Right-of-Use Asset Impairment Under ASC 842 and ASC 360

Right-of-use assets are subject to impairment, but ASC 360 governs the test rather than ASC 842. ASC 842 establishes the asset and its amortization, while ASC 360 determines whether its carrying amount remains recoverable. Both standards therefore apply to the same recorded balance.

Black Owl Systems keeps lease records and their accounting schedules together throughout the term.

What qualifies as a right-of-use asset?

A right-of-use asset represents the lessee’s right to use an identified asset throughout the lease term. It is recorded at commencement, starting with the lease liability and adjusting for prepayments, incentives, and initial direct costs. These adjustments are explained in the guide to measuring a right-of-use asset at commencement.

Teams reporting under IFRS 16 or ASPE 3065 should apply their framework’s impairment requirements, compared below. A centralized lease management record helps retain assessments and supporting evidence; Black Owl’s implementation and advisory services can support that workflow.

What are some examples of asset impairment?

The indicators that prompt an impairment review of a right-of-use asset are similar to those for other long-lived assets. Four of the indicators listed in ASC 360-10-35-21 arise particularly often with leased property.

One is a significant fall in the leased asset’s market value. Another is a significant adverse change in its use or physical condition. Vacating a leased office is an example of a change in use.

A current-period operating loss at a location with a history of losses is a third indicator. The fourth is an expectation, judged more likely than not, that the asset will be disposed of before its useful life ends.

Business decisions can also trigger a review. Closing a store, combining two offices, moving to remote work, or losing the customer served by a particular facility all change what the leased asset is expected to produce during its remaining term.

Impairment must be distinguished from remeasurement, even though both can affect the same lease in one reporting period. Impairment is a write-down under ASC 360 following a decline in recoverable value. Remeasurement recalculates the lease under ASC 842 because the contract has changed.

Treating one as the other leads to incorrect entries. The requirements for lease modifications and reassessments address changes that reopen measurement, rather than a loss of value.

Establishing the asset group

In most cases, the right-of-use asset is not tested individually. ASC 360 requires testing at the asset group level: the lowest level at which cash flows are largely independent of those generated by other assets.

A retail store illustrates how this works. Its right-of-use asset, leasehold improvements, fixtures, and equipment form an asset group because they generate the store’s cash flows together. None generates cash independently of the others.

The boundary chosen for that group can determine the test’s outcome. An overly narrow assessment may fail an asset that the broader group supports. An overly broad one allows profitable locations to conceal a failing location.

Are right-of-use assets classified as fixed assets?

Right-of-use assets are distinct from fixed assets, and most companies report them on separate balance sheet lines. They are, however, long-lived assets, which brings them within ASC 360. Operating lease and finance lease right-of-use assets are also usually presented separately from one another.

This distinction affects presentation, not the impairment test. The classification of owned fixed assets explains the balance sheet category alongside which right-of-use assets appear.

IFRS uses a cash-generating unit instead of an asset group. Its definition focuses on the smallest group producing largely independent cash inflows. Because the definitions differ, identical facts can lead to a different grouping, and a different impairment conclusion, under each framework.

Step one: assessing recoverability

ASC 360-10-35-17 establishes a two-step process. The first step screens for recoverability; it does not measure the loss. Compare the asset group’s carrying amount with its undiscounted future cash flows from continued use and eventual disposal.

When those cash flows equal or exceed the carrying amount, the group is recoverable. No impairment loss is recorded, and no further testing is needed. When they fall below the carrying amount, proceed to the second step.

Three aspects of the cash flow model deserve particular attention. First, keep the amounts undiscounted throughout this step, since this is a recoverability screen rather than a valuation. Second, use the remaining useful life of the group’s primary asset as the forecast period. That period is often the lease term.

Third, leave the lease payments out of the cash outflows. The lease liability is already recorded separately on the balance sheet. Deducting those payments would count the same cost twice.

A store-level model that subtracts rent can therefore show a failed test for an asset group that is actually recoverable.

Step two: calculating and allocating the impairment loss

The second step measures the loss as the difference between carrying amount and fair value. For the right-of-use asset, fair value reflects what a market participant would pay for the remaining right to use the asset.

For real estate, market rent is a common starting point. A fall in market rent below the contracted amount means the right of use is worth less than the agreed rent. Another common method uses the present value of expected sublease income.

