Goodwill Impairment With Uncertainty of COVID-19
by David Turney, CFA | 02 Aug 2020
The World Health Organization (WHO) announced that COVID-19 (also known as coronavirus) officially became a pandemic on March 11, 2020. This outbreak has contributed to market volatility causing substantial declines in market capitalization for public companies and potentially negatively impacting companies’ financial performance through supply chain and production disruptions, workforce restrictions, travel restrictions, reduced consumer spending and sentiment, among other factors. Depending on a company’s unique set of facts and circumstances, these market events will more than likely trigger the need to conduct interim impairment testing.
Assessing Potential Impairment
Goodwill impairment testing is conducted annually under the guidance detailed in ASC 350, Intangibles – Goodwill & Other. However, more frequent testing is required when events occur that indicate it is more likely than not that impairment exists. The financial impact from the pandemic could be assessed as a “triggering” event. While short-term disruptions may not indicate an impairment, the effects of a prolonged suspension of activities may cause asset impairments. The table below, while not exhaustive, contains possible triggering events for impairment of goodwill in the current environment.
- Deterioration in general economic conditions (limitations on accessing capital, other developments in equity and credit markets, etc.)
- Deterioration in the environment in which the reporting unit operates (decline in market-dependent multiples or metrics, a change in the market for the reporting unit’s products or services, etc.)
- Increases in raw material costs, labor, or other costs that can negatively affect earnings and cash flows
- Negative or declining cash flows or a decline in actual or planned revenue or earnings compared with actual or projected results of relevant prior periods
- Changes in entity-specific events, including management, key personnel, strategy or customers, contemplation of bankruptcy, litigation, etc.
- Changes in the carrying amount of assets at the reporting unit including the expectation of selling or disposing certain assets
It should be noted that these factors apply to both public and private companies, even those private companies that have previously elected to amortize goodwill under ASU 2017-04. While the election to amortize goodwill over time mathematically decreases the likelihood of an impairment, audit teams may request a “Step 1” impairment request during times of economic downturns; contraction of valuation multiples combined with deteriorating company performance can lead to a drop in the fair value of an asset.
Long-lived assets to be held and used (including finite-lived intangible assets), indefinite-lived intangible assets, and goodwill may all need to be tested for impairment at the same time.
The order in which a company tests each asset or asset group within a reporting unit for impairment is important because the goodwill impairment model requires a comparison of the fair value of a reporting unit to its carrying amount to signal impairment. The order in which assets generally need to be tested for impairment is (1) indefinite-lived intangible assets, (2) long-lived assets to be held and used, and (3) goodwill.
The first step of a goodwill impairment test involves estimating the fair value of the reporting unit primarily via the income approach and market approach. The fair value of the reporting unit is then compared to its carrying value to determine if an impairment has occurred.
We note that the current environment introduces complexity regarding financial projections prepared by company management. Management will need to carefully evaluate and update key inputs and assumptions. If management reduces revenue growth and margin assumptions, there will likely be a significant affect on the determination of the fair value of a reporting unit given recent market conditions. Examples of key inputs that are common in valuation techniques include:
- Gross margin
- Earnings before interest, taxes, depreciation, and amortization
- Selling, general, and administrative expense
- Capital expenditures
Further, other valuation assumptions that may need adjustment in the current environment include assessing appropriate discount rates, analyzing and applying multiples from publicly traded comparable companies, and considering applicability of transaction multiples that occurred prior to the current environment. While some industries and companies may be more vulnerable than others, both the effects of the pandemic and COVID-19 containment measures may affect social and economic behavior, increasing overall uncertainty.
Intrinsic can help companies navigate the nuances of impairment triggers and in the event an impairment analysis is required, we can assist with valuations of goodwill, indefinite-lived intangibles, and long-lived assets for impairment testing purposes pursuant to ASC 350, Intangibles – Goodwill & Other, ASC 360 -10, Impairment or Disposal of Long-lived Assets.
For a discussion on the above and how COVID-19 may impact your impairment testing, please reach out to myself or any of our valuation team members.
// ABOUT THE AUTHOR
David serves as a Managing Director and head of Intrinsic’s Financial Reporting Valuation practice. He leads the firm’s activities regarding financial reporting technical issues and resolution, as well as interactions with professional and industry associations. In addition, David focuses on business development and relationship management across the firm’s private equity, venture capital, and operating company clients. He has over 13 years of experience working with senior management of both public and private companies, including many Fortune 500 clients. David has executed and managed over 1,000 valuation engagements for a variety of purposes, including financial reporting, financial opinions, corporate tax, gift and estate, litigation and dispute resolution, reorganizations, and divestitures. His experience includes assisting multinational corporations with their valuation requirements due to acquisitions and divestitures (with several deal sizes in excess of $2.5 billion) across various industries, including industrial products, consumer products, technology, materials, healthcare, communication, and sports and entertainment. Further, he has extensive experience with professional sports franchise valuations, including franchises in the NBA, NHL, MLB, NFL, and the English Premier League.
Prior to joining Intrinsic, David was a member of the Duff & Phelps’ Valuation Advisory Services practice and a Manager at Willamette Management Associates. While at Duff & Phelps and Willamette Management Associates, he focused on providing valuation services, expertise, and advice to corporations, private equity firms, law firms, and other clients. David began his career in financial services at Ibbotson Associates, serving as a member of the asset allocation consulting team before transitioning into valuation services.