The longest-running bull market since World War II began in March 2009, and over the past few years, many debated “when, not if,” a downturn would occur. But no one could have predicted that a global pandemic would lead to unprecedented disruption and dislocation in the capital markets and the quickest end to a bull market in history.
As of March 23, the S&P 500 had fallen nearly 30% from its February highs. While the markets have recovered somewhat, many industries have been hit hard. Reporting entities will now need to consider whether the impact of COVID-19 and the resultant market downturn constitutes a triggering event for purposes of goodwill, intangible asset, and fixed-asset impairment testing.
Before we delve into potential triggering events, we thought a quick recap on impairment testing requirements under U.S. Generally Accepted Accounting Principles (GAAP) for various asset classes would be helpful.
Impairment Testing Requirements
|Goodwill||Indefinite-Lived Intangibles||Long-Lived Assets (including Finite-Lived Intangibles)|
|Relevant Guidance||ASC 350||ASC 350||ASC 360|
Annually and upon triggering event (for private companies electing accounting alternative, only upon triggering event)
Annually and upon triggering eventUpon triggering event
Level of TestingReporting unit (operating segment or component)Individual assetAsset group (lowest level of independent cash flow)Method of Testing
One step on a fair value (e.g., discounted cash flow) basis
One step on a fair value (e.g., discounted cash flow) basis
Two steps – first step on an undiscounted cash flow basis, second step on a fair value basis
Order of Testing (Assets Held and Used)ThirdFirstSecondOrder of Testing (Assets Held for Sale)SecondFirstThird
Triggering events differ for goodwill/indefinite-lived intangibles and long-lived assets. That said, an impairment of goodwill or indefinite-lived intangibles may trigger the need to conduct impairment testing for long-lived assets. Additionally, and while not specifically identified in ASC 360, significant entity-level events may trigger impairment testing for long-lived assets. Below are examples of triggering events for goodwill/indefinite-lived intangibles and long-lived assets, respectively.
|Goodwill and Indefinite-Lived Intangibles||Long-Lived Assets (including Finite-Lived Intangibles)|
Macroeconomic conditions (deterioration in general economic conditions)
Significant decrease in market price of a long-lived asset (asset group)
Industry and market considerations (deterioration in the environment in which a company operates)Significant adverse change in the extent or manner in which a long-lived asset (asset group) is being used or in its physical condition
Cost factors (increases in raw materials, labor, etc.)
Significant adverse change in legal factors or in the business climate
Overall financial performance (negative or declining cash flows, decline in actual or planned revenue or earnings)
Accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of a long-lived asset group
Other relevant entity-specific events (changes in management, key personnel, strategy, etc.)Current-period, historic, or projected operating or cash-flow loss associated with the use of a long-lived asset group
Events affecting a reporting unit (change in composition of net assets, expectation of disposing all or a portion of the reporting unit)
Expectation of disposing a long-lived asset or asset group before the end of its useful life
Sustained decrease in share price (in absolute terms or relative to peers)
Obviously, certain triggering events listed above will be more relevant to the current environment than others. With respect to COVID-19, we believe companies should specifically consider the following potential triggering events.
Macroeconomic conditions such as a deteriorating on in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates, or other developments in equity and credit markets
Clearly, COVID-19 has impacted macroeconomic conditions globally. Equity markets have seen dramatic decreases in value in a short period of time. We have also witnessed unprecedented volatility in the global markets; it is difficult to predict how markets will look tomorrow, let alone one to two months from now.
Governments have begun to intervene as they attempt to prevent a prolonged recession. From a U.S. perspective, it is unknown whether or when efforts to “flatten the curve” will be successful and allow the country to get back to business as usual. As this continues to unfold and a greater data set is available for analysis, we will have a better sense as to the short-, medium-, and long-term impacts on the global economy.
Industry and market considerations include elements such as a deterioration in the environment in which an entity operates, an increased competitive environment, a decline in market-dependent multiples or metrics (considered 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
While nearly all companies have been affected in some way by COVID-19, certain industries have been more adversely impacted than others. The airline industry was down nearly 60% in the last month, based on the S&P 500 Airlines Industry Index. Cruise line stocks are down as much as 87% year-to-date. In addition, bar and restaurant stocks are down over 40% in the last month, based on the Dow Jones U.S. Restaurants & Bars Index, with individual restaurant stocks down as much as 90%. Conversely, certain companies have seen an increase in demand for their products and services during this time.
With this context, it is clear certain industries will need to consider impairment testing sooner than others and likely prior to their annual testing date. In determining whether a triggering event has occurred, companies should consider all facts and circumstances, including the near- and medium-term outlook for demand for products and services in their particular industry.
Overall financial performance includes such factors 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
In light of the COVID-19 crisis, many companies have already warned that earnings will be lower than forecasted. Public companies representing a broad spectrum of industries have significantly reduced or removed earnings guidance. It will likely take some time for companies to assess the impact of COVID-19 on their specific business and to update their forecasts to account for it. Once companies are able to assess impacts to actual and forecasted results, they should consider whether such impacts represent a triggering event.
In doing so, the threshold for determining whether a triggering event has occurred may differ by reporting entity. For example, reporting entities that consummated a recent material acquisition or had a recent occurrence of goodwill impairment are at more risk. Any decrease in future cash flow expectations would likely cause an incremental impairment as opposed to a reporting entity that passed its most recent impairment test by a wide margin.
If applicable, a sustained decrease in share price (consider in both absolute terms and relative to peers)
To be clear, a decline in the overall stock market is not, in and of itself, necessarily a triggering event. The stock market can be highly volatile, and the intent of the guidance is not to induce a wave of impairments every time the stock market swings. This is why ASC 350 specifically uses the phrase “sustained decrease.”
Unfortunately, the guidance does not define or prescribe what is meant by “sustained.” Certain companies and industries may already be able to assert, with a high level of confidence, that their current share price declines will be “sustained,” but we do not have the requisite data set to determine whether this will be true for the overall market or less directly impacted companies and industries.
Regardless of whether or not it is determined that an immediate triggering event has occurred, it is important that public companies include appropriate disclosures as to the risks presented by COVID-19 and the current economic environment. To the extent that such conditions persist and become an impairment trigger, the SEC will expect that companies have provided an appropriate level of foreshadowing in their public filings.
Steve Hills is a managing director and head of the technical accounting consulting practice at Stout,a global advisory firm. Dave Lindstrom is a director in the valuation advisory group.