During the first quarter of 2020, the economic decline caused by the COVID-19 pandemic has raised many questions about the fair value of a variety of assets held in a broad range of industries and companies. This has been demonstrated by the significant declines in public share prices by many public companies as well as the declines noted in the broader stock market indices.
This market movement, along with the impact on future cash flows, and the resulting effect on other fair value indicators will create many questions about what may constitute a triggering event for organizations to determine whether to test their assets for impairment purposes.
Which Organizations Will Face Impairment Considerations First?
It’s important to note that coronavirus-related accounting implications will only be a factor for the 2020 assessment of impairment, and not for organizations that have not yet issued their Dec. 31, 2019 financial statements. (Companies that have yet to issue financial statements will need to add subsequent event disclosures that reference COVID-19). The accounting rules require the fair value of an asset to be evaluated as of the date of the impairment test using information which was known or knowable at the time. Therefore, as the primary impacts of the COVID-19 virus were not known as of Dec. 31, 2019, these conditions would not be expected to impact impairment testing at that time. Details around entities estimates of the impact of COVID-19 in 2020, should be included in the subsequent events footnote.
For financial statements that are prepared for periods after Dec. 31, 2019; such as quarterly reports or fiscal annual periods ending March 31, 2020, the effects of the pandemic will need to be considered. For those organizations with material amounts of goodwill, indefinite lived intangibles, amortizable intangibles or fixed assets, the analysis should begin with evaluating if a triggering event has occurred that will require a detailed impairment analysis.
The accounting guidance does not provide a bright line definition for what constitutes a triggering event, which is due to the significant differences in the nature of assets and the differences in what may affect their valuation. Rather, organizations should evaluate the facts and circumstances that may indicate an asset’s fair value is less than its carrying value. The FASB has provided various examples of potential triggering events to assist in the evaluation process. Accounting Standards Codification section 350-20-35-3C (Intangibles – Goodwill and Other) includes the following examples of triggering events:
These could include deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates, or other developments in equity and credit markets.
Industry and Market Considerations
A deterioration in the environment in which an entity operates, an increased competitive environment, a decline in market-dependent multiples or metrics, a change in the market for an entity’s products or services, or a regulatory or political development could be considered a trigger for impairment accounting.
Increases in raw material, labor, or other costs that have a negative effect on earnings and cash flows might be a trigger.
Overall Financial Performance
Negative or declining cash flows or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods may be a triggering event. Consider if your supply chain and demands for products or services were disrupted by COVID-19.
Other Relevant Entity-Specific Events
Relevant events in this category could include changes in management, key personnel, strategy, or customers; contemplation of bankruptcy; or significant litigation.
Events Affecting a Reporting Unit
Change in the composition or carrying amount of its net assets, a more-likely-than-not expectation of selling or disposing of all, or a portion, of a reporting unit, the testing for recoverability of a significant asset group within a reporting unit, or recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit would trigger impairment in most cases.
This list is not intended to be all-inclusive, and some factors may be viewed differently for organizations based on their industries and their specific facts. For example, organizations will need to consider when their business started to feel the effects of the COVID-19 pandemic. Although the decline in the U.S. stock market started to hit at the end of February, organizations with business activities in China might have felt effects even earlier.
Alternatively, some organizations may be experiencing an increase in demand and profitability for their products and services despite the overall decline in the macroeconomic conditions of the overall economy. Further, the nature of the asset being tested and the results from the most recent impairment test are also factors to consider in evaluating a triggering event.
Public Company Considerations
For public companies, one potential indicator of a triggering event may be if there is a significant decline in the publicly traded stock price of a company. The SEC staff has stated previously that they do not believe registrants should ignore recent changes in their stock prices when considering impairment testing. However, SEC staff has also stated that they do not believe the market capitalization indicated by using a point-in-time market price as of the date of its goodwill impairment is required.
Instead, the use of a range of dates from a reasonable period leading up to the impairment testing date would be appropriate. While reasonable period is not defined by the SEC staff, it is generally believed to be fairly short in nature and should be supported by the facts and circumstances for each issuer. Companies that use longer periods should expect to have to provide greater levels of support for the length of time used to their auditors as well as to the SEC staff if requested through a comment letter.
Therefore, while U.S. generally accepted accounting principles (GAAP) does not require a publicly traded company to reconcile its stock price and market capitalization to the combined fair values of its reporting units, it is a meaningful comparison that may serve to either corroborate or challenge the results of a company’s fair value conclusions. This type of analysis and documentation by publicly traded companies would be expected as part of a company’s internal controls over financial reporting for impairment and triggering events. In addition, this type of information may be useful information to disclose in the company’s annual or interim reporting.
How to Measure for Impairment
Future cash flow information will frequently be required for impairment testing purposes, whether it is for an undiscounted cash flow test for depreciable or amortizable assets, or as part of a discounted cash flow analysis for testing goodwill or other intangibles. These future expectations may be greatly impacted during times of uncertainty. Management should work with their specialists to ensure this uncertainty is addressed within the valuation model that is used.
Valuation models may need to be modified with a higher company specific risk factor included in the discount rate to reflect this risk, or a probability-weighted approach may be appropriate. If a company has shut down some or all of their operations, management will be required to make estimates of when their business will begin to operate again, as well as what additional costs will be incurred during this period. If after completing their analysis, a company determines that it does not have an impairment, the company should disclose the relevant information regarding their analysis and assumptions as well as what events might lead to an impairment in the future. The concept of foreshadowing impairments is relevant even outside of the current economic environment, but is expected by many to be a subject of increased scrutiny by the SEC staff in the current environment. While the SEC staff’s views are specific to those of registrants, they provide meaningful insight into what disclosures may be useful for privately owned companies as well.
While impairments may be viewed by some companies as things to avoid, impairments are likely to be increasingly common during this period. The more willing organizations are to accept and acknowledge these risks in their accounting and financial disclosures, the better these results will be able to be understood by the users of the financial statements.
In addition, many organizations have a history of making adjustments to their non-GAAP measures for impairments as they feel these metrics are useful to the financial statement users. If a company revises their non-GAAP measures during this period to include impairments, they should ensure they are properly disclosing the reasons for the change, and management should evaluate the need to recast comparable measures from prior periods.
Anticipating What Comes Next
Chances are if an organization sees the potential for goodwill impairment, other long-lived assets might be impaired as well, including indefinite lived intangibles, amortizable intangibles and fixed assets. While the operational and economic impacts of these unprecedented events are still not fully known, management’s use of its best estimate will be necessary in assessing impairments.
No one can perfectly predict the future, so the more robust the disclosures an organization makes regarding these risks, the greater the ability for users of the financial statements to understand the financial results.
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Dave is a Managing Director and Leader of CBIZ & MHM New England's Accounting Advisory Practice. He can be reached at 617.761.0508 or at email@example.com.