Goodwill and Long-Lived Asset Impairment Issues Related to COVID-19

The COVID-19 outbreak and worldwide response has had a dramatic impact on the global economy and in turn businesses and their operations. As the situation continues to evolve companies are experiencing substantial declines in market capitalizations, production and supply chain disruptions, workforce and travel restrictions, reduced consumer spending and sentiment, and heightened market volatility resulting in overall local and global uncertainty. With uncertainty, comes risk, which generally has a negative impact on value.

Companies operating in the current environment must consider if this uncertainty and the impact of the pandemic on business is impairing value. Under ASC 350 Intangibles – Goodwill and Other, an entity must test annually for goodwill impairment, and more frequently if a “triggering event” occurs that makes it more likely than not (greater than 50% probability) that the fair value of a reporting unit is below carrying value. This requirement for more frequent impairment tests due to a triggering event is also applicable to companies that elect for the private company accounting alternative for amortization of goodwill. For many companies, it is likely that recent events surrounding the COVID-19 outbreak would constitute a triggering event and necessitate additional goodwill impairment testing.

ASC 350-20-35-3C contains a non-exhaustive list of triggering events that could indicate possible goodwill impairment, many of which are applicable to companies in the current pandemic environment. The list includes the following:

1. 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
2. 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
3. Cost factors such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows
4. 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
5. Other relevant entity-specific events such as changes in management, key personnel, strategy, or customers; contemplation of bankruptcy; or litigation
6. 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 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
7. If applicable, a sustained decrease in share price (consider in both absolute terms and relative to peers).
   
   

In determining the necessity of a goodwill impairment test, there are other considerations that companies will need to consider. Companies will need to determine if a triggering event occurred in the first quarter ended March 31, 2020 as the pandemic was ramping up, or in the second quarter ending June 30, 2020, when some of the worst affects may begin to be felt. Additionally, company management will need to determine if the effects of the pandemic are likely to be temporary or permanent, and the resulting effect on future cash flows and impairment. Also, both direct and indirect impacts of pandemic and the response will need to be considered in projecting cash flows and determining the presence of goodwill impairment.

If it is determined that a triggering even has occurred due to the pandemic and its impact on operations or reporting unit, an additional goodwill impairment test will need to be performed. The fair value of the reporting unit is determined and compared to the carrying value and if the fair value is lower, goodwill impairment is indicated.  

Long-Lived Assets and Other Assets

In addition to goodwill impairment, it is likely that many companies could face impairment of long-lived assets and other assets as a result of COVID-19.

Like goodwill, indefinite-lived intangible assets (such as a trademark or tradename ascribed an indefinite life) are subject to impairment testing on an annual basis and more frequently if a triggering event occurs. Impairment indicators are similar to those for goodwill and many of these trigger events could be applicable due to the pandemic. If it is determined that it is more likely than not that the indefinite lived intangible asset is impaired, an impairment test must be performed. The fair value of the asset must be computed and if it is less than the carrying amount then impairment is indicated.

Long-lived assets (such as property, plant, and equipment and finite lived intangible assets) are not subject to annual impairment testing, but are tested for impairment when events and circumstances dictate that the carrying amounts of these assets are not recoverable. Impairment exists if the undiscounted future cash flows from the asset are less than the carrying amount. Many companies could face triggering events for impairment of long-lived assets due to COVID-19. Under ASC 360 Property, Plant, and Equipment, the following is a not exhaustive list of factors that could indicate impairment of long-lived assets:

1. A significant decrease in the market price of a long-lived asset (asset group)
2. A significant adverse change in the extent or manner in which a long-lived asset (asset group) is being used or in its physical condition
3. A significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset (asset group), including an adverse action or assessment by a regulator.
4. An accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of a long-lived asset (asset group).
5. A current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of a long-lived asset (asset group).
6. A current expectation that, more likely than not, a long-lived asset (asset group) will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. The term more likely than not refers to a level of likelihood that is more than 50 percent.
   
   

In additional to the aforementioned asset groups, other assets could also be subject to impairment as a result of the pandemic. These assets include receivables, inventories, contracts, securities, investments, or deferred taxes. Companies may need to determine the effect of COVID-19 on each of these asset groups.

It is also important that companies apply the right order / procedures in performing impairment testing on assets related to impact of the pandemic. Impairment testing should be applied the following order:

1. Adjust carrying amounts of other assets not covered by ASC 350 or ASC 360
2. Test indefinite-lived intangibles for impairment
3. Test long-lived assets for impairment
4. Test goodwill for impairment

The professionals at Citrin Cooperman have extensive experience in impairment analyses, purchase price allocations, and valuations for fair value and accounting purposes. As the world continues to grapple with the effects of COVID-19, our valuation experts continue to guide our clients through these trying times. Please feel free to contact us or reach out to us with any COVID-19 or triggering event related comments or questions.