The COVID-19 outbreak has disrupted business activity in the U.S. and around the world. As people and governments continue to deal with the vast array of new challenges created by the virus, companies must proactively address the disruption’s impact upon the ongoing value of company assets.
Because of the uncertain timeline and sporadic severity of the pandemic, the economic impacts on impairment are difficult to measure. As companies assemble goodwill impairment models and prospective financial statements, there are a significant number of complex accounting and valuation issues to consider.
Goodwill Impairment Considerations
FASB provides guidance for goodwill impairment testing under ASC 350 – Goodwill and Other. When not being amortized, goodwill must be tested annually or when a “triggering event” occurs. Triggering events include changes in industry and market conditions, increasing costs and negative changes in cash flows or revenue, among others.
ASC 350 lists seven triggering events in all, but because the onset of the virus has no bright line “event” date, the potential impact is difficult to determine. The “significant or adverse change in legal factors in the business climate” will ultimately vary by geographic location, industry, and other market segments.
Sequencing Impairment Evaluation
When a triggering event determines that goodwill must be tested and valuation is required, companies must then evaluate impairment in the proper sequence, so that goodwill is assessed after other assets have been assessed. This ensures that no assets are inadvertently shielded or improperly valued.
Testing for Impairment
ASC 350 outlines two ways to quantitatively test for goodwill impairment.
- The first, outlined in ASC 350, is commonly referred to as public company rules and involves a two-step goodwill impairment test.
- The second is a one-step impairment test, outlined in ASC 350 – ASU 2014-02. It is commonly referred to as private company rules. In this case, an election is made by management to amortize goodwill.
Determining Fair Value
Although ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, determining fair value is going to be an iterative process.
Critical drivers of valuation models are likely to remain in flux and the degree of uncertainty for such drivers can vary greatly by geographic location and industry. For example, determining appropriate discount rates and cash flow forecasts will be significantly impacted by disruptions to individual supply chains as well as shifting demand for specific products or services.
- Obsolete Projections. Prior projections from management, both short and long term, should be reviewed and most likely revised to reflect the impact of COVID-19 on the business as a whole.
- Documentation. New projections and various forecast scenarios will require carefully documented and quantifiable support, and may very well be iterative.
- Fair Value of the Company Itself. If the impacts of COVID-19 have contributed to a decline in the fair value of the company itself, goodwill impairment can be further impacted.
Using a Valuation Specialist
Now more than ever, organizations must remain agile and recognize the importance of accurate fair value reporting in order to plan appropriately for the future.
Goodwill impairment testing and valuation will require scenario planning, meticulous documentation, and unique accounting and valuation expertise.
The SEC urges companies to proactively address financial reporting matters earlier than usual and provides the following guidance about seeking expert support:
“to the extent a company or its auditors will need to consult with experts to determine how the evolving COVID-19 situation may impact its assets, including impairment of goodwill or other assets, it should consider engaging with those experts promptly so that its reporting remains as timely as possible, as well as complete and accurate.”
Benefits of Expert Guidance
It is highly advisable to have the impairment analysis reviewed by an audit firm with a team of valuation specialists who have depth and breadth of experience performing such a review. In partnering with an expert, you ensure the following stability for your company:
- Preparedness. A valuation team that is well versed in goodwill impairment analyses will ensure that you take a proactive approach to following the SEC guidance regarding timely reporting.
- Quantification of Risk. With updated cash flow projections, management can confidently communicate and defend goodwill valuation as well as prospective financial information.
- Documentation. Proper valuation involves compiling prospective financial information and developing and applying impairment models driven by various assumptions, facts and circumstances. A valuation team will proactively ensure that all assumptions (e.g. WACC, selected multiples, selected control premium, change in net working capital assumptions, etc.) and conclusions are properly documented in real time.
The impact of COVID-19 on the global economy continues to evolve. Companies must remain vigilant in evaluating accounting and valuation issues as circumstances change.
At Windham Brannon, our Business Valuation team is committed to providing reliable and well-documented research and analysis built on best-practice methodologies. This strategy ensures we provide our clients with the most comprehensive and in-depth company valuations to support smarter business decisions.
For more information about how Windham Brannon’s Business Valuation Practice can help you navigate goodwill impairment in calm or turbulent times, contact your Windham Brannon advisor or Valuation Principal Tom Brooks.