Lease Impairment Testing and Journal Entries Under ASC 842

Lease impairment testing under ASC 842 runs on the long-lived asset framework in ASC 360, not on ASC 842 itself. When something signals that a right-of-use (ROU) asset may not be recoverable, you group it with the other long-lived assets that share its cash flows, compare the group’s carrying amount to its undiscounted future cash flows, and, if that test fails, write the group down to fair value. The loss is permanent, and for operating leases it quietly changes how lease expense behaves for the rest of the term.¹

When Testing Is Required

You do not run the two-step test every reporting period. ASC 842-20-35-9 sends lessees to ASC 360-10-35, which triggers testing only when events or changes in circumstances suggest the carrying amount of an asset group may not be recoverable.¹ ASC 360-10-35-21 lists common indicators:

A significant drop in the market price of the leased asset or the group it belongs to.
A major change in use or physical condition of the leased property, including damage that reduces capacity.
An adverse business climate or regulatory change, a lost major customer, or a steep decline in demand.
Cost overruns on leasehold improvements or build-out that far exceed the original budget.
Current and projected operating or cash flow losses at the location, especially when the projections show no recovery.
A current expectation, at greater than 50 percent likelihood, that the leased asset will be disposed of well before the end of the lease term.

The list is illustrative rather than exhaustive. A restructuring that relocates operations away from a leased site is a textbook internal indicator even though the standard does not name it. The judgment is whether the event signals a permanent downward shift in what the lessee can extract from the property.

Identify the Asset Group First

Before running any numbers, fix the unit of account. ASC 360 requires testing at the “asset group” level: the lowest level at which identifiable cash flows are largely independent of the cash flows of other assets and liabilities.² The ROU asset for a leased office or retail location is almost never tested by itself.

Leasehold improvements, furniture, fixtures, and other long-lived assets at the same location typically generate cash flows together with the ROU asset, so they belong in the same group. A retail chain, for example, groups each store’s ROU asset with the improvements and equipment at that store, because the cash flows are driven by the individual store’s operations.

Grouping errors distort results both ways. Draw the group too broadly and profitable locations mask trouble at struggling ones. Draw it too narrowly and an asset that supports a profitable operation can appear impaired when it is not. Cash flows from one asset group cannot offset shortfalls in another when applying the recoverability test.²

Step 1: The Recoverability Test

Compare the asset group’s carrying amount to the sum of the undiscounted future cash flows expected from its continued use and eventual disposition.¹ Carrying amount is the unamortized ROU asset balance plus the other long-lived assets in the group.

Cash flow estimates should reflect the most probable sequence of future events. For the ROU asset, remaining fixed lease payments enter as outflows. If the lessee plans to sublease the space, estimated sublease income counts as an inflow. Residual value guarantee obligations flow through the estimate as well.

The word “undiscounted” is doing real work. Ignoring the time value of money keeps this test a relatively low bar. If undiscounted cash flows exceed carrying amount, the group passes, no loss is recorded, and testing stops.¹ If they fall short, move to Step 2.

Step 2: Measure the Loss at Fair Value

The impairment loss equals the amount by which the group’s carrying amount exceeds its fair value.¹ Fair value under ASC 820 is the price that would be received to sell the asset in an orderly transaction between market participants at the measurement date.³

Active markets for ROU assets rarely exist. Most lessees estimate fair value with a discounted cash flow model built on the same projections used in Step 1, but with a market-participant discount rate applied. Time value of money matters here because the goal is what a hypothetical buyer would pay today. The rate should reflect how a market participant would price the risk in the cash flows, not the lessee’s incremental borrowing rate or weighted average cost of capital. Small changes in the rate can swing the loss significantly, which is why discount rate selection is the most common source of measurement dispute.

ASC 820 organizes fair value inputs into three levels: quoted prices in active markets for identical assets (Level 1), observable data for similar assets (Level 2), and internally developed models and assumptions (Level 3).³ Nearly every ROU asset impairment measurement lands in Level 3, and that classification drives the disclosure burden.

