Today’s economy is marked by volatility, and recessionary potential continues to bloom; this mix of indicators necessitates a focus on accounting for asset impairment. The financial impact of inflation and rising interest rates has become a key consideration for companies as they explore restructuring options and other strategic adjustments to their operations. However, evaluating the fair value of assets is not always straightforward, as the nuances of the impact and recovery process can complicate the task.
Refresher on Asset Impairment
Public companies and some private companies are required to test for impairment of goodwill on an annual basis. In addition, asset impairment occurs under ASC Topic 350 Intangible – Goodwill and Other when a triggering event causes the fair value of an asset (or group of assets) to fall below its carrying value. Similar triggering event impairment guidance exists for Property, Plant and Equipment assets in ASC Topic 360. Therefore, to test for impairment properly, it is crucial to understand how the accounting guidance defines a triggering event and what that means for impairment testing.
The accounting guidance requires public companies and some private companies to evaluate for a goodwill-triggering event throughout the entire financial statement period. Public companies evaluate for asset impairment continuously due to their quarterly reporting requirements. However, many private companies have historically conducted asset impairment analysis only as part of their year-end financial statement reporting. A recent update to the accounting standards for simplification allows private companies the option to only measure goodwill impairment due to triggering events at the end of reporting periods. If elected by a private company, this approach will align more closely to the common practice which had previously emerged. Under this approach, rather than testing for a goodwill impairment on the date of a triggering event, the test can be performed at the end of the next reporting period, which may be either interim or annual, depending on the company’s reporting requirements.
Triggering events are not a universal occurrence; they are specific to your organization and your assets. Further, a triggering event is not simply an event that indicates the decline in an asset’s value but indicates that the decline in the fair value may now be below the asset’s carrying value. As such, if a minimal difference between the fair value and carrying value previously existed, a slight decline in fair value may indicate that a triggering event has occurred. Alternatively, an asset with a fair value significantly exceeding the carrying value is far less likely to experience a triggering event.
The following are some key types of triggering events to keep in mind.
Considering the current economic climate characterized by surging interest rates, it is crucial for companies, particularly those in debt-intensive industries, to remain cognizant of the potential impact of such increases on their fair value. As interest rates climb, a corresponding drop in company value can ensue, fundamentally altering both the valuation model and the broader perception of the company. Companies need to remember that triggering events such as these can occur without directly impacting the company’s operations, as it impacts the fair value of the company and its assets.
Industry & Market Considerations
An organization’s unique industry and market must also be considered. For example, supply chain disruptions caused by the pandemic still create challenges for most manufacturers and distributors. Mergers and acquisition activity has slowed down in most industries since the start of the prior year. On the flip side, rapid changes to technology and creative destruction within the marketplace are positively impacting some businesses. The key to the impairment analysis is to understand whether the disruption had a negative effect on the key drivers of fair value for the organization or assets.
The current inflation rate represents a four-decade high, posing a significant challenge for organizations grappling with cost escalation. Particularly concerning is the confluence of rising inflation and a potential inability to pass these additional costs on to customers, which can put tremendous pressure on margins. Additionally, industries are contending with a dual predicament of labor scarcity in certain sectors while simultaneously experiencing layoffs in others, further complicating the cost management issue for organizations. Therefore, the evaluation of cost factors is very specific to a company’s operations.
It is expected that the stock market will remain volatile throughout 2023. Therefore, CFOs should monitor market activity closely to assess any fluctuations. Public companies should evaluate a decline in the market price of their publicly traded equity as a potential triggering event. Private companies may also observe meaningful declines in the market values of publicly traded competitors, which may indicate that the fair value of their business has also been impacted. As the triggering event guidance is based upon the fair value at a point in time, a subsequent recovery in stock prices is not likely to provide meaningful evidence that a triggering event was not experienced.
Several major corporations have experienced layoffs this year, posing triggering event considerations for organizations facing the same fate. For example, a significant reduction in workforce by a company would signal a detrimental shift in the business, adversely affecting its prospects and ultimately impacting the company's valuation. If a company is considering a spin-off or other business unit disposition, this could also cause an expectation that the fair value of the business or group of assets within the business has declined. In many instances, the pandemic may not have created these conditions but may have caused an increase in their severity or hastened their occurrence.
Accounting for Impairment and Potential Accounting Changes
Once a triggering event has been identified, your organization will need a multi-step process to evaluate the asset or goodwill for impairment. This involves future cash flow modeling, with specific considerations for depreciable assets and discounted cash flow or market comparison analysis for goodwill and intangibles.
For more information about impairment analysis, please contact a member of our team.
Published on May 09, 2023