COVID–19 – Impairment Considerations (Goodwill, Intangibles and Long-lived Assets)
Published April 15, 2020
The COVID-19 outbreak has presented many financial and reporting challenges for Companies as they deal with reduced operations or even a complete shut-down during this pandemic. One of these financial reporting challenges will be performing proper asset impairment tests. Evaluation of impairment on goodwill, intangible assets, and other long-lived assets represents a significant accounting estimate with varying rules around evaluation depending on the nature of the asset. Companies need to keep in mind the requirements under generally accepted accounting principles that apply to these assets, and ensure they are performing the correct type of evaluation. There will also be a need to reassess the existing assumption and methods in place for evaluating impairment to properly factor in the impact of the COVID-19 outbreak on their business.
Below are some of the questions many businesses will be asking in the coming weeks and months specifically around the asset impairment topic:
If I am already amortizing my goodwill and intangibles and depreciating my long-lived assets, is an impairment evaluation still required?
Yes. Whether these underlying assets are being amortized or not an impairment test is required when a triggering event occurs. Triggering events indicating a potential goodwill or other long-lived asset impairment could come in a variety of forms. The Accountings Standards Codification (ASC) provides the following examples of items, events or circumstances which could be triggering events in ASC 350-20-35-3C:
- Macroeconomic conditions such as a 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 such as a deterioration in the environment in which an entity operates, an increased competitive environment, a decline in market-dependent multiples or metrics (consider in both absolute terms and relative to peers), a change in the market for an entity’s products or services, or a regulatory or political development
- Cost factors such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows
- Overall financial performance such as 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
- Other relevant entity-specific events such as changes in management, key personnel, strategy, or customers; contemplation of bankruptcy; or litigation
- Events affecting a reporting unit such as a 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
- If applicable, a sustained decrease in share price (consider in both absolute terms and relative to peers).
This list is not all inclusive, however, as you can tell by the above examples, the conditions created by the COVID-19 outbreak are likely to trigger this requirement to perform an impairment evaluation. Depending on the nature of the asset being evaluated, the normal frequency of evaluation may vary but, in all instances, when a triggering event occurs an assessment as to if the underlying asset is impaired is required. When considering a need for an impairment evaluation on long-lived assets, a temporary idling of significant long-lived asset or a group of long-lived assets resulting from COVID-19 could be considered a triggering event, requiring Companies to perform the two-step impairment test required by ASC 360.
ASC 350 requires that for all goodwill and all indefinite lived intangible assets the evaluation as to if impairment exists should be performed on annual basis or when a triggering event has occurred. The guidance under ASC 360 indicates that for long-lived assets (like fixed assets), as well as amortizable intangible assets, the evaluation for impairment is only required when a triggering event has occurred.
What will I need to consider when evaluating these assets for impairment and assessing fair value?
When assessing if an impairment exists, Companies are required to assess fair value and, in some cases, recoverability based on undiscounted cash flows (see following question for more detail). In developing a calculation of fair value there are many factors that need to be considered when assessing the fair value of a tangible long-lived asset. Fair value can be assessed based on market data about the value of the underlying asset or discounted future cash flows generated by the asset or group of assets. When assessing goodwill, fair value needs to be calculated at the reporting unit level and then compared to the carrying value of that reporting unit.
The fair value calculations used should incorporate current market data and forecasts by Companies and should include the direct impacts of items like expected supply chain interruption, decreased demand and revenues, temporary shutdown, and other anticipated factors. Given the degree of uncertainty Companies may need to consider using multiple projections weighted by expected likelihood of each scenario. These scenarios should incorporate items like a varying period of shut-down based on the COVID-19 responses, and potential impacts from suppliers in other markets who have been more significantly impacted by the spread of the virus. Also, varying assumptions regarding revenue recovery and over what period. These varying scenarios may require differing discount rates be applied by the Company based on risks that exist in the forecast.
Given the current environment, the discount rates have been greatly impacted by the reductions in the risk-free rate which has occurred during the COVID-19 outbreak. These reductions should factor into Companies calculation of future cash flows that may be used in assessing the fair value of a reporting unit or asset.
I have never had to evaluate my long-lived assets (fixed assets) for impairment. What steps do I need to take to properly perform this assessment?
The evaluations of the long-lived assets and intangibles being amortized is a two-step methodology. This is unlike the one-step methodology for goodwill and indefinite lived intangibles. ASC 360-10-35-17 details the requirements of the two step process Companies should follow in assessing if an impairment loss exists:
An impairment loss shall be recognized only if the carrying amount of a long-lived asset (asset group) is not recoverable and exceeds its fair value. The carrying amount of a long-lived asset (asset group) is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset (asset group). That assessment shall be based on the carrying amount of the asset (asset group) at the date it is tested for recoverability, whether in use (see paragraph 360-10-35-33) or under development (see paragraph 360-10-35-34). An impairment loss shall be measured as the amount by which the carrying amount of a long-lived asset (asset group) exceeds its fair value.
As you can tell from the above guidance a Company must first assess if the carrying value of the asset exceeds the undiscounted cash flows from the use and eventual disposition of the asset. If the asset fails this test then the impairment recognized will be based on the difference between the carrying value of the assets and the fair value. The fair value in many cases could be estimated using market data about the asset or discounted future cash flows from use and eventual disposition of the asset. It is important to note that a long-lived asset or intangible subject to amortization may have a carrying value lower than its fair value but still not be subject to impairment under generally accepted accounting principles due to “passing” step 1. It is important that companies ensure they are first performing an analysis of the undiscounted future cash flows in determining if the assets are subject to step 2 and potential impairment under this guidance.
When performing the assessment of the undiscounted cash flows it is also important to only include the future cash flows directly associated with the asset less any associated cash outflows. Those estimated cash outflows used should exclude any interest charges. (ASC 360-10-35-29). The undiscounted cash flows should be those estimated over the remaining asset life as detailed in ASC 360-10-35-31.
In making the projections over the remaining life of the asset, Companies will need to factor in cash outflows necessary to maintain the asset such as repairs and maintenance, as well as capital costs that maintain, or even increase, the service potential of the long-lived asset. (ASC 360-10-35-33).
If I have both goodwill and related long-lived assets that could be subject to impairment which one should I test first, and should results of any impairment on one impact the calculation on the other?
The order in which Companies assess if an impairment has occurred is important as the impact of adjusting carrying value in the first test will be factored into the subsequent tests of impairment on the next class of assets. Companies should first assess if any impairments in indefinite-lived intangible assets have occurred (under ASC 350). Then, next up are long-lived assets (fixed assets) and intangibles subject to amortization, excluding goodwill (under ASC 360). Once adjustments, if any, related to these assessments are complete goodwill should then be evaluated. The determinations made in the tests around intangibles other than goodwill and long-lived assets could impact the resulting impairment calculated on the goodwill carried by the Company.
There are many considerations and challenges Companies will face in applying the above discussed impairment guidance to their goodwill, intangible assets and long-lived assets as a result of COVID-19. As noted above in question 2, projecting cash flows and fair values in this current environment will be especially challenging, but not impossible. It is important that Companies ensure they are properly applying generally accepted accounting principles based on the nature of the assets being evaluated, and that they are properly adjusting estimates used in their calculations for changes brought on by this pandemic.
Please contact us at COVIDACCT@MCMCPA.COM if you have question or need assistance with respect to financial accounting and reporting matters.
Nothing in this document should be construed as providing tax advice. Please consult with your own professional tax advisor. In addition, this document represents the information that we have up to the date the presentation was made and cannot be relied upon for additional updates beyond that date.