An asset may be disposed of individually or as part of a disposal group. A disposal group is a group of assets to be disposed of in a single transaction as a group and the liabilities directly associated with those assets that will be transferred with those assets (e.g., environmental obligations, warranty obligations associated with a product line, etc.).
In this post, I am going to discuss about long-lived assets disposed of by sale, criterion and its accounting treatment. As usually, it comes with case example. Enjoy!
Criteria for Long-lived Assets Held-for-sale
Long-lived assets (or disposal groups) are classified as held-for-sale in the period in which all of the following six criteria are met:
Criteria-1. Management possessing the necessary authority commits to a plan to sell the asset (disposal group)
Criteria-2. The asset (disposal group) is immediately available for sale on an “as is” basis (i.e., in its present condition subject only to usual and customary terms for the sale of such assets)
Criteria-3. An active program to find a buyer and other actions required to execute the plan to sell the asset (disposal group) have commenced
Criteria-4. An assessment of remaining actions required to complete the plan indicates that it is unlikely that significant changes will be made to the plan or that the plan will be withdrawn
Criteria-5. Sale of the asset (disposal group) is probable, as that term is used in the context of ASC 450-20 (i.e., likely to occur), and transfer of the asset (disposal group) is expected to qualify for recognition as a completed sale within one year
Note: Certain exceptions to the one-year requirement are set forth in ASC 360 for events and circumstances beyond the entity’s control that extend the period required to complete the sale.
Criteria-6. The asset (disposal group) is being actively marketed for sale at a price that is reasonable in relation to its current fair value.
A newly acquired long-lived asset (disposal group) that is being held for sale is to be classified as held-for-sale on the date of acquisition if:
- It meets criteria 5. above [subject to the same exceptions noted in 5]; and
- Any other of the required criteria that are not met at the date of acquisition will probably be met within a short period (approximately three months or less) of acquisition.
If the criteria are met after the balance sheet date but prior to issuance of the entity’s financial statements, the long-lived asset is to continue to be classified as held-and-used at the balance sheet date.
Appropriate subsequent events disclosures would be included in the financial statements in accordance with AICPA Statement on Auditing Standards 1, AU Section 560, Subsequent Events.
How to Measure Long-lived Assets Classified as Held-for-sale
Long-lived assets (disposal groups) classified as held-for-sale are measured at the lower of their carrying amount or fair value less cost to sell. A loss is recognized for any initial or subsequent write-down to fair value less cost to sell. A gain is recognized for any subsequent increase in fair value less cost to sell, but recognized gains may not exceed the cumulative losses previously recognized. Long-lived assets that are classified as held-for-sale are presented separately on the balance sheet.
“Cost to Sell” of Long-lived Asset Held-for-sale
Cost to sell consists of costs that directly result from the sales transaction that would not have been incurred if no sale were transacted. Cost to sell includes brokerage commissions, legal fees, title transfer fees, and other closing costs that must be incurred prior to transfer of legal title to assets. Prior to measurement of fair value less cost to sell, the entity adjusts the carrying amounts of any assets included in the disposal group not covered by ASC 360 including any goodwill.
The entity may not accrue, as part of cost to sell, expected future losses associated with operating the long-lived asset (disposal group) while it is classified as held-for-sale. Costs associated with the disposal, including costs of consolidating or closing facilities, are only recognized when the actual costs are incurred. If the exception to the one-year requirement applies (permitted when there are certain events and circumstances beyond the entity’s control), and the sale is expected to occur in more than one year, the cost to sell is discounted to its present value.
Depreciation of Long-lived Asset Held-for-sale
Long-lived assets (disposal groups) held for sale are not to be depreciated (amortized) while being presented under the held-for-sale classification. Interest and other expenses related to the liabilities of a held-for-sale disposal group are accrued as incurred.
