COVID-19 disruptions make accounting for asset impairment more relevant as organizations grapple with the financial impact the pandemic has had on operations. While some organizations experienced an immediate and significant change at the start of the pandemic, recovery may have come faster than the government stimulus programs went into effect. For others, recovery even with the stimulus relief may be slow, or even worse, may still not be occurring. These companies could be exploring restructuring options and other more substantial adjustments to how they operate.
The nuances to the impact and recovery process may complicate the evaluation of the fair value of assets during 2020 and into 2021 as well. Below are some tips and guidance to help you evaluate potential impairments.
Refresher on Asset Impairment
Publicly 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 there has been a triggering event which 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 as well. Therefore, to be able to test for impairment properly, it is important to understand how the accounting guidance defines a triggering event and what that means for impairment testing.
The accounting guidance currently requires the evaluation of a triggering event throughout the entire financial statement period, although in practice differences in application have emerged. Public companies evaluate for asset impairment on an ongoing basis 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. The economic impacts of COVID-19 have highlighted this difference in the application of the accounting standards. A recently proposed accounting simplification for private companies may allow private companies the option to only measure goodwill impairment annually, which would align closer to the common practice which has emerged. If elected, the proposed accounting standards update would eliminate the requirement for certain private companies to perform the assessment of triggering events for goodwill during interim reporting periods.
As this guidance is only recently proposed, the remainder of this article will focus on the current guidance.
In the wake of the pandemic, organizations may find that assets have substantially changed in value even if the assets were recently acquired. Just as the impact of the pandemic was felt differently by companies, so, too, will the impact of the pandemic be felt differently on the fair values of assets. 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 the value of an asset, but one that indicates the decline in the fair value may now be below the asset’s carrying value. As such, if a very small difference between the fair value and carrying value previously existed, a small decline in fair value may indicate a triggering event has occurred. Alternatively, an asset with a fair value that significantly exceeds the carrying value is far less likely to experience a triggering event.
Therefore, it is important to analyze and test for impairment considering the larger economic impacts of the pandemic as well as how the fair value of your business and assets may have changed. The following are some key types of triggering events to keep in-mind.
Under the current accounting guidance, a triggering event may have occurred even if your organization has subsequently recovered. Organizations should consider what their expectations for their business were before the pandemic and how the macroeconomic conditions of the pandemic changed those expectations. If the macroeconomic conditions at the beginning of the pandemic were not expected to negatively impact the business, this may not cause a triggering event.
Industry & Market Considerations
An organization’s unique industry and market must also be considered. For example, the supply chain disruptions felt by the pandemic safety precautions have presented a unique challenge for some manufacturers and distributors. A local government requirement to close restaurants or entertainment venues as a result of the pandemic would indicate the businesses impacted by this type of a requirement had experienced a triggering event. On the flip side, rapid changes to technology and the creative destruction within the marketplace is having a very positive impact on 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.
Despite the economic challenges faced by many businesses due to the lack of demand, some businesses may instead face supply side issues. Raw material shortages may affect increased costs in obtaining certain items. Others may be grappling with higher labors costs as demand for skilled workers increases or the organization struggles to maintain productivity in a remote setting. The evaluation of cost factors therefore is very specific to a company’s operations.
During 2020, U.S. markets experienced their most volatile and dramatic changes on record. The immediate decline in personal and business consumption as well as the loss of employment for many resulted in a downturn in the markets teetering on a recession. 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 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.
Some triggering event considerations may not be directly related to the pandemic. For example, if unexpected changes in key management personnel indicate that a significant value decrease may have occurred, that may be considered an impairment event. 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 involved 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 Nate Vander Hamm or a member of our team.
Published on February 09, 2021