Impairment of Long-Lived Assets: GAAP and Tax Treatment

As restaurant operators seek and open locations, things do not always go as planned. For instance, areas where restaurants are operating can become saturated with competition, demographics and target audiences can evolve or management decided they simply no longer want to operate that location and will close it after year-end. Under generally accepted accounting principles (GAAP), these situations require analysis of poor performing stores. However, on your tax return, the results may have a different effect.

Let’s look at an example: Management of Company A has been watching a group of poorly performing stores and decides further analysis is required. GAAP requires that projected future cash flows need to be calculated on these stores. This calculation involves projecting earnings before interest, taxes, depreciation and amortization for each year through the remaining obligated lease term. However, if any of those locations were owned versus leased, then projected future cash flows should be calculated over the remaining economic life. Once that calculation is complete, the total of those projected future cash flows is compared to the net book value of the long-lived assets.

In that example, the results of the management’s calculations show that the undiscounted cash flows is less than the net book value of the long lived assets by $600,000. In accordance with GAAP, Company A would record an impairment charge of $600,000.   

How do you allocate the impairment charge? You must first know what you can take with you or redistribute to other stores. For example, leasehold improvements cannot typically be taken with you, therefore the net book value of these assets would be 100% impaired and the remaining impairment charge should be allocated to the remaining equipment. Note, the total impairment charge should be recorded as a reserve and not a direct write-off against the assets.  

The income statement effect of the impairment is part of continuing operations and should not be presented “below the line” or in “other expense.” However, it can be separately presented so that an investor or banker can segregate it from any analysis performed on your company.

Many restaurants are confused on how impairment is treated on the tax return. Under the tax law, a company may not record losses until the asset is actually written off. Therefore, in our example above, if the impairment was recorded in 2016 but management did not physically close the location until 2018, the tax law would not permit Company A to deduct these losses until 2018 when the location physically closes or if the assets were sold.

Under GAAP, since the location closed and will not operate in 2018, the impairment reserve, related assets and accumulated depreciation will be written off and any remaining difference recorded as loss on disposal of assets on the income statement.