To Test or Not to Test
Given the recent impact of COVID-19 on the economy, unemployment and daily operations, the discussion of potential goodwill impairment (and related testing thereof) has become a hot topic for many entities across all industries. Accounting Standards Codification (ASC) 350, Intangibles – Goodwill and Other (ASC 350), states that entities must evaluate their goodwill for impairment at least annually; however, during interim periods (for those reporting interim results), a goodwill impairment analysis could be necessary if the entity has an indication that the fair value of a reporting unit has fallen below its carrying value, a condition defined by the guidance as a triggering event. Understanding what constitutes a triggering event is an important consideration even for those following the Private Company Council accounting alternative who are not required to assess goodwill for impairment annually, rather only when a triggering event occurs.
Determining whether a triggering event occurred for those entities who had an interim reporting date at March 31, 2020, was a significant undertaking for many and may continue to be for financial reporting dates occurring in the foreseeable future with continued market uncertainty.
Historically, some regulators have expressed concerns over public entities’ recording goodwill impairment charges at multiples times throughout a fiscal period, essentially challenging an entity’s ability to accurately apply the goodwill impairment test. However, with the unprecedented and rapid disruption of the global economy, accompanied by the high levels of future uncertainty, this conventional wisdom might be challenged. Entities possibly may experience multiple triggering events throughout the current fiscal year. Therefore, the scrutiny around identifying triggering events and the assumptions used in any impairment model are expected to have continued importance.
Examples of Goodwill Triggering Events
While the list below is not exhaustive, ASC 350-20-35 provides examples of triggering events for goodwill:
| ||Macroeconomic Conditions: 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 Conditions: 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: Increases in raw materials, labor or other costs that have a negative effect on earnings and cash flows. |
| ||Financial Performance: 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. |
| ||Entity-Specific Events: Changes in management, key personnel, strategy, or customers; contemplation of bankruptcy; or litigation. |
| ||Changes in Composition of Reporting Unit: 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. |
| ||Sustained Decrease in Share Price: If applicable, a sustained decrease in share price (consider in both absolute terms and relative to peers). |
It is clear that COVID-19 has had global impacts on some macroeconomic conditions. For example, on Jan. 2, 2020, the U.S. 10-year daily treasury yield was 1.88 percent compared to an astoundingly low rate of 0.70 percent as of Mar. 31, 2020.1 In contrast, the foreign exchange rate for the U.S. dollar to euro (0.892 as of Jan. 2, 2020) has experienced some volatility but has seen a rebound at 0.904 as of Mar. 31, 2020.2 Industry and market impacts due to COVID-19 are also widely varied. The demands for online services such as video/television streaming and online/at-home fitness solutions have experienced a surge, while other industries such as hospitality are experiencing steep declines.
Entities may want to assess whether they have experienced a triggering event, and if they conclude there has been such an event, they may need to proceed to a goodwill impairment test as required under the standard. Assessing whether there has been such a triggering event as defined by ASC 350, however, does involve judgment, and as mentioned above, will receive considerable scrutiny from regulators and external auditors.
Example: The Use of Judgement
Relating to a decline in stock price, the guidance in ASC 350 does not define the term “sustained.” In isolation, a decrease in share price is not necessarily an automatic indication of a triggering event. The guidance suggests comparing the relative decrease to peers, which if consistent amongst the industry, and when considered in isolation, may lead one to conclude that the decrease is related to general economic events and not specific to the company individually. However, entities may determine that an overall decline in the market could be indicative of macroeconomic conditions that are expected to impact the value of the company. Entities should consider forecasts and projections to determine whether the situation is expected to be temporary and, as a result, whether the reduction in stock price is reflective of short-term market volatility rather than a long-term, sustained decline in fair value.
The guidance does not suggest that the existence of one negative factor results in a triggering event. Rather, the guidance requires entities to assess various factors to determine whether it is probable that the company’s fair value is less than its carrying value. One potential way to consider the various factors mentioned in the guidance is to weight them relative to their estimated impact on the entity’s fair value. If the company concludes that a triggering event has occurred, then an interim impairment analysis should be performed to determine if in fact goodwill is impaired. The determination of a triggering event, or lack thereof, involves judgment from management, and their analysis should be thoroughly documented regardless of the conclusions reached. As the economic environment and resulting impacts of COVID-19 continue to shift and evolve, entities should revisit potential goodwill impairment triggers on a continued basis.
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- Daily Treasury Yield Curve Rates, U.S. Department of the Treasury.
- Oanda Currency Converter.