value (income approach, market approach, or cost approach) and the key assumptions applied