Allocating the Loss Across the Group

When the group contains multiple long-lived assets, allocate the loss pro rata based on each asset’s relative carrying amount. There is one hard limit: no individual asset can be written below its own fair value. If a pro rata share would push an asset below its fair value, cap the allocation at that floor and redistribute the excess across the remaining assets in the group.

None of the loss is allocated to the lease liability. The liability reflects a contractual obligation to pay and is unaffected by impairment. It changes only through a lease modification, a remeasurement event, or termination.

The Journal Entry and the New Basis

The entry is simple. Debit an impairment loss account, typically inside operating expenses, and credit the ROU asset to reduce its carrying amount. Any other assets in the group that absorbed a portion of the loss get their own credits.

The new, lower ROU asset balance becomes the asset’s revised cost basis. Amortization is recalculated by spreading that new balance over the remaining lease term, applied prospectively only. Prior periods are not restated.

What Changes on the Income Statement After Impairment

For an operating lease, this is the part that surprises people. Before impairment, an operating lease produces a single straight-line lease expense each period. After impairment, that straight-line pattern breaks. The lease liability continues to accrete interest using the same effective interest method as before, but the impaired ROU asset is now amortized straight-line over the remaining lease term. Those two components no longer combine to a flat total, and periodic lease cost becomes front-loaded, similar to a finance lease.⁴

The lease still retains its operating classification. Presentation and disclosure continue to follow operating lease guidance. Only the expense calculation shifts.⁴

For finance leases, the transition is less disruptive because amortization and interest were already separate line items. Recalculate amortization using the new carrying amount over the remaining term and move on.

Abandonment Is a Different Path

A decision to vacate space does not automatically mean the ROU asset is impaired. It might mean the asset is abandoned, and the accounting differs. Abandonment applies when the lessee permanently stops using the property for any business purpose, including storage. If the lessee intends to sublease or expects to resume use later, the asset is not abandoned. It may be impaired, but it is not abandoned.

Under abandonment, the lessee shortens the ROU asset’s useful life to the period between the decision date and the cease-use date, so the ROU asset reaches zero by the day the lessee stops using the property. Abandonment is applied at the individual lease component level, unlike impairment which uses the asset group.

The lease liability is unaffected. Contractual payments continue to run unless the lease is formally terminated or modified, and interest continues to accrue on the liability even after the space is vacated. That ongoing cost catches some companies off guard when they assume walking away ends the accounting obligation.

If the lessee is actively marketing the space to a subtenant, the situation is more likely an impairment than an abandonment, because economic benefit is still expected through sublease income. That expected income enters the undiscounted cash flow estimate in Step 1 and may prevent or reduce the loss.

Disclosure and Permanence

Present the impairment loss within income from continuing operations, unless the leased asset relates to a discontinued operation.¹ Show it as a separate line item or otherwise distinguish it from routine depreciation and amortization so readers can identify its one-time character.

Footnote disclosures should describe the impaired ROU asset, the circumstances that led to the write-down, and the indicators that triggered the test. Disclose the method used to determine fair value and where the measurement sits in the ASC 820 hierarchy. For Level 3 measurements, disclose the key assumptions and inputs in the DCF, including the discount rate and cash flow projections.³

Once recorded, an impairment loss on a long-lived asset held and used cannot be reversed. Even if market conditions recover and the ROU asset’s fair value rebounds, the lessee is prohibited from writing the asset back up. The post-impairment balance is the permanent new cost basis for every future amortization calculation.²

1
Grant Thornton. Applying ASC 360 to Right-of-Use Assets
2
Viewpoint. Impairment of Long-Lived Assets to Be Held and Used
3
SEC.gov. Note 10 – Fair Value Measurements
4
Viewpoint. Impairment – Lessee