COVID-19 Pandemic to Trigger Midyear Goodwill Impairment
Airlines, cruise ships, restaurants, entertainment venues, hotels and many other types of businesses are expected to report goodwill impairments for the first quarter of 2020 because of the novel coronavirus (COVID-19). COVID-19 is a clear triggering event that would cause many companies to have to test for impairment on an interim basis — before the scheduled annual testing date.
What is goodwill impairment?
Goodwill is an intangible asset recorded on balance sheets following merger and acquisition (M&A) activity. Goodwill figures on public companies’ balance sheets skyrocketed by $386 billion in 2019 as a result of a record number of M&As, the highest level since the 2008 financial crisis, according to the latest Duff & Phelps study released December 3, 2019.
The book value of goodwill is determined by deducting the fair market value of tangible assets, identifiable intangible assets and liabilities obtained in the purchase, from the cost to buy a business. When goodwill declines in value, it’s considered “impaired.” Impairment charges can lower a company’s earnings.
What are the accounting rules for testing impairment?
Private companies may elect to amortize goodwill. (See “Simplified alternative for private companies,” below.) Otherwise, under U.S. Generally Accepted Accounting Principles (GAAP), public companies (and private companies that don’t elect to amortize goodwill) must test it at least annually for impairment. When impairment occurs, the company must write down the reported value of goodwill.
Regardless of whether they choose to amortize goodwill, all companies must test for impairment whenever a “triggering event” occurs that could lower the value of goodwill. Examples of triggering events include the loss of a key customer, unanticipated competition and negative cash flows from operations. Impairment may also occur if, after an acquisition has been completed, there’s a stock market or economic downturn — such as the market and economic downturn caused by COVID-19 — that causes the parent company or the acquired business to lose value.
Why are impairments likely to spike in 2020?
The COVID-19 crisis comes at a time when the rules that simplify the test for goodwill impairment take effect for large public companies. In 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2017-04, Intangibles — Goodwill and other (Topic 350): Simplifying the Test for Goodwill Impairment. It took effect January 1, 2020, for calendar year-end public companies. The standard eliminates the second step of the goodwill impairment test. The change was aimed at reducing costs for companies while retaining the informational value of the goodwill impairment test.
The simplified impairment testing model has been used by private companies to measure impairment since 2014. Under this model, an impairment loss is measured as the difference between the carrying amount of the reporting unit and its fair value, capped at the amount of goodwill within the reporting unit. Compared with the prior model, the ASU 2017-04 approach will likely increase the number and amount of goodwill impairment losses reported.
“I do think that there will be more impairments at the quarter because of the COVID-19 crisis causing companies to have more triggering events,” David Gonzales, senior accounting analyst at Moody’s Investors Service, said on March 30, 2020. “And more triggering events mean more testing and then it is likely that we will get some more impairment in Q1 and then kind of an expansion of that logic for the rest of the year that there will be more impairments throughout the year.”
Last year, the FASB issued Invitation to Comment (ITC) No. 2019-720, Identifiable Intangible Assets and Subsequent Accounting for Goodwill. It asked for feedback on whether to allow public companies the option to amortize goodwill and for possible ways to change the testing for goodwill impairment to make it more operational. Feedback was mixed. In the wake of potentially massive COVID-19-related impairment losses, it will be interesting to see how the FASB decides to proceed on this project.
There are many unknowns about the severity and duration of the COVID-19 pandemic. Contact your CPA for help navigating this potential crisis and its effects on your company’s financial statements.
SIDEBAR: Simplified Alternative for Private Companies
Accounting Standards Update No. 2014-02, Intangibles — Goodwill and Other (Topic 350): Accounting for Goodwill, made it easier for private companies merging with or buying other companies to account for the goodwill recorded with the deals. It gave private companies the option to amortize acquired goodwill over a useful life of up to 10 years. The test private businesses have to perform to determine whether the goodwill has lost value was also simplified in 2014.
Instead of automatically testing for impairment every year, private companies that elect to amortize goodwill are required to test only when there’s a triggering event, meaning the company has evidence that the fair value of the acquired business is less than the carrying amount on the balance sheet.
The novel coronavirus (COVID-19) pandemic is a clear triggering event, especially for smaller private businesses that lack the resources to weather the current downturn. In today’s uncertain marketplace, measuring impairment can be challenging. Contact your CPA to help evaluate how the downturn is expected to affect your operations over the long run.