Both methods need a discount rate reflecting market participants. The lessee’s incremental borrowing rate is not the rate used for this fair value measurement. Selecting a rate for the valuation is a separate estimate from the rate established at commencement.

Once measured, the loss is allocated across the asset group in proportion to each asset’s carrying amount. There is a limit: where an individual asset’s fair value can be determined, the allocation cannot reduce it below that value. Any loss left over is redistributed among the group’s remaining assets.

Journal entries for an impaired right-of-use asset

This example is illustrative.

Consider a five-year operating lease requiring annual payments of $100,000 in arrears, discounted at a 5% incremental borrowing rate. The opening lease liability is $432,948. The company also incurs $15,000 in initial direct costs, bringing the initial right-of-use asset to $447,948.

The total lease cost is $515,000 over five years, or $103,000 of straight-line expense annually. At the end of year two, the right-of-use asset has a carrying amount of $281,325, while the lease liability is $272,325.

The company vacates the premises at the beginning of year three. Expected undiscounted cash flows are now $165,000, below the asset’s $281,325 carrying amount, so the recoverability test fails. A valuation based on expected sublease income establishes fair value at $150,000.

The resulting impairment loss is $131,325, calculated as $281,325 less $150,000.

The lease liability remains $272,325 after this entry. The company’s payment obligation has not changed, so the impairment does not adjust the liability. The liability side of the entries recorded over the lease term continues as it did before the write-down.

How do you depreciate a right-of-use asset?

Before impairment, the operating lease right-of-use asset itself does not follow straight-line amortization. Each year’s amortization is the amount remaining after interest is deducted from the total lease cost. In this example, that produces a combined annual expense of $103,000. The straight-line pattern therefore applies to total lease cost, rather than to the asset’s amortization alone.

Impairment changes that pattern. Under ASC 842-20-35-10, the remaining carrying amount is amortized on a straight-line basis over the remaining lease term. The single-cost presentation ends, with amortization and interest reported separately from that point.

The final three years compare as follows:

The remaining $150,000 is amortized in three equal annual amounts of $50,000, bringing the right-of-use asset to zero when the lease ends. Annual expense no longer stays at $103,000. It is lower and declines over the remaining years because the impairment loss was recognized up front.

Impairment does not change any amount in the lease liability schedule. Teams that reconcile the right-of-use asset against the liability each month may see the difference and assume something is wrong. After a write-down, the balances remain apart.

There is no error to correct, and no adjustment should be posted merely to bring them back into line. Where the balances previously matched, that reflected their measurement rather than a requirement to keep them equal. Impairment breaks that alignment. The amortization schedule must be rebuilt from the impairment date onward.

Distinguishing impairment, abandonment, and subleasing

Vacating a property does not always call for impairment accounting. Companies often record an impairment when the facts instead require abandonment treatment. The three possible treatments have different triggers and amortization consequences.

Where the company has stopped using the premises and does not intend to return, the asset is abandoned rather than impaired. Amortization is accelerated so that the right-of-use asset reaches zero by the cease-use date.

That distinction makes a substantial difference to expense timing. Impairment recognizes an immediate loss, then allocates the remaining balance over the full remaining lease term. Abandonment allocates the entire remaining balance over a much shorter period.

Subleasing follows a separate sequence. Test the asset for impairment first, then account for the sublease as its own arrangement. Putting a third party into the leased space does not remove the head lease from the lessee’s balance sheet.

An outright exit from the lease has a different result again. Early termination accounting removes both the right-of-use asset and the lease liability, with a gain or loss recorded on derecognition.

Impairment under IFRS 16 and ASPE 3065

The frameworks differ in the group of assets tested, the method used, and whether a recognized loss can subsequently be reversed.

Reversibility is the largest difference. US GAAP does not permit an impairment loss on a held-and-used asset to be reversed. Under IFRS, the loss is reversed when the indicators that caused it reverse.

IAS 36 also dispenses with the preliminary recoverability screen. Its single test compares carrying amount with recoverable amount, defined as the higher of fair value less costs of disposal and value in use.

As a result, a group may pass the US test using undiscounted cash flows and still fail the IFRS test using discounted amounts. The treatment under ASPE 3065 is closer to the US GAAP model.