If, at any time after meeting the criteria to be classified as held-for-sale, the asset (disposal group) no longer meets those criteria, the long-lived asset (disposal group) is to be reclassified from held-for-sale to held-and-used, measured at the lower of:
- Carrying value prior to classification as held-for-sale, adjusted for any depreciation (amortization) that would have been recognized had the asset (disposal group) continued to be classified as held-and-used; or
- Fair value at the date of the subsequent decision not to sell the asset (disposal group). The adjustment required to the carrying amount of an asset (disposal group) being reclassified from held-for-sale to held-and-used is included in income from continuing operations in the period that the decision is made not to sell.
FASB concluded that impairment losses from long-lived assets to be held and used, gains or losses recognized on long-lived assets to be sold, and other costs associated with exit or disposal activities [as defined in ASC 420] should be accounted for consistently. Therefore, if the entity reports a measure of operations (e.g., income from operations), these amounts are reported in operations unless they qualify as discontinued operations, as explained below.
The income statement classification of these amounts is to be consistent with the accounting policy for classifying the depreciation of the underlying assets per the following examples:
Machinery and equipment used in production Cost of goods sold
Office equipment General and administrative
Trucks and delivery equipment General and administrative or,
if a separate category of expenses,
Combination factory/office building Allocate between cost of goods sold,
and general and administrative
in the same manner as depreciation
If a component of an entity (as defined below) is reclassified as held-and-used, the results of that component that had previously been reported in discontinued operations are reclassified and included in income from continuing operations for all periods presented.
Revaluating Long-lived Asset Held-for-sale
Upon removal of an individual asset or liability from a disposal group classified as held-for-sale, the remaining part of the group is to be evaluated as to whether it still meets all six of the criteria to be classified as held-for-sale. If all of the criteria are still met, then the remaining assets and liabilities will continue to be measured and accounted for as a group. If not all of the criteria are met, then the remaining long-lived assets are to be measured individually at the lower of their carrying amounts or fair value less cost to sell at that date. Any assets that will not be sold are reclassified as held-and-used as described above.
Example of Long-lived Assets Disposed Of by Sale
The Lie Dharma Candy Company chooses to stop sales of its candy cane product line, and accordingly shifts the $840,000 carrying cost (i.e., book value) of its candy cane twister equipment into a held-for-sale account.
After several months of trying to close a sale of the equipment, Lie Dharma’s controller notes that the fair value of the twister equipment is now $855,000. However, after projected sale costs that include commissions, legal fees, and title transfer fees are included, the net fair value is only $825,000. The controller accordingly writes down the equipment cost to $825,000 with the following entry:
[Debit]. Loss on fair value adjustment = $15,000
[Credit]. Equipment held-for-sale = $15,000
After another two months, the controller notes that the equipment’s fair value, net of estimated disposition costs, has increased to $860,000. Though this represents a gain of $35,000 over the adjusted carrying cost of the equipment, he can only recognize a gain up to the amount of all previously recorded losses, which he does with the following entry:
[Debit]. Equipment held-for-sale = $15,000
[Credit]. Gain on fair value adjustment = $15,000
Six months after the twister equipment is classified as held-for-sale, Lie Dharma’s management concludes that it will wait for better market conditions to sell the equipment. Lie Dharma’s controller reclassifies the equipment as held-and-used with the following entry:
[Debit]. Equipment = $840,000
[Credit]. Equipment held-for-sale = $840,000
Prior to its classification as held-for-sale, the equipment had been depreciated on a straight-line basis over a ten-year life span using an original equipment base cost of $1.2 million, so $60,000 would otherwise have been incurred while the equipment was classified as held-for-sale; this would have reduced the equipment’s net carrying cost (i.e., book value) from $840,000 to $780,000. Since this is lower than the estimated fair value of $860,000 as of the date when the decision was made to halt sale activities, the controller records the following entry:
[Debit]. Depreciation—equipment = $60,000
[Credit]. Accumulated depreciation—equipment = $60,000
After four more months, Lie Dharma receives an unsolicited cash offer of $875,000 for the twister equipment, which it accepts. During these additional four months, the equipment has been depreciated by a further $40,000. Lie Dharma’s controller records the sale with the following entry:
[Debit]. Cash = $875,000
[Debit]. Accumulated depreciation—equipment = $460,000
[Credit]. Equipment held-and-used = $1,200,000
[Credit]. Gain on equipment sale = $135,000