Two recent news items have made this an opportune time for a post — actually, two posts — about the accounting for the “impairment” of an asset.
- The SEC is considering whether Exxon violated the securities laws by failing to record an “impairment” charge on its oil and gas assets.
- The FASB has finalized its latest simplification to the topic of goodwill impairment. During the proposal stage, the FEI submitted a comment letter requesting that management be able to exercise more judgment about when to recognize an impairment charge.
This first post will deal with the Exxon matter. I will assume that you know enough of the gory details about the timing and measurement of an impairment charge. But before we look at these cases, I do want to remind readers that these particular accounting rules have been extremely controversial for a very long time; it is no coincidence that it is where U.S. GAAP and IFRS differ the most. The gap between them is profound and the opportunities to manage earnings so coveted by the respective issuer-constituents, the boards made no serious attempt to close it during the lost dozen or so years of the misbegotten and aborted roadmap to IASB hegemony. But if you are interested in more background, these posts, going back years ago, describe many of those gory details that I would rather not get into here:
I also want to use these recent events to get something off my chest that I have itching to write about for a while: the term “impairment” as camouflage for just how arbitrary and unreliable the standards are for writing down long-lived assets.
To the best of my knowledge, “impairment” is relatively recent accounting jargon. It was officially added to U.S. GAAP in 1995 with the publication of SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. The gist of that standard and its U.S. GAAP successors — now codified in ASC 360-10-35 — is that an asset should be written down to fair value when its carrying amount is eventually deemed to be “impaired.” This actually gives us two similar concepts to evaluate with important differences: (1) asset impairment; and (2) the “impairment” of the carrying amount of an asset.
- Read “asset impairment” without thinking about accounting. As plain English, it would describe something like reduced operating effectiveness. Yet, as accounting terminology, an asset could be written down even though it operates practically as good as new.
- Defenders of the “impairment” rules might counter that “asset impairment” shouldn’t be taken literally. This is their position notwithstanding the literal title of the standards and the topical titles in the ASC. They say that “impairment” refers to the “carrying amount” of the asset — not the asset itself. Close, but no cigar. For one thing, the FASB has come to use the term “carrying amount” instead of “book value” to appropriately clarify that the amount subject to a write down under ASC 360-10-35 is usually a number that can only be described by its calculation. In other words, it does not represent an actual financial attribute of the asset. For this reason among others, “impairment of the carrying amount” makes no logical sense.
Finally, the underlying causes of a long-lived asset write down under U.S. GAAP or IFRS doesn’t fit the word “impairment” either. All causes boil down to fixes of past mistakes: either management made the mistake of overpaying for what they got (very common in the case of business combinations and goodwill); and/or the asset was not depreciated rapidly enough. These are not “impairments.” They are merely journal entries made to (finally) correct errors that could have occurred years ago.
With that off my chest, let’s take a look at the Exxon case. Apparently it is not clear to the SEC staff how Exxon has avoided U.S. GAAP’s asset impairment trigger following a 60% decline in oil prices. Most, if not all, of its peers took write downs.
Even with the SEC’s good intentions in mind, I can’t escape the thought that determining the appropriate time and amount of a write down is an exercise in futility. The historic-cost based “carrying amounts” of long-lived assets in oil and gas, like in every other industry, are contrived numbers that bear little or no relationship to an actual financial attribute (e.g., cost to replace, fair value, value in use) of the asset. The whole question of “impairment” is concerned with when these contrived “carrying amounts” have devolved from stabs in the dark to utter indefensibility. Aside from keeping accountants fully employed and the SEC occupied with enforcing something, is “impairment” accounting a waste of time and money? Shouldn’t shareholders want actual current valuations instead of “carrying amounts”? Wouldn’t you think that Exxon already has a very good idea of the value of its oil and gas assets? Why are Exxon’s shareholders and the investing public kept stabbing in the dark themselves until some arbitrary write-down date that will always be too late to shed much light?
The second thing I think about is that accounting based on current, independent valuations would make things easier all around, including auditing. My heart goes out to PwC, truly, for the public relations mess it finds itself in over the Oscars fiasco. But questions about the adequacy of their audit of Exxon should have an existential air about them as contrasted with the public hand wringing over the damage the Oscars did to PwC’s “brand” — as if the services of a Big Four audit firm are marketed like lite beer.
It will be interesting to see, if we ever get the chance, how PwC will respond to the SEC staff’s questioning. Presumably, PwC’s other oil and gas clients took large writedowns. Presumably, PwC would have performed an analysis leading it to conclude that management’s estimates that went into those writedowns were “reasonable,” just as auditing standards require them to do. Presumably, PwC also performed an analysis somehow leading it to conclude that Exxon’s estimates, which resulted in no write down, were also “reasonable.”
Presumably, any of this really matters. Whatever the write down under U.S. GAAP or IFRS comes out to be, it will have no bearing on the economic reality that the value of Exxon goes up and down all the time as the fluctuations in energy prices affect the value of its assets. But, if I were the auditor, I would not want to be walking that tightrope between clients who took write downs and the behemoth that thinks they are untouchable in an SEC investigation. But then again, PwC is practically untouchable by the SEC: it is a TBTSTS firm (too-big-to-sanction-too-severely).
Perhaps the Exxon case is notable simply for the apparent chutzpah of its management and the sway it holds over its TBTSTS audit firm. But I do think it is more significant than just that. Exxon is one of many data points from the universe of public companies that do the impairment accounting song and dance every time the economic music slows down a beat or two. Shareholder value gets chewed up; but the impairment accounting rules still leave open the significant likelihood that CEOs sweep clean the bonus pool for “making their numbers.”
And auditors collect their fees — in exchange for blessing the financial statements, and for locking arms with management should the SEC come knocking at the door.