Impact of the COVID-19 Pandemic on Goodwill -- Impairment Considerations (ASC 350)
March 05, 2021
By Varnit Kaushik
The COVID-19 pandemic has caused unprecedented turmoil in the global economy and financial markets, the breadth and duration of which remains unknown. The outbreak has contributed to market volatility, one of the many factors to be considered to see if triggering events for an impairment test has occurred. While some industries and companies may be more vulnerable than others, the effects of the pandemic and aggressive COVID-19 containment measures have affected social and economic behaviour, increasing the overall uncertainty. The discussed factors can result in a negative impact on the valuation of businesses and recoverability of associated goodwill.
The impacts of the COVID-19 pandemic could trigger the need for an interim goodwill impairment test. Examples of such events and circumstances include the following:
- 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. The economic impact of COVID-19 needs to be assessed in the current environment to determine if a triggering event has occurred due to change in macroeconomic conditions.
- 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, a change in the market for an entity’s products or services, or a regulatory or political development. While most industries have been impacted, certain industries like air travel and hospitality have been hit the hardest due to the COVID-19 pandemic.
- Cost factors, such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows. The impact of lockdowns and other measures taken by the various governments to curb the spread of COVID-19 should be assessed on the cost factors.
- 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. Company projections may be affected by disruptions in its supply chain, a shift of demand for its products and services, or the loss of customers due to COVID-19. Many companies are also facing liquidity crunch impacting cash resources.
- Other relevant entity-specific events, such as changes in management, key personnel, strategy, or customers; contemplation of bankruptcy; or litigation. As per an article by Bloomberg.com1 , more than 330 companies that declared bankruptcy in the U.S. this year blamed COVID-19 in part for their demise.
- Sustained decrease in share price (consider in both absolute terms and relative to peers).
Fair Value Considerations
In case of existence of impairment indicators, prior to testing goodwill for impairment, companies should first test other non-financial assets (e.g., accounts receivable, inventory) and indefinite-lived intangible assets, then long-lived assets (including definite-lived intangible assets), and finally, goodwill. For goodwill impairment test, Step 1 requires the company to determine the fair value of the reporting unit. Fair value of the reporting unit should be calculated in accordance with ASC 820 Fair Value Measurement. Each of the valuation approaches (i.e., market approach, income approach and cost approach) requires significant management judgment and valuation expertise. The key assumptions in these models often involve forward looking information such as forecasted future revenues, EBITDA, working capital requirements and capital expenditures. The projections provided by management need to incorporate the impact of the COVID-19 pandemic, depending on the sector, industry and line of business. The initial market reactions for COVID-19 may be based on a disproportionate weighting of downward scenarios relative to more refined insights into the long-term impact of the pandemic on the economy and a particular industry.
Additionally, the fair value models also involve valuation specific inputs such as a discount rate in the form of weighted average costs of capital (WACC). Due to the COVID-19 pandemic, uncertainty and risks have increased, leading to a likely increase in the market participant’s required rate of return. Management should assess if they have the appropriate expertise to evaluate these assumptions, or if they should engage a specialist to assist with the selection and application of these fair value models.
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- Impact of the COVID-19 Pandemic on Goodwill -- Impairment Considerations (ASC 350)