COVID 19: Is Trigger-Based Impairment Testing Required on Goodwill?

The COVID-19 pandemic has resulted in widespread uncertainty, disruption and market volatility. The pandemic has left us with many questions, including questions related to accounting for pandemic-related transactions that are far reaching and less common accounting issues, such as impairment testing on goodwill.

Have you considered whether the COVID-19 economic decline constituted a triggering event requiring an assessment of goodwill for impairment? If so, what is the time period that defines the “event” for such an assessment? Is such testing required if the market has subsequently recovered? Is testing required if the related business entity in question has broadly recovered?

Privately-held companies can currently be under any one of three different accounting models for goodwill impairment:

• The traditional model one-step approach (no amortization, required impairment test at least annually)
• The traditional model two-step approach
• The Private Company Council (PCC) alternative (amortization with trigger-based impairment test).

Regardless of the model used, trigger-based impairment testing is required “when an event occurs or circumstances change” that indicate a “more likely than not” possibility that the fair value is below carrying value. This trigger-based impairment testing can take place at any point during the calendar year.

Is an asset impairment testing triggering event related to COVID-19?

HERE’S WHAT YOU NEED TO KNOW

Evaluating Trigger-Based Goodwill Impairment Testing
In evaluating whether a trigger-based goodwill impairment test is needed, all three accounting models reference the following qualitative factors (as noted in FASB ASC 350-20-35-3C) to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount.

Examples of such events and circumstances include:

• 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)

In addition, the following qualitative factors should be considered in determining whether a trigger-based goodwill impairment test is needed (as noted in FASB ASC 350-20-35-3F, FASB ASC 350-20-35-3G, FASB ASC 350-20-35-68 and FASB ASC 350-20-35-69):

• An entity shall consider the extent to which each of the adverse events and circumstances identified could affect the comparison of a reporting unit’s fair value with its carrying amount. An entity should place more weight on the events and circumstances that most affect a reporting unit’s fair value or the carrying amount of its net assets. An entity also should consider positive and mitigating events and circumstances that may affect its determination of whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity has a recent fair value calculation for a reporting unit, it also should include as a factor in its consideration the difference between the fair value and the carrying amount in reaching its conclusion about whether to perform the first step of the goodwill impairment test.
• An entity shall evaluate, on the basis of the weight of evidence, the significance of all identified events and circumstances in the context of determining whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The existence of positive and mitigating events and circumstances is not intended to represent a rebuttable presumption that an entity should not perform the first step of the goodwill impairment test.

Timing Related to Triggering Events
In assessing the qualitative factors, it’s important to understand the timing related to events and circumstances. The COVID-19 triggering-event was a broad decline in economic conditions that unfolded over a period of time without a distinct beginning and end. Due to the nature of the pandemic, it seems there is some flexibility in the exact triggering date.

In March 2021, FASB issued ASU 2021-03, Intangibles - Goodwill and Other (Topic 350): Accounting Alternative for Evaluating Triggering Events, which established an accounting alternative for private companies and not-for-profit entities to evaluate goodwill triggering events at their reporting date, whether the reporting period is an interim or annual period, instead of monitoring for triggering events within the reporting period. However, this flexibility does not extend to other entities.

Entities not included within the scope of the ASU 2021-03 accounting alternative are not able to deem that the flexibility in exact triggering date extends to an entire annual reporting period (thus, it is not appropriate to conclude that impairment occurred in March but economic circumstances improved in the same year and goodwill recovered).

It’s also important to remember that assets like goodwill with fair value-based impairment tests cannot be recovered once impaired. In addition, impairment has not been limited to any certain industry or geographic location. From public company filings in Q2 of 2020, there were 309 impairments with over $100 billion of impairment expense recognized over numerous industries. The impact appears to be widespread.

The Next Step in Goodwill Impairment
Given the magnitude of the pandemic, it is anticipated that robust documentation of consideration of the qualitative factors, carrying value determinations and fair value estimates will be necessary, at a minimum, for companies with material goodwill balances, regardless of the goodwill accounting model used. Lack of diligence in this area could result in materially misstated financial statements in the current and future years.