Among the many consequences of COVID-19, impacts such as business and production disruptions, supply-chain interruptions, negative impacts on customers, volatility in the equity and debt markets, reduced revenue and cash flows, and other economic consequences may occur. The entities whose operations are negatively affected by COVID-19 may need to consider testing their assets for impairment.
Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 350-20 provides guidance on accounting and reporting for goodwill and requires that goodwill be tested for impairment at least annually. According to FASB ASC 350-20-35-30, goodwill should also be tested for impairment “between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount” (a triggering event). FASB ASC 350-20-35-3C provides the following examples of such events and circumstances and paragraphs 3F-3G of FASB ASC 350-20-35 describe the process for making these evaluations:
a. 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
b. 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
c. Cost factors such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows
d. 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
e. Other relevant entity-specific events such as changes in management, key personnel, strategy, or customers; contemplation of bankruptcy; or litigation
f. 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
g. If applicable, a sustained decrease in share price (consider in both absolute terms and relative to peers).
As indicated in FASB ASC 350-20-35-3F, these examples are not all-inclusive, and an entity should consider other relevant events and circumstances that affect the fair value or carrying amount of a reporting unit.
Given the current economic environment, entities may conclude that it is necessary to perform an interim goodwill impairment test.
Private companies and not-for-profit entities that have elected the accounting alternative under FASB ASC 350-20 to amortize goodwill are still required to test it for impairment (at either the entity level or the reporting-unit level) if an event occurs or circumstances change that indicate that the fair value of the entity (or the reporting unit) may be below its carrying amount (a triggering event). FASB ASC 350-20 uses the same triggering events for entities that have elected the accounting alternative as well as for those that have not. As a result, entities that have elected the accounting alternative may also conclude that they have a triggering event, requiring them to test goodwill for impairment. The likelihood of goodwill being actually impaired will depend on many factors, including the recency of the acquisition giving rise to goodwill. In other words, goodwill that results from a recent acquisition and which, therefore, has not yet been amortized over a significant period, is more likely to be impaired than goodwill that results from a more distant acquisition.
Entities should also consider whether to test their other assets for impairment and to make sure they perform those tests in the appropriate order. FASB ASC 350-20-35-31 requires that goodwill be tested for impairment only after the carrying amounts of the other assets of the reporting unit have been tested for impairment under other applicable accounting guidance. For more information, see the “Order of Impairment Testing” discussion later in this article.
Performing the quantitative goodwill impairment test involves determining a reporting unit’s fair value in accordance with the guidance in FASB ASC 820, Fair Value Measurement. Determining the fair value of a reporting unit is subjective and requires the use of significant judgment based on specific facts and circumstances. Given the current uncertainties, this is likely to be even more challenging than usual. Coming up with appropriate forecasts, discount rates and, for public companies, performing reconciliation of the reporting unit’s fair value to market capitalization may be especially challenging.
When considering and/or performing a goodwill impairment test, it may be helpful to refer to the AICPA Accounting and Valuation Guide, Testing Goodwill for Impairment, which provides guidance and illustrations for preparers of financial statements, independent auditors, and valuation specialists regarding the accounting, valuation, and disclosures related to goodwill impairment testing.
Indefinite-Lived Intangible Assets
Entities’ indefinite-lived intangible assets (such as certain trademarks) may also need to be evaluated for impairment. Paragraphs 15-20 of FASB ASC 350-30-35 provide guidance on impairment testing of indefinite-lived intangible assets and require that they be tested for impairment annually and more frequently if events or changes in circumstances indicate that it is more likely than not that the asset is impaired (triggering events). FASB ASC 350-30-35-18B provides examples of such events and circumstances, which are similar to those considered for goodwill.
As a result, entities needing to perform interim testing of goodwill for impairment may also conclude that they should test their indefinite-lived intangible assets.
Order of Impairment Testing
It is important to perform impairment testing in the appropriate order. Consistent with FASB ASC 360-10-35-27, the impairment testing should be performed in the following order:
- Adjust the carrying amounts of any assets (such as accounts receivable and inventory) and liabilities (such as accounts payable, long-term debt, and asset retirement obligations) not covered by FASB ASC 360-10 that are included in an asset group in accordance with other applicable GAAP.
- Test for impairment and adjust carrying amounts of indefinite-lived intangible asset(s) that are included in an asset group under FASB ASC 350-30.
- Test long-lived assets (asset group) and amortizable intangible assets under FASB ASC 360-10.
- Test goodwill of a reporting unit (or, for private companies, an entity) that includes the aforementioned assets under FASB ASC 350-20.
This sequence is necessary because it allows to make any required adjustments to the carrying amount of the reporting unit (or, for private companies, an entity) prior to the performance of the goodwill impairment test.
Yelena Mishkevich, CPA, CGMA
Senior Manager, Accounting Standards - AICPA
1 The following discussion regarding when to perform goodwill impairment test is relevant for entities that have already adopted the provisions of ASU No. 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, as well as for those that have not. This is because while ASU No. 2017-04 eliminated Step 2 of the goodwill impairment test, it did not amend the guidance regarding frequency of goodwill impairment testing or examples of triggering events listed in FASB ASC 350-20-35-3C.
Prior to the amendments in ASU No. 2017-04, the quantitative goodwill impairment test consisted of two steps. Step 1 compared the fair value of the reporting unit with its carrying amount; if the fair value was less than the carrying amount, then Step 2 was performed to measure the amount of impairment loss, if any, by comparing the implied fair value of goodwill with its carrying amount. In computing the implied fair value of goodwill in Step 2, an entity had to perform procedures to determine the fair value at the impairment testing date of its assets and liabilities (including unrecognized assets and liabilities) following the procedure that would be required in determining the fair value of assets acquired and liabilities assumed in a business combination.
Under the guidance as amended by ASU No. 2017-04, the quantitative goodwill impairment test involves only one step of comparing the fair value of a reporting unit with its carrying amount and recognizing an impairment charge for the amount by which the carrying amount exceeds the fair value.
ASU No. 2017-04 is effective for annual and any interim impairment tests performed for periods beginning after:
- December 15, 2019, for public business entities that are SEC filers, excluding entities eligible to be smaller reporting companies as defined by the SEC.
- December 15, 2022, for all other entities.
- Early adoption is permitted.
- The amendments should be applied on a prospective basis.