Understanding Stranded Assets: Risks and Impacts

Stranded assets are assets that are unable to earn their original economic return due to changes in the landscape in which the assets operate. In simpler terms, stranded assets are assets that are worth less than expected.

Summary

• Stranded assets are assets that are unable to earn their original economic return.
• Stranded assets impact both the balance sheet (reducing asset value) and income statement (non-cash loss).
• An impairment test can determine whether an asset is stranded.

Understanding Stranded Assets

Stranded assets are assets that faced:

• Unexpected write-downs
• Premature write-downs
• Devaluations
• Conversion into liabilities

At an extreme, stranded assets may face obsolescence and, as a result, be written off a company’s balance sheet entirely, with the resulting loss reflected on the income statementIncome StatementThe Income Statement is one of a company's core financial statements that shows their profit and loss over a period of time. The profit or.

Stranded assets arise due to unexpected negative changes in the assets earning power, caused primarily by external factors. For example, a machine used solely to produce gas-powered cars is likely to be considered a stranded asset as society becomes more environmentally conscious and increases its adoption of electric vehicles. As a result, the machine’s economic return would become impaired as it produces fewer gas-powered cars than originally intended.

Stranded assets are commonplace in industries faced with:

• A quick technology lifecycle
• Environmental challenges
• Regulatory changes
• Governmental intervention
• Changing social norms

Testing an Asset for Impairment

To determine whether an asset is “stranded,” accountants conduct impairment tests. An impairment test is a common accounting procedure used to determine potential asset devaluations. Under the Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS), tangible assets and intangible assetsIntangible AssetsAccording to the IFRS, intangible assets are identifiable, non-monetary assets without physical substance. Like all assets, intangible assets must be written down when impaired below their book value.

Testing for Impairment under US GAAP

Under GAAP, the asset’s carrying value (original cost – accumulated depreciationAccumulated DepreciationAccumulated depreciation is the total amount of depreciation expense allocated to a specific asset since the asset was put into use.) is compared with the undiscounted future cash flows (UFCF) generated by the asset. If the carrying amount exceeds the UFCF, the asset is considered impaired.

Testing for Impairment under IFRS

Under IFRS, the asset’s carrying value is compared to (1) the fair value less costs to sell the asset and (2) the fair value in use (the present value of future cash flows generated by the asset). If the carrying amount exceeds either the greater of either fair value less costs to sell or fair value in use, the asset is considered impaired.

Impact of Stranded Assets on Financial Statements

Asset devaluations impact a company’s income statement and balance sheet. The amount of the devaluation reduces the company’s assets value on the balance sheet, and the charge is reflected in the income statement as a loss. Since an asset devaluation is a non-cash event, there is no associated outflow of cash. To solidify your understanding of the impact of a stranded asset, let us walk through an example:

Example: A company reports under GAAP and is an operator of oil platforms. Due to the growing popularity of clean energy, management expects its oil platforms, currently at a carrying valueCarrying AmountThe carrying amount is the original cost of an asset as reflected in a company’s books or balance sheet, minus the accumulated depreciation of of $5,000,000, to only be able to generate total undiscounted future cash flows of $3,000,000.

Question: Are the oil platforms considered impaired? If so, what would be the appropriate journal entries?

Answer: Under GAAP, the oil platforms are considered impaired, as the carrying value is above the total undiscounted future cash flows generated. An impairment loss of $2,000,000 would be necessary. The journal entries would be as follows:

Stranded Assets in an Environmentally Friendly Society

With progression towards a greener society and investors pursuing clean energy investments, fossil fuel companies’ assets are set to become stranded. According to a study, one to four trillion US dollars could be wiped off global fossil fuel assets as future demand for fossil fuel decreases.

For example, in the wake of the 2020 coronavirus pandemic, a downbeat view on longer-term oil prices, and countries pursuing the Paris Agreement climate goals, oil giant British Petroleum Company Plc reported plans to write down the value of its assets by USD 13-13.7 billion.

Not only are oil and gas companies facing stranded assets in the pursuit of a greener society – traditional car manufacturers are facing the same fate. Regulators in various jurisdictions are currently pursuing the electrification of cars to decrease carbon dioxide emissions

For example, China intends to make all new vehicles sold in 2035 eco-friendly, and Japan plans to stop the sale of gas-powered cars by the mid-2030s. In the U.S., California Governor Gavin Newson signed an executive order in 2020 stating that all vehicles sold in the state of California must be emission-free by 2035.

Currently, carmakers are in a race to update or modify factories dedicated to producing internal combustion engines to avoid them from becoming stranded.

More Resources

CFI offers the Commercial Banking & Credit Analyst (CBCA)™Program Page - CBCAGet CFI's CBCA™ certification and become a Commercial Banking & Credit Analyst. Enroll and advance your career with our certification programs and courses. certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful:

• Analysis of Financial StatementsAnalysis of Financial StatementsHow to perform Analysis of Financial Statements. This guide will teach you to perform financial statement analysis of the income statement,
• Goodwill Impairment AccountingGoodwill Impairment AccountingGoodwill is acquired and recorded on the books when an entity purchases another entity for more than the fair market value of its assets.
• IFRS vs. US GAAPIFRS vs. US GAAPThe IFRS vs US GAAP refers to two accounting standards and principles adhered to by countries in the world in relation to financial reporting
• Projecting Income Statement Line ItemsProjecting Income Statement Line ItemsWe discuss the different methods of projecting income statement line items. Projecting income statement line items begins with sales revenue, then cost