COVID-19 and goodwill impairment: When to test

Interim impairment — to test or not to test? That’s the question for U.S. companies feeling the financial pain of COVID-19. The last few months have been uniquely trying for most Americans as we adapt to a new normal. COVID-19-related shutdowns have resulted in operational and supply chain disruptions and unprecedented volatility in asset prices. One of the accounting impacts is the potential for goodwill impairment on a company’s financial statement.

FASB ASC 350-20 requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that could reduce the fair value below its carrying amount. If this amount of a reporting unit is zero or negative, goodwill of that reporting unit must be tested for impairment on an annual or interim basis – if an event occurs or circumstances exist that suggest that it is more likely than not that a goodwill impairment exists. Examples of some triggering events include the following:

• Macroeconomic conditions:
  • Deterioration in general economic conditions
  • Limitations on accessing capital
  • Fluctuations in foreign exchange rates
  • Unforeseen developments in equity and credit markets
• Industry and market considerations:
  • Deterioration in the environment in which an entity operates
  • Increased competitive environment
  • Decline in market-dependent multiples or metrics (consider in both absolute terms and relative to peers)
  • Change in the market for an entity’s products or services
  • Regulatory or political development
• Substantial increases:
  • Raw materials, labor, or other costs that have a negative effect on earnings and cash flows
• Changes in financial performance:
  • Negative or decline in cash flows
  • Declining actual or planned revenue or earnings compared with actual and projected results of relevant prior periods
• Other relevant entity-specific events:
  • Changes in management, key personnel, strategy, or customers
  • Expectation of bankruptcy or litigation
• Events affecting a reporting unit:
  • Changes in the composition or carrying amount of its net assets
  • A probable expectation of selling or disposing all, or a portion, of a reporting unit
  • Testing for recoverability of a significant asset group within a reporting unit
  • Recognition of a goodwill impairment loss in the financial statements of a subsidiary that’s part of a reporting unit
• If applicable, a sustained decrease in share price (consider in both absolute terms and relative to peers).

After assessing the totality of events or circumstances such as those described above, an entity may determine that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount. If this is the case, the first and second steps of the goodwill impairment test are unnecessary. However, if an entity determines it’s more likely than not that the fair value of a reporting unit is less than its carrying amount, then the entity must perform the first step of the two-step goodwill impairment test.

The impacts of the COVID-19 pandemic will affect individual industries differently.

As an example, AutoNation (NYSE:AN), the nation’s largest publicly traded retail auto dealership, performed an interim impairment test in the first quarter of 2020, citing:

“In light of the uncertainty surrounding the COVID-19 pandemic and the decrease in our market capitalization as of March 31, 2020, we concluded that a triggering event had occurred potentially indicating that the fair values of our reporting units were less than their carrying values as of March 31, 2020. Therefore, we performed quantitative goodwill impairment tests for each of our reporting units as of March 31, 2020.”

Results of the impairment test showed that AutoNation recorded a $318.3 million goodwill impairment charge for the quarter ended March 31, 2020. Below is an illustration of the performance of AutoNation and some of its peers over the first quarter of 2020. The Dow Jones industrial Average and the S&P 500 index show that stock prices for the auto dealer industry declined more than twice as much as did the general index.

The table above shows deterioration in market value for the auto dealer industry as an example. The impacts of the COVID-19 pandemic will affect individual industries differently. While some industries have experienced negative results from the safer-at-home environment, others, such as technology, video communications, and grocery, cleaning, internet security, and streaming services have benefited. The below shows the performance of some of these companies over the first quarter.

Clearly, COVID-19 has not impacted all companies equally. Make sure you continually monitor your company’s financial performance and consider the potential goodwill impairment triggers. If you believe that any of the items above may be applicable to your company, please reach out to the Plante Moran valuation team to discuss options for a quantitative impairment test. Our professionals have extensive experience working with companies on financial reporting, valuation, and other technical accounting issues. We stand ready to